Blog | Cryptocurrency

Crypto Trading Corner: The Cost of Uncertainty

In the world of investing and trading, how can “bad” certainty be a good thing?
 

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In the world of investing and trading, how can “bad” certainty be a good thing?

I’m going to show you with an Ethereum example. Make sure to read to the end and I will show you a way to apply this blog’s information in your own investing.

This last March probably displayed the greatest example of how markets treat uncertainty. One thing that is very important to learn, sometimes bad certainty is worth more than uncertainty.

Remember markets are priced by future value, so if you know a certain asset is going to be $100 in 1 year but today it is worth $10, it’s almost guaranteed that you would purchase the asset like crazy. But what if there is a time or price constraint? Let’s actually map this out in an example, let’s assume we guess the price of ETH to hit $10k by end of 2022 if it successfully deploys both the merge and sharding (don’t worry about knowing what these mean for this example).

If ETH is already $9.9k today in April, it would be very hard to justify buying it since there’s only 1% upside and we still have 3 quarters to go.

If ETH is $4k today though, that would mean more than 100% gain within 9 months! Of course, any fund would be happy with that return and would allocate accordingly based on other investment options.

But let's say it’s 12/28, and it’s $9.9k, that extra 1% wouldn’t be too bad in that case, funds would still buy up for that 1% in 3 days.

Notice above, we have two major points of information that determine valuation. 1. The time we think the asset is appropriately valued based on a milestone and 2. The value at that milestone

Obviously, we are making a huge assumption on the $10k valuation due to the upgrades, but let’s just roll with it because it also depends on other macro factors.

Now let’s throw some uncertainty in the mix.

Say that last week the next ETH phase, merging, failed to happen on testnet. Suddenly, that pushes out the ETH Consensus Layer migration. Maybe it pushes it to March 2023, maybe June 2023, maybe even farther out instead of 2022.

What does that mean? It means that now the $4k price point we mentioned before actually isn’t as compelling. With that uncertainty, the valuation of ETH could even drop lower!

Now look at what happened in markets, ETH merge happened successfully on Testnet, that means that it’s highly likely that the migration could happen in June, our $10k price target is back on track, and ETH should now be worth $4k within this time period. By the way, ETH is up 30% in the last 2 weeks, that is not a coincidence. As long as we have some certainty on some timeframes, that is worth more than not knowing the timeframe at all.

Make sense so far? Well, let’s now apply this to other news that is happening. There are a few major key decisions that people were waiting for this month. One was the situation in Ukraine, would that get resolved any time soon? Would it continue to cause issues with oil and other food shortages?

The other was the Federal Reserve’s decision on interest rates. Will it be 0.25%? 0.5% or more? Will it be 6 remaining raises or more than 9?

Without any certainty on these numbers, the market prices things much farther out, and as a result, people are unwilling to allocate capital or make price projections. When we found out this month that Russia was de-escalating, and that the Federal Reserve would raise interest rates 0.25% and only have 6 more increases, that enabled markets to start investing in the future, not in the present. Markets ran back up and are nearly back to all-time highs, despite other issues remaining such as a slowing economy and rampant inflation.

Use this to your advantage, if you know there is uncertainty priced into an asset, that’s usually a great time to buy. Sometimes the worst-case scenario is priced into the asset or markets, with interest rates being a prime example, and your downside is actually lower as a result. It’s a unique situation where downside is slim and upside is high, a great investment combo.

Now think about another factor, we’re all worried about uncertainty with crypto regulation. So, think about what is being priced in right now and how that might actually be unfairly priced. With upcoming regulations to crypto, we can choose to evaluate the price to be due to uncertainty and expect things to go up once there is certainty around them.

In summary: We’re all aware that there are still issues with the macro economic environment and uncertainty in crypto regulations, but use this as a strategy, not as a concern. As long as there are no unreasonable regulations, crypto will have huge upside as long as there are clear rules.

Original publish date: April 07, 2022

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