"There shall be weeping and gnashing of teeth."
And sure enough ... there is.
The angst, if not black depression, amongst cryptocurrency investors is now palpable. Bitcoin is range-bound and our dear STEEM can't seem to break a buck. Main stream media is filled will crypto-related tales of woe and my good buddy @cryptogee recently published an article entitled, Still Smiling After My Biggest Crypto Loss: What's Yours?
Most distressingly, Steemit is awash with posts invoking the Power of Positivity.
I get it. It feels good to vent. Moreover, misery loves company and when things are not going well, a bit of empathy is comforting ..."We're all in it together." But such emotional solace is also very dangerous. Emotion binds us ... but so too does it blind us. And one person being emotional gives permission for others to do the same. It spreads. But the fact that there are others feeling your pain does nothing to alleviate the problem that's causing it. As the limbic system ramps up, the pre-frontal cortex turns off. In finance, feelings are a problem. To navigate financial markets ... you must suppress your emotions and think ... often, quite viciously.
I used to run two hedge funds: The first focused on asset-backed securities (securitization); the second, currency-trading. Let me promise you, the market doesn't care whether you're feeling positive or negative or whether you're psyched or suicidal. Nor does it care about New Age aphorisms or the metaphysical bromides being espoused by a legion of self-appointed "thought leaders" and "life coaches:" "Are You Living in Abundance or Scarcity?" ... "According to the Law of Attraction ..."
Do you believe the "Law of Attraction" is being employed on the trading floor of Goldman Sachs? Cryptocurrencies are growing up and you're now competing against a host of hedge funds and investment banks. If you can't set aside your emotions, whether negative or positive, the financial markets are not the place for you. They will destroy you financially and do a number on your psyche in the process.
The intent of this Series of Articles is to address, rationally (and brutally where necessary), what is going on in the world of cryptocurrencies in general, and specifically, how to fix (quickly, before it's too late) the systemic problems that plague Steemit.
The first articles in this Series were:
- Jerry Banfield, Down-Voting & Freedom of Speech
- "Down-Voting as Censorship" - A Series About Fixing Steemit - Part 2 Be sure to read the comments section, especially the comment thread of @bossel ... it contains implementation information for my proposal and such proposal will become important (in later articles) beyond just its Freedom of Speech implications. As a favor, would someone with a bit of upvote power upvote that comment thread so it rises to the top and is therefore easier to find. Thanks.
Cryptogee Comments & Replies
Five months ago, @cryptogee and I engaged in a series of comments and replies in response to his original article, Killing Bitcoin With A Million Sob Stories. I've copied-pasted them below (lightly edited). Give them a read and I'll update and expand upon such comments at the end (respecting Derivatives ... due to length, the rest will be addressed in subsequent articles).
The key to the future of cryptocurrencies is derivatives markets.
The extreme volatility of cryptocurrencies will be tamed only when sophisticated investors can begin using call and put options to neutralize, or limit, their risk. Indeed, the most precious thing any cryptocurrency could acquire at present would be the ability for its investors to enter into a costless-collar: The simultaneous buying of an At-The-Money put option (preventing downside loss) while simultaneously selling an At-The-Money call option (forfeiting upside gain) ... in effect, temporarily freezing the price at no cost (other than transactions fees). This is what large companies and retailers require in order to utilize cryptocurrencies in anything other than a novelty fashion ("Look, we're hip .... we accept Bitcoin").
At present, fear means "selling" (or stress-vomiting) and so it's a roller-coaster of hyper-optimism followed by hyper-pessimism. No one gets to be "emotionally neutral." This, of course, is easier said that done. Putting aside government regulators and exchanges, in order to have a functioning options market (high liquidity, and thus tight bid-ask spreads) you need a Market Maker ... someone who will buy or sell the security irrespective of the price.
In order to do that, though, a Market Maker needs other Market Makers against whom he can hedge his risks. Market Makers don't care about the price of a security per se ... they only care that there is a balance between buyers and sellers, because they are both. Ironically, it will probably be Goldman Sachs et al (hold your nose) who end up providing this service. Who else has the capital, trading experience and risk tolerance to fulfill the Market Maker(s) role on a grand scale?
One of the problems with cryptocurrencies at present is their inability to focus capital for a purpose. You just have a million cats running around doing their own thing. Years ago, some upstart individuals got the idea that they could cut out the middle-man (banks) and began making micro-loans to borrowers through exchanges on the Internet. Peer-to-peer lending was born.
There were countless articles written about the upending of the traditional banking system. Today, most of the funding for peer-to-peer lending originates from banks. The banks joined the party. But, because they were larger, they could afford to charge a lower interest rate, for the same degree of risk, than could individual lenders.
