Tuesday, August 9, 2022

Four Phases of The Crypto Market Cycle

A crypto market cycle typically consists of four different phases of price trends that are caused by several types of external factors. Here is what they look like and how to take advantage of them.AUG 09, 2022|

BEGINNER

Takeaways

  • A crypto market cycle consists of four phases — accumulation, markup, distribution, and markdown
  • Each crypto market cycle lasts four years on average
  • The main factors that affect a crypto market cycle include its correlation with Bitcoin, the halving of Bitcoin, and social metrics

What Does the Crypto Market Cycle Look Like? 

At a high level, market cycles are specific patterns that typically emerge from the psychology of market participants and the greater economic environment. This is a natural phenomenon that occurs in every market, and the crypto market is no exception. 

Crypto market cycles start with little to no interest in the market. However, as more interest and demand arise, asset prices generally rise to keep up with the increasing demand. At some point, prices reach a peak and eventually start to drop, as interest declines and supply outweighs the demand. At the end of each cycle, a new cycle begins. 

Although it is difficult to pinpoint the start or the end of a market cycle, most cryptocurrencies (excluding stablecoins) go through similar stages. Understanding the characteristics of each stage and how a typical user may approach each of these stages can help you to participate in the market in a more informed way.  

1. The Accumulation Phase

Accumulation is the first phase of every market cycle. It starts after the end of the previous cycle when sellers have exited the market and prices are perceived to begin stabilising. 

In this phase, the market volume is typically lower than average, as interest in the market remains low. Therefore, no clear trend emerges, and assets typically trade within a tight range. 

Characteristics:

  • Market sentiment is dominated by disbelief and uncertainty
  • Low price volatility
  • Low trading volume

The accumulation phase is also known as a consolidation phase, which generally marks the end of the downtrend. Some market participants may still consider it an uncertain time to enter the market, as it can be hard to deduce whether the asset will continue trending lower. But from another perspective, longer-term holders often look at the accumulation phase as the precursor to what they hope will be the start of a bull market. 

This period is especially attractive for long-term users who are looking to buy and hold. For short-term traders, however, patience is key, as this phase can last anywhere from weeks to months or even years. At this point, positive news relating to the market circumstances at large can capture market participants’ attention and potentially push the market into the next phase — the markup phase. 

2. The Markup Phase

Commonly referred to as the bull market phase, the markup phase is when the market moves higher in price at an increasing rate. During the markup phase, new groups of market participants enter the market, and with that generally comes a notable increase in volume at the beginning of this phase. 

From a market sentiment standpoint, despite still being cautious, market participants start becoming optimistic about the outlook, as companies and press begin publishing positive headlines. 

The demand for an asset begins to outweigh the supply, causing prices to appreciate in value as a result. 

Characteristics:

  • Market sentiment is dominated by optimism and excitement
  • An uptrending price chart
  • Increase in trading volume
  • Favourable economic conditions

The markup phase may be a good time for new participants to enter the market, as the upward price movement is much easier to recognise. Additionally, dips or pullbacks in the markup phase are mostly considered by many as an opportunity to buy, rather than a caution signal. 

However, despite the overall optimism in the markup phase, assets will not necessarily increase in price. Not all assets follow the overall trend, and some may still be affected by negative news particular to them, which may cause their price to go against the general trend. 

3. The Distribution Phase

At some point, after a bull run, some buyers become sellers. This is the distribution phase, where the buyers and sellers in the market are at equilibrium. 

On one side, there are market participants who are still looking to buy, as they have confidence that the bull market is not over. On the other side are sellers, who are looking to lock in their profits. This creates tension between the bulls and bears. While this phase of the market still sees high trading volume, asset prices generally fluctuate within a limited range until either the bulls or bears surrender.  

As a result, this phase may cause the overall market sentiment to turn from optimistic to a separation between greed and fear, with the prevailing uncertainty of whether the uptrend will continue or if a bear market is coming. The fear and greed index is a common indicator used by analysts to gauge this change in overall market sentiment. 

Characteristics:

  • Market sentiment is simultaneously coloured by overconfidence, greed, and uncertainty
  • Low price volatility
  • Elevated trading volume, but without an increase in price

The distribution phase is also the first sign of weakness after a bull market. In turn, this can lead some to deduce that a further downtrend might be coming. 

