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In crypto too, volatility can be your best friend!

Updated: Oct 6, 2022

Over the past year, we have seen bitcoin and Ethereum hit record highs of $68,990 and $4,891, respectively, dropping to around $19,000 and $1,500 to end today at $ and $. Making money in crypto seemed easy enough until the new "crypto winter" arrived!

Is blockchain technology here to stay?

Despite the volatility and multiple corrections, blockchain technology continues to grow at a rapid pace.

Indeed, the cryptocurrency market has seen several corrections this year:

The moon-growing stablecoin project ... imploded and suddenly fell to zero (Luna).

Two of the most popular exchanges (BlockFi and Celsius) went bankrupt and lost 90% of their value.

The crypto hedge fund 3AC went bankrupt and was put into forced liquidation by the British Virgin Islands ("forced liquidation" and "British Virgin Islands" are words that are not usually used in the same sentence!)

The list goes on and on as we enter 2022, and yet... cryptocurrencies are still here. Crypto has a chaotic history (Mt Gox, Silk Road, Chinese ban, etc) but like any nascent technology, it is building.

As Statistica mentions, with a current market capitalisation encompassing over 40% of all crypto-currencies on the market (see chart below), bitcoin is clearly the locomotive of the investment space.

So let's stick with bitcoin, because if bitcoin is evolving, the whole market is evolving too... at least that's what has happened so far!

Its adoption by the mainstream financial system as a tradable asset class and its penetration into various markets, including emerging markets, ensures its survival.

Indeed, the much-anticipated annual "2022 Global Crypto Adoption Index" report by Chainalysis Inc. draws a clear conclusion: the fundamentals of crypto appear to be sound.

What does this mean?

Firstly, even if global adoption is slowing down worldwide it remains above pre-bear market levels. Large, long-term crypto currency holders continued to hold bitcoin during the bear market, so while their portfolios have lost value, these losses have not yet been realised as they have not sold.

The second finding is that emerging markets dominate the global crypto-currency adoption index. Of the top 20 countries with the highest adoption index, 10 are lower-middle income countries (Vietnam, Philippines, Ukraine, India, Pakistan, Nigeria, Morocco, Nepal, Kenya and Indonesia), 8 are upper-middle income countries (Brazil, Thailand, Russia, China, Turkey, Argentina, Colombia and Ecuador) and 2 are high-income countries (United States and the UK).

Of note, Vietnam retains the top spot, the US moves up to fifth, and China returns to the top 10.

Global adoption remains well above the levels that preceded the 2020 bull market. The data suggests that a critical mass of new users who invest in crypto-currencies during bull markets tend to stay invested even when prices fall, allowing the ecosystem to experience consistent net growth through market cycles. This could be due to the value that users in emerging markets derive from crypto-currencies. These countries dominate the adoption index, largely because crypto-currencies offer unique and tangible benefits to people living in unstable economic conditions such as hyperinflation for example.

Finally, the entry of financial institutions such as Goldman Sachs, JPMorgan and BlackRock to name but a few into the crypto-currency market, should bring economic and political support to blockchain technology.

The cryptocurrency market will continue to experience wild volatility.

Volatility is necessary - it is an essential bridge for an asset class to deliver value over the long term.

This is not the first cryptocurrency winter, we have been through this before. Each time, the sector has emerged stronger as adoption and use cases continue to grow.

Unlike the first wave of investors - who still see bitcoin as a long-term store of value - the new players see bitcoin as a trading asset, as a risk asset hence its correlation with high-growth technology stocks.

More volatility is likely for bitcoin (BTC) in the coming months as the largest crypto-currency by market capitalisation faces decoupling from traditional markets and downgraded macroeconomic scenarios.

Bitcoin has already fallen by more than 60% from around $47,500 at its January high to just below its current level of $18,500. Increased volatility also reflected by the uncertain economic environment and the central banks' policy of raising interest rates.

But even more downward volatility could be ahead as macroeconomic uncertainty weighs heavily on crypto investors.

"Volatility is unlikely to disappear in the coming months as the Fed prepares to accelerate the process of reducing its massive $9 trillion balance sheet or so-called quantitative tightening in September," researchers at Kaiko wrote recently. "Coupled with rising interest rates and a macro-focused approach to monetary policy, this will likely put additional pressure on risk assets."

This means volatility is here to stay. How can we use it to make it an ally?

Develop a crypto investment strategy in an uncertain market

Bitcoin's volatility presents a unique opportunity to collect significant premiums by selling call options, a strategy commonly applied in traditional markets by the investment fund. This strategy, that is already used in the Wave Bitcoin income and growth product, requires a strong expertise in the crypto space and is monitored with a unique custody structure limiting the risk exposure.

Bitcoin remains a very volatile asset, more volatile than the real estate market, gold, oil and the S&P 500 as shown in the chart below.

Volatility has a positive impact on the price of options, resulting in higher returns: higher volatility implies higher risk and therefore a higher premium.

Options strategies can be implemented by reducing exposure to bitcoin while generating a monthly premium (call writing).

Annualized call premium VS. Annualized Volatility

Despite its volatility, adding an optimal allocation to bitcoin in a portfolio increases the overall expected return and improves the risk-adjusted returns (or Sharpe ratio) of a portfolio. While the Sharpe ratio of a hypothetical portfolio is optimised at around a 6% allocation to bitcoin, the largest marginal improvement in a portfolio's Sharpe ratio occurs in the 0.5-2.0% allocation range. (source: Wave Financial)

So it's time to convert volatility into return and build an investment strategy based on the potential upswing in cryptocurrencies!

Learn more about our product here:

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