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Bitcoin drops to $30,000
Tuesday, Bitcoin (BTC-USD) prices found themselves below the $30,000 mark, down a fifth from the previous week.
If it was a high value stock, I would recommend buying the dip. Profit-generating companies have strong “intrinsic values” that provide downside protection.
But Bitcoin and its ilk have no such buffer. Much like fiat currencies (which can also go to zero), cryptocurrencies only have value because other people believe they have value. Once that trust disappears, cryptocurrencies head towards zero.
As crypto prices continue to fall, my Moose Master strategy continues to signal the ‘sell’ on the asset class.
The strategy, unfortunately, requires us to lock in losses. But if history is any indicator, Bitcoin and other cryptos still have a long way to go before they hit bottom.
Source: Catalyst Laboratories / Shutterstock.com
Terra Luna faces a Black Swan event
Bitcoin isn’t the only cryptocurrency to be crushed this week.
Monday evening, moon earth (LUNA USD) fell 60% as its stablecoin TerraUSD (UST-USD) lost its peg to the dollar. By Wednesday, confidence in the whole ecosystem had collapsed. LUNA is now trading under $1.
It is a devastating loss. Terra was one of my top crypto picks last December; at the time, I called the token “a game-changer”. And although I warned investors about its $66 “hot-money Solana” price, even I hadn’t anticipated such a rapid decline.
“Terra is rewriting the rules of how stablecoins work,” I wrote in that letter. With its collapse this week, Terra Luna’s legacy seems far more infamous than I anticipated.
An earthly thing to waste
The Terra ecosystem relies on an arbitration system to create its stablecoins. Rather than using durable assets like gold or dollars to back its currency, TerraUSD depends on traders to trade between UST and LUNA to maintain parity with the dollar.
The “algorithmic stablecoin” has clear advantages over rivals such as Attached (USDT-USD). Rather than backing each coin with durable assets – a proven system – Terra uses a set of free market incentives to maintain the UST/dollar bond.
If the UST falls below $1, the Terra system automatically rewards traders who trade units of the stablecoin for Luna. This decreases the UST supply and increases its price. And if it exceeds $1, the reverse happens.
In a sense, the system mirrors ETFs, an asset class that relies on arbitrageurs and market makers to maintain prices.
But there is a catch: if people lose faith in an arbitration system, everything stops.
And that’s exactly what happened Monday night at LUNA HQ, as the UST slipped to $0.80…
…before hitting $0.60.
The most likely explanation is that an initial drop in LUNA reduced the demand for converting UST to LUNA. With fewer arbitrageurs willing to cut the UST supply, the network’s burn mechanism could not keep up with investor-based selling.
Whatever the initial cause, the end result was clear: in a self-fulfilling prophecy, investor distrust of Terra’s ecosystem has rendered its anchorage untrustworthy.
Even now, no amount of cajoling from Terra CEO Do Kwon seems able to stem the tide.
“Close to announcing stimulus package for $UST,” Kwon tweeted Tuesday morning. “Hang tight.”
Terra’s flagship cryptocurrency would lose 97% of its value anyway.
The bad news would keep piling up. On Wednesday, allegations surfaced that Mr. Kwon was previously involved in a flawed algorithmic stablecoin, Basis Cash. And by Thursday, Terra had lost virtually all of its remaining value.
Don’t wait for a recovery
Terra’s woes highlight a broader trust issue with crypto markets:
In the current market environment, few investors are willing to “buy the dip”.
On the retail investor side, social media stuck to the usual favorites. This week, trending tickers on Stocktwits, a popular investment forum, included investments such as the S&P 500 ETFs (NYSEARC:TO SPY) and AMC Entertainment (NYSE:CMA). Cryptocurrencies rank much lower.
Meanwhile, institutional investors seem hesitant to double down on their crypto losses.
“Bitcoin is a great barometer of risk now,” said Neil Wilson, analyst at brokerage Markets.com. “And we see its decline as evidence of significant deleveraging.”
the Moose Master strategy echoes sentiment. Sudden price drops are usually clear warning signs to take money out of the market.
After all, a “momentum bet” without the “momentum” is… Well…
Just a bet. And the odds on crypto keep getting longer.
In other words, tactical investors should consider lowering their crypto stakes in the short term, even if it means locking in some losses. The only thing worse than losing $20 in your wallet is losing $100.
As for LUNA?
Buying the token today is a naked bet on the Terra team’s ability to rebuild trust in their system.
On the one hand, other financial companies have already done so (ie American Express in 1973 and Citi in 2008). If LUNA can regain investor confidence, that’s a potential 10x return.
On the other hand, many others never come back from the brink. Barings Bank disappeared in 1995 after a rogue trader lost millions. And Lehman Brothers remains the punchline for many Wall Street jokes.
Today’s closed-door negotiations may end up saving Terra. But much like the 2008 talks that saved Citi and sacrificed Lehman, the outsiders are flying blind. Mr. Kwon has already hidden the truth from investors. He can do it again.
Should I buy Ethereum?
Long-term crypto investors could still trust high-quality games like Ethereum (ETH-USD). When you are the dominant cryptocurrency in NFTs and token finance, it will take more than a market downturn to destroy your long-term prospects.
Yet, buying Ethereum today is a lot like investing in Amazon (NASDAQ:AMZN) in the mid-2000s. Prices are down from their peak, but there is still clearly more room to fall.
During the dot-com crash, many startups suffered from their dependence on customers and funding. Venture capitalists losing money on a company have tightened their purse strings more widely. It triggered involuntary bankruptcies in more promising startups, and so on. Amazon survived the dot-com meltdown primarily through a timely $672 million convertible bond issue that year.
Cryptocurrencies will face a similar crisis over the next few months. Less funding from VCs and investors will starve promising crypto teams of development capital. And since many coins share common bonds, losses in one crypto are sure to snowball and upset elsewhere. For example, fewer NFT transactions will impact exchanges, Ethereum and Layer-2 protocols such as X immutable (IMX-USD) that supply the businesses.
Rising rates will also make the situation worse. As the Federal Reserve puts the brakes on an overheating economy, investors will find themselves with less cash available to speculate.
As I wrote on Tuesday, many investors are still unaware of these risks. Same parts as ApeCoin (APE-USD) are still hot, despite the loss of billions in investor cash. And zero-income businesses like Nicholas (NASDAQ:NKLA) still manage to retain billion-dollar valuations.
This means that even higher quality assets like Ethereum still have room to fall (I predict a 6-12 month rally is in order).
But don’t wait forever; no one comes down the mountain to tell us to invest once we hit the bottom of the market.
PS Do you want to know more about cryptocurrencies? Penny shares? Choice ? Drop me a note at [email protected] or connect with me on LinkedIn and let me know what you’d like to see.
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As of the date of publication, Tom Yeung had (neither directly nor indirectly) any position in the securities mentioned in this article.
Tom Yeung, CFA, is a Registered Investment Advisor on a mission to simplify the world of investing.
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