During this time, some participants who bought an asset prior to or at the beginning of the markup phase may begin liquidating their positions in preparation for what they perceive to be an upcoming bear market, also known as the markdown phase. 

4. The Markdown Phase

The markdown phase, or the bear market, is the scariest phase for most market participants. It starts as soon as the supply exceeds the demand in the distribution phase, and is a period that’s fuelled by fear in the market, as the outlook becomes increasingly negative. 

The more that participants begin fearing the upcoming state of the market, the more the selling pressure builds. In some situations, this cascading effect can send prices of an asset to levels not seen since the markup phase. 

From a technical perspective, the markdown phase is defined by a downtrending chart and a high volume price decline. From a market sentiment perspective, it begins when news articles turn negative, with words like ‘recession’ in their title. 

Characteristics:

  • Market sentiment is dominated by anxiety and panic
  • Downtrending price chart
  • Elevated trading volume
  • Unfavourable economic conditions

The markdown phase is a short seller’s dream, and the period where they stand to gain from the market drawdown. In this period, even good news can have trouble pulling an asset out of a downtrend, as participants adopt a cautious approach to avoid losses in the current harsh market climate. 

But there is light at the end of the tunnel because markdown phases don’t last forever. At the end of this phase generally comes the new crypto market cycle. What lies around the corner might be yet another markup phase. 

How Long is a Crypto Market Cycle? 

Despite its young history, crypto has already seen several market cycles. 

One of Bitcoin’s first market cycles came in 2013, where, in just a few months, the asset went from US$150 in its accumulation phase to over US$1,150 at the peak of the markup phase. It eventually slumped back to US$250 in the markdown phase in early 2015.

The next cycle kicked off in 2017: starting at around US$1,000 and climbing to a peak of US$19,000 by the end of the year, only to return to a low of about US$3,700 by the end of the markdown phase. 

In both examples, it took the asset roughly four years to complete a market cycle; hence, the conclusion that an average crypto market cycle takes four years. However, be wary when making decisions based on this data, because it is based on a very small sample set and there may be black swan events that the industry hasn’t seen. 

Factors That Affect a Crypto Market Cycle

In traditional finance, the factors that affect a market cycle are synonymous with the factors that might cause a bull or bear market.

These are:

  • Political sentiment 
  • Supply and demand 
  • Fiscal and monetary central bank policies 
  • Corporate performance data
  • Technical indicators

The cryptocurrency market, however, has historically seen additional unique features: 

Bitcoin Halving

The technological advancements behind a cryptocurrency can often become the catalyst for the start of a markup or markdown phase for the asset. For instance, the Bitcoin halving

This process involves the halving of rewards for Bitcoin miners after every 210,000 blocks. In layperson terms, it reduces the rewards for mining on the Bitcoin network, and in return, limits the supply of new Bitcoins. 

Because of this, if the demand remains strong, it will generally push the Bitcoin price higher due to the perceived lack of market supply. Historically, Bitcoin’s halving has always created a new markup phase, making it a good indicator in which to pay attention. 

Bitcoin Correlation

It is worth noting that, regardless of the niche of a crypto asset (except stablecoins), most share a strong correlation with Bitcoin, which occupies 54%%2054.4%25,Binance%20Coin%20(BNB)%204.3%25) of the entire crypto market capitalisation (at the time of writing). Hence, if there are no strong catalysts, the market cycles of smaller crypto assets are likely to resemble the market cycle of Bitcoin. 

Social Media Influencers

An interesting observation of many minor cryptocurrencies is that, due to their small market cap, their prices can be affected significantly by influencers. One of the biggest influencers is Elon Musk. 

In February 2021, the meme coin Dogecoin (DOGE) surged over 50% immediately after Musk tweeted about it. On another occasion, after Musk was asked how many Shiba Inu coins (SHIB) he owns, to which he then replied “none,” the cryptocurrency suffered a 20% decline in market value. 

Although social metrics are hard to measure or predict, crypto assets have a tendency to fluctuate based on tweets or other forms of social media engagement from influential figures. 

How Can Users Take Advantage of Market Cycles? 