Concentrated capital is a weapon.
Look at Steemit. Look at what whales and dolphins can do that minnows cannot. And, crucially, it's not just a matter of scale. If you, Cryptogee, used 5% of your assets to sponsor a contest, people would coming running ... and such participation has numerous knock-on effects that are highly profitable. If I used 100% of my assets to sponsor a contest, people would fall out of their chairs laughing. You have concentrated capital, I don't.
I would be less worried about banks crashing cryptocurrencies than simply co-opting them. They will simply provide the services which make them pragmatic to use in the real world. He who concentrates the capital, controls the system, including Market Making ... and therefore, the future of cryptocurrencies.
What an excellent analysis as usual @quillfire.
In particular I find it interesting about the derivatives market, even though I have heard that term before, I had absolutely no idea what it meant. I think you also hit the nail on the head, at the end of the day banks want profit, and crypto at some point tends to go through fiat, I mean we value our crypto in fiat after all! Very true also about concentrated capital, I guess that is what will act as a 'cat herder' and yeah Goldman probably will jump in on it. Do you see this as an inevitable progression; or is there some as-yet-unseen factor going to come into play?
I used to run a family of hedge funds, and one was based upon currency trading. As a result, I got to know a lot about currencies. Currency markets are made up of numerous participants with very different motivations. Of course, you have traders who invest in the currency itself as the underlying security.
But, you also have multi-national corporations who only use foreign currencies as a means of transferring wealth from one place to another. Take, Nike for example. It sells shoes, shirts and shorts in hundreds of different countries. In the US, it sells them for US Dollars. In the UK, for pounds. As a US company, it needs to convert those pounds to Dollars as it repatriates its profits. Nike doesn't care about trying to currency speculate (bet that the Pound will appreciate or depreciate against the US Dollar over the next 30 days). They want to lock-in their planned 15% profit. Period.
And that requires freezing the exchange rate using derivatives (options and futures). Now multiply Nike by tens of thousands of multi-national corporations. Add in a billion international travelers paying for hotels, restaurants and taxis in foreign countries with currencies from their own. The point is that to make fiat currency markets work, there has to be centralized Market Makers so as to accommodate the many different currency exchange strategies being employed by the host of different market participants.
That requires enormous amounts of concentrated liquid capital so as to be able to handle the unpredictable, and fluctuating, demands for currency pair exchanges (USD/GBP in our example). Now add in all the other currency pairs to USD. Now add in all the other currency pairs with GBP. Now add in YEN/EUR and EUR/CDN ... The quantity of concentrated capital required is staggering.
Cryptocurrencies don't have this yet. For cryptocurrencies to become status quo mediums of exchange for the Nike's of the world, there must be a functioning derivatives market. To have a functioning derivatives market, you first need Market Makers so as to provide the ability to hedge currency fluctuations. In order to be a Market Maker, you need to be able to concentrate enormous amounts of capital. At present, only the "Big Banks" have this ability (and no one else is even close). And even if someone else was able to concentrate such capital, wouldn't they be a Big Bank in all but name?
Steemit is an interesting deviation for the norm in this respect (which is why I'm here despite there being no derivatives market for the currency). It has an internal economy which is partially isolated from the outside world. People keep publishing posts irrespective of the value of STEEM in relation to other currencies. And, it has a quasi-put option built-in at $1.00 (the Witnesses have the ability to decrease the money supply at a buck).
But Steemit also has an Achilles Heel ... and a huge one at that. Steemit's Central Premise (it's raison d'etre) is that "Content Shall be Compensated Commensurate with its Quality." This is the fundamental assumption upon which all else depends. And it is failing miserably.
As a Prime example, consider your Great STEEM Giveaway Contest. (For those who don't know, Cryptogee sponsored a contest that awarded huge upvotes for the best comments to one of my posts ... a poem + article discussion). The post was excellent and there was massive participation. Both the quantity and quality of comments would rival those of any post in the entire history of Steemit. This should have been a $1,000+ post. It garnered $1.56. https://steemit.com/poetry/@quillfire/for-the-people-poem-the-law-for-it-whom
This was a comment in the Daily Dose (PoetsUnited) that appeared yesterday (written by poets about poets):
Quillfire is the most skillful poet in our little group [approx. 250 at the time] and he could be the number one poem every day. This poem is a masterclass in poetry and he even invented his own form of sonnet, the Savagerean Sonnet. If you like poetry this is one not to be missed. And I mean this post and this poet! https://steemit.com/poetry/@quillfire/raving-refrain-poem-a-savagerean-sonnet-explanation-100-days-of-poetry-contest-day-5
$4.94 ... one of my largest post-payouts ever ... and most of that came from the Contest's sponsor.
Content Shall be Compensated Commensurate with its Quality.
Either the whales' sonar systems suck ... or they're turned off because they have a voting strategy which doesn't entail discovering, or even caring about, quality content. I could point to a dozen similar sites across Steemit. If in 5 weeks I can find them, despite barely looking ...
Any stable system can be measured on its ability to take a punch. This is referred to as the system's "robustness." Can it get back up off the mat and continue to function normally? It takes, roughly, nine torpedoes to sink a modern US aircraft carrier. Modern US aircraft carriers are robust.
In normal securities markets, Market Makers are regulated by government agencies to ensure that they don't cheat. This is important because it is very easy to manipulate the price of a security in the short-term. Such regulation ensures the integrity of the system itself.
On Steemit, the whales have enormous concentrations of capital. But, because there is no regulation, they are Market Makers that can do anything they like, including self-serving behavior that invalidates the Central Premise ... thereby jeopardizing the integrity of the entire system. They could, of course, take action that would force adherence to the Central Premise, but, as a group, they won't, as it would disrupt their short-term interests. Human beings are myopic. And, like an arms-race, it would be suicide for the Good Whales to unilaterally disarm (implement good practices) ... as this would only give the Bad Whales more power.
To compensate for these distortions, all other market participants are either forced to game-the-system (in whatever way they can) or maintain their morals by remaining penniless. This is not sustainable.
As the Central Premise of Steemit is actually quite brilliant, I suspect the way this ends is with the creation of a new cryptocurrency that replicates the theory of Steemit ... while safeguarding against its realities. A cryptocurrency where the Central Premise is sacrosanct: "Content Shall be Compensated Commensurate with its Quality." There would be a mass migration within a matter of weeks (talk about needing Velocity) ... and the stragglers will most likely be the Steemit whales who, too late, would then attempt to implement the reforms they always knew were required.
People will, of course, always find ways to cheat, but scale matters. 95% isn't perfect, but it still gets you into Harvard. As measured against its ability to achieve its Central Premise, Steemit, at present, is not even a minimally-functioning system, let alone a robust one. A spit-ball could sink it. Personally, 90% of my research into cryptocurrencies involves searching for such an alternative cryptocurrency. Given that Steemit's code is open source, and the relative facility in launching a new cryptocurrency (and hence the reason why there are more than 1,000 of them), I'm astonished it hasn't already happened.
Whales, if you're reading this ... this is straight-line logic. Do what you have to do, or someone else will. If you're interested, I have some ideas on how to fix what's broken.
As an aside: I would rank the average of "cryptocurrency analysts" found here on Stemmit as abysmal. I am aghast at the number of amateurs pretending to be professionals. Here's a clue: If a particular cryptocurrency doesn't have a Central Premise, a reason to be, then it won't survive. Can you imagine Christianity surviving without Christ ... Nike without shoes ... Cryptogee without hypothetics!
Technical analysis, a favorite here on Steemit, was developed over a century for financial instruments that, directly or indirectly, had underlying economic value. Stocks create dividends. Bonds pay interest. Cryptocurrencies, in general, (STEEM is an exception) do neither. It's like measuring mass with a thermometer. Technical analytic tools work (to whatever degree that they do) because they identify cyclical trading patterns ... but the impetus for such cyclical trading patterns are cyclical financial performance and/or macro-economic trends that occur in the real world. The vast majority of cryptocurrencies have no underlying economic function and therefore fundamental analysis is impossible (because there are no fundamentals).
And hence, the popularity of TA for cryptos ... there's nothing else to use as you pretend to be analyzing something. A great deal of TA is the result of self-fulfilling prophecy. That is, because a whole bunch of traders are all using the same indicator, they cause the movements that the indicator purportedly predicted. TA indicators go in and out of fashion, however, so whatever works today may not work tomorrow. Moreover, the hedge funds know which TA indicators the amateurs use and can easily manipulate them for profit. I don't dismiss TA in it's entirety, but it is widely misused.
In my estimation, there is room for perhaps 2-3 Super-Cryptos: Currencies widely used as general mediums of exchange, just as fiat currencies are used today. Even then, a couple of those will probably have to be specialized. For example, by being super-secretive (thereby facilitating criminal exchange, money laundering, fraudulent transfer and tax evasion) or by being the internal fuel for smart contracts.
All others will have to have an underlying economic purpose ... like Steemit. Such currencies will be more akin to private currencies or company scrip. All the others will end up in the dustbin. Evolution rewards the useful. It is unkind to the useless.