Although market cycles are fairly simple to understand, crypto assets are still a new asset class with new underlying technology. This can add multiple layers of complications when trying to ascertain where the market currently stands with regard to the crypto cycle. To add, market cycles may not always have the same patterns, and market participants typically cannot tell until looking back in retrospect. 

Understanding that markets are cyclical — and managing your portfolio so that it accounts for markdown phases — can help ensure that you won’t be caught off guard. As much as we’d all like our assets to only increase in price, market cycles are ultimately inevitable. 

Due Diligence and Do Your Own Research

All examples listed in this article are for informational purposes only. You should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained herein shall constitute a solicitation, recommendation, endorsement, or offer by Crypto.com to invest, buy, or sell any crypto assets. Returns on the buying and selling of crypto assets may be subject to tax, including capital gains tax, in your jurisdiction.

Past performance is not a guarantee or predictor of future performance. The value of crypto assets can increase or decrease, and you could lose all or a substantial amount of your purchase price. When assessing a crypto asset, it’s essential for you to do your research and due diligence to make the best possible judgement, as any purchases shall be your sole responsibility.

Source: https://crypto.com/university/four-phases-crypto-market-cycle


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Risk Mitigation Part 1

This summarizes my other posts on the topic of risk mitigation. It deals with how to think about risk in your portfolio. I also have included a summary of Reducing the Risks of Black Swans by Larry Swedroe if you want to read more on incorporating the strategies into a more Boglehead type portfolio.

Mark Spitznagel

The Dao of Capital

  • "The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy." Hazlet
  • "You have to love to lose money and hate to make money to be successful" Klopp
  • Far better to avoid direct, head-on competition and instead, pursue the roundabout path toward an intermediate step that leads to an eventual position of advantage
  • Natural systems – from forests to markets – continuously seek balance.
  • Austrian investing takes a roundabout path to market success by pursuing immediate loss during the investment process so you can gain more advantageously in the future.
  • If investors could use history to predict market movements, they'd never be surprised by them or lose huge amounts of money.
  • The market cannot be understood as predictable and law-abiding since it's unpredictable and chaotic at its core.
  • The roundabout – the pain of positioning and paying now for the advantage and payoff later – only works when we remove our temporal blinders that keep us hyper focused in the moment. Then, and only then, can we pursue those proximal aims intended to give us an intermediate advantage from which the distal ends are more easily and effectively achieved. To say this is extremely challenging is an understatement.
  • To succeed with the strategy of Austrian Investing, you must be able to tolerate initial setbacks.
  • A system should naturally achieve balance through internal guidance. Attempts to intervene in the system will usually cause more problems than they solve. The Austrian School of Economics believes this about markets: government intervention doesn't help balance markets, it distorts them.
  • We can only succeed with Austrian investing if we can stop focusing on the short term. This is extremely difficult, but it's also critical to our success in the long run. It's hard because humans are designed to prefer things that benefit them now rather than later.
    • This is part of our evolution as humans; we had to focus on immediate threats in order to survive and thrive as a species. Our culture also teaches us that the moment is all that matters—we live in an instant gratification society where people want everything right now without having to work hard for it or wait long periods of time (such as saving money).
  • Patience is the most precious treasure
    • Most people are unable to take the roundabout route because our evolution and desire for the here and now (Like the children in the marshmallow study, 1 now or 2 later). Therein lies an edge to the Austrian investor who can take the roundabout approach
    • The reason for this difficulty can be found in our wiring, those genetic tracings of our evolutionary journey rooted in survival, when overlooking immediate needs was reckless and life-threatening.
  • Without a functioning feedback loop, the system goes haywire like a faulty thermostat
  • The Federal Reserves attempts at "Fire Suppression" leads inevitably to bigger and more deadly "Forest Fires"
  • Austrians believe in the "boom and bust cycle" where artificially low interest rates foster an unsustainable boom (characterized by overleveraged borrowers investing in operating capital that will be unproductive at natural interest rates) and the inevitable bust.
  • Markets tend to experience infrequent, large moves or "fat tails"
  • Wall Street's problem is one of lost opportunity; you MUST go for it now or you won't have a chance tomorrow. This causes Wall Street traders to focus on the now

  • You can't time the market. IE – Pick tops and bottoms.