There is absolutely nothing about being a decentralized blockchain-based currency that overturns the basic laws of finance and economics. The entire history of both has simply been exchanging one set of problems in preference for another. Cryptocurrencies are no different. Perhaps a couple of dozen will find useful niches in which to co-exist with a litany of other financial instruments. The rest will evaporate, along with the delusions of legions of dreamers.
Wow! Where do I begin? First of all, thank you for explaining how a derivatives market works and the need for one, that was perfectly explained and I never even thought of what a company goes through when recouping profits in different currencies.
It also highlights how the cryptocurrency market has a long, long way to go, before it can even think about replacing the current fiat system. What I'd like to ask you though is; does the Shapeshift app, which I'm sure a lot of vendors use, mitigate the need for a derivatives market? In case you haven't heard of it, the app instantly converts your crypto into your currency of choosing. Instinctively I'm thinking it does, simply because the vendor now doesn't have to worry about the price of Bitcoin, as he can shape shift to Yen, Euros, or Dollars.
However as I write this, I think I'm answering my own question, because of course the vendor is still vulnerable to minute-by-minute price fluctuations, whilst the orders are waiting to be confirmed. Anyway, I'd like to hear your thoughts on that.
OK, onto to Steem/Steemit, I think you hit the nail on the head, that it ultimately is failing on its promise, though I don't believe the failure is total. I have seen people come onto the site and go from zero to high per-post earnings, by posting quality content. This may not happen as often as it should, however it is happening.
I would so love to hear your ideas on fixing it, as I have wracked my brains, and listened to quite a few suggestions. There were talk of caps, which in my mind, do nothing whatsoever, the problem lies with the fact that somebody could be posting one or two liners, but if they have a whale friend, or they themselves are whales, then they can vote for that content. Whether the rewards are capped or not won't make a difference to them, somebody could make 10 posts a day about absolute nonsense, and vote for every one. Sure you're minimizing the Steem Dollar amount of their rewards, however their overall percentage take on the reward pool, will remain the same.
Then we come to the solution of minimizing weighted voting, or getting rid of it all together. However this is more likely to exacerbate the problem. As now you don't even have to be a whale to abuse the system, you can simply start a million bot accounts and start mass voting on rubbish. When I first joined Steemit, I thought that the algo was somehow going to work out how reputable each person was, and assign voting weight that way. However this would prove very difficult to implement, as any of the indicators that code could use to assess reputation, can easily be gamed.
I have read your reply a few times now, and I want to think about it some more, and like I said would love to hear your ideas on how to fix Steem's Achilles heel. (perhaps a post or posts?) As ever, thanks for the food for thought!
Ah also I just remembered a question I wanted to ask regarding the hyper-pessimism/optimism of the markets and the role of market makers thereof. Are, or even, can tether coins somehow play the role of the derivatives; by adding some kind of stability? Thanks
Derivatives, whether Futures (called "forwards" when created off-exchange by banks) or Options (calls and puts), are simply contractual financial instruments that "derive" their value from some other underlying financial instrument (a stock, bond, currency, etc.). [There are other kinds of derivatives as well but I'm keeping it simple.]
Such derivatives involve obtaining the right to buy or sell the underlying security at a pre-determined price sometime in the future. Derivatives are used to either enhance speculation (profit potential) or to hedge against unfavorable price movements (principal protection). Important to note (with respect to cryptocurrencies) is that the latter motivation is frequently employed by non-financial actors such as farmers, miners and multi-national corporations engaged in cross-border trade.
In December of 2017, futures for Bitcoin were introduced on both the Chicago Board of Exchange (CBOE) and the Chicago Mercantile Exchange (CME). The New York Stock Exchange is said to be interested in getting in on the action as well. Ledgerx now provides Bitcoin call and put options.
All this is excellent news for cryptocurrencies.
That said, as I explained to Cryptogee, creating a "functioning derivatives market" requires more than just exchanges and regulatory approval. It also requires a number of deep-pocketed Market Makers. Creating a functioning derivatives market will be a process of fits and starts. Liquidity that is sufficient today may not be sufficient tomorrow. It will be tumultuous.
But here's the important part: As a functioning derivatives market develops around Bitcoin, it will dramatically change Bitcoin's price action. This is absolutely unavoidable.
Hence, as Bitcoin "grows up," the way it will be traded in the future will be very different from how it was traded in the past. Although well beyond the scope of this article (it's complicated), derivatives tend to stabilize the price of the underlying security (in this case the cash price of Bitcoin).
"Range-bound" could simply be "price-stablized," couldn't it? It only looks like "strange behavior" relative to the way Bitcoin used to behave prior to derivatives being introduced.
Here's a brief Forbes article from a couple of years ago respecting Bitcoin derivatives:
For those who really want to dig into the subject (and you should because this is REALLY important to understand):
Bitcoin becoming temporarily price-pinned ought not be in the least bit surprising. Indeed, it was predictable.
A Cautionary Note: A "functioning derivatives market" acts very differently than a "non-functioning derivatives market." At the outset, the presence of derivatives (which internalize a great deal of "leverage" or "gearing" for you Brits) can make market manipulation easier, not harder. This will change as the market matures. This phenomenon is not unique to cryptocurrencies. As I explained in my Cryptogee comments, however, derivatives are absolutely necessary if cryptocurrencies are ever to become practical for day-to-day commerce.
Once Bitcoin derivatives become established, there will be tremendous pressure to add others (Wall Street is greedy). Keep in mind, however, that the vast majority of cryptocurrencies won't qualify for their own derivatives. They'll be too small with insufficient trading volumes to attract the necessary bevy of Market Makers. And hence, cryptocurrencies will quickly be divided into the "haves" and "have-nots."
When this occurs, the "have-nots" will be largely decimated. Hedgeable vs. non-hedgeable ... who's going to choose the latter?
Fortunes will be lost.
An analogous situation can be observed in the stock market. There are large publicly traded companies (with derivatives, and hence ... that are hedgeable) and small penny stocks (without derivatives, and hence ... that are not hedgeable). Penny stocks are extremely volatile, subject to market manipulation and extremely speculative in nature. Pump and dumps are common. Investors react to rumors like nitro-glycerin reacts to flame. Most investors, especially institutional ones, wouldn't touch them with a ten-foot pole.
In the not-distant future, launching a new cryptocurrency will become much more difficult, not just because of increased regulatory scrutiny, but because of a lack of hedgeability. "Getting off the ground" will become as difficult as it is for all other start-up ventures.
A lot of cryptocurrency advocates are ideologically motivated. "Sticking it the Man" is a worldview objective. As should be obvious by now, this is a worldview doomed to fail. Cryptocurrencies are going to fall into line and behave. They are going to say, "Yes sir, No sir" to government regulators and institutional investors just like everyone else. Anarchists dream of "No Rules, No Rulers" will join a host of other Utopian dream-schemes in the dustbin of history. Governments possess the Power To Compel and the Concentrated Capital of investment banks is a weapon of insurmountable potency. Believe to the contrary at your peril.
STEEM is currently unable to maintain Top 30 status amongst cryptocurrencies. This is not good.
Being in the Initial Alt-Coin Derivatives Group may well mean the difference between life and death. In the next couple of months, a number of Steemit competitors will be coming on-line. And, there is already a steady stream of Steemians signing up ... myself included. And it's not just Minnows ... there's plenty of Dolphins as well. Active recruitment is well underway.
The reason is simple: Steemit suffers from a number systemic flaws, of which everyone is aware, but the people who could fix them ... Whales and Witnesses ... won't. Indeed, a number are involved with their perpetration.
The "cryptocurrency-backed social media platform" that gets derivatives first will have a tremendous advantage over its competitors. Very probably an insurmountable one. Given its existing user base, Steemit ought to be able to win this race handily, but such success is not at all certain. It what can only be considered an act of self-immolation, Steemit Whales and Witnesses fiddle while Rome burns.
Keep in mind, it's not Steemians who will decide whether Steemit gets derivatives ... it will be Market Makers. No Market Maker with an IQ over 2 would touch Steemit as presently configured. It is a dysfunctional cheater's paradise, a fact articulated by countless Steemians and outside observers.
Correlation & Decoupling
Undoubtedly, everyone's noticed that the prices of cryptocurrencies (excepting stablecoins which derive their value from real world assets) are highly correlated. When the price of Bitcoin goes up 10%, the price of STEEM goes up 20%. And similarly, when the price of Bitcoin goes down 10%, STEEM's price drops by 20%. This will continue until functioning derivative markets are created. While it is likely that there will always be some degree of correlation, derivatives will allow a substantial degree of decoupling to occur.
Given STEEM's underlying economy, its ability to rapidly decouple from Bitcoin is greater than most other cryptocurrencies ... BUT ONLY if Steemit performs as it was designed ... which, at present, it is not.
By the end of this Series, I will propose ways to resolve all the systemic problems currently effecting Steemit. Stayed tuned for my next article, "Central Premise," where I will begin to address specific problems, and their solutions, at length.
You guys know the drill. Be verbose ... but articulate.
And remember ...
Go Love A Starving Poet!
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