  • Short term doesn't matter

  • When interest rates are low, bonds are not as negative correlated as you would like with equities and not as much of a safe haven. Do not chase yields

  • The federal reserve will have difficulty "normalizing rates"

  • Alpha (inefficiencies) is difficult to capture for investors

    • The question you have to ask yourself is "Can you be more efficient than the market?" NO
  • We don't know how the next recession will play out ahead of time. Cover your contingencies. Don't just plan for one.

  • Don't fight the fed. IE – Shorting risk assets

  • In a crash, almost all asset correlation goes to 1

    • Diversification in that scenario won't protect your portfolio
  • If you are in the derivatives market (IE – ETNs), you are taking credit risk from the issuer

  • 2 types of safe havens. Nothing else is a safe haven.

    • Insurance (Left tail way OTM 30% puts)
    • Does very well in a crash
    • small loss during up market
    • has a high degree of confidence (not a lot of "noise")
    • Store of Value (Gold)
    • does ok in a crash
    • up/down during an up market
    • has a high degree of confidence
    • No counter party risk
  • Safe Haven imposters - vulnerable in a crash, needs a lot of luck for that safe haven to pay off in a crash. Have a low degree of confidence it will pay off during a crash

    • Unsafe Haven
    • Hedge funds
    • long/short equity fund (can't time correctly)
    • High dividend stocks
    • REITs
    • Commodity index
    • Hopeful Haven
    • Value stocks
    • 10 - year bonds
    • VIX (difficult to time and it will punish you severely during a up market)
    • Silver
  • The federal reserve low interest rates are causing investors to chase yield and creating distortions in the market

  • You want to have money for when the liquidation of this malinvestment occurs so you can buy cheap equities

  • Precious Metals/Gold are a great store of value

  • Focus on your "dry powder"

  • Investing in the stock market is a good idea, but you have to be careful. When interest rates are too low and there's too much money being printed by central banks, it can lead to malinvestment. Malinvestment is when people invest in things that aren't useful or valuable for society. That leads to crashes in the market.

    • Distorted markets are prone to crashes
    • So, stay out of them and wait for the distortions to pass before investing again.
  • Tobin's Q (Misesian Stationary index) is a good measure of stock valuations. Market is fair valued at 1

    • It is the ratio of the market value of the companies/replacement cost of those business or total US corporate equity/total US corporate net worth. Lower number is better. High was 2.15 in 2000. 2021 is 2.75
  • Tobin's Q has a direct inverse correlation with future stock returns. Higher number = lower returns. When financial markets are distorted, they carry the seeds of their own destruction. The inevitable bust that follows the boom is not an unexpected event.

  • Basic premise is to stay out of the market for long periods of time when distortions are running high and wait for the inevitable collapse to purchase cheap equities. The objective of roundabout investing is not to make money now, but to position ourselves for better investment opportunities later

  • The challenge to the Misesian strategy is that it requires contrarian thinking, to "zig" when the rest of the world is "zagging". You have to step back when the MS Index is high so you can act like a corporate raider when it is low

  • Explosive Left Tail risk hedging (what Mark does) is very difficult for the average investor or even professional. Don't try it

  • For the average retail investor, Cash is good when Tobins Q is high so you have "dry powder" for the inevitable collapse. You don't want to be shorting the market or in risk assets. This is difficult because you will watch the market go up while you are setting on the sidelines

  • Benjamin Graham – "Many shall be restored that now are fallen and many shall fall that now are in honor."

Mark Spitznagel Safe Haven

  • Safe Haven – An asset that provides safety from risk
    • Risk is exposure to bad contingencies. Most of these will never happen, but they can and they can appear in any number of forms
    • Investment risk is the potential for loss, and the scope of that loss
      • A Safe haven asset is an investment that mitigates that risk to preserve and protect your capital. They are shelters from financial storms
  • Safe haven investing is both a defensive measure to avert future loss and an offensive one to exploit future opportunities with "dry powder".
  • A risk mitigation strategy must be cost effective. Anyone can develop a strategy that does well in a down market, but we must not have a cure that is worse than the disease
  • Benjamin Graham – "The essence of investment management is the management of risks, not the management of returns."
  • Do not attempt what Spitznagel does as a retail investor or even professional.
  • Everett Klipp - "A small loss is a good loss." Risk mitigation and survival are everything in investing. Don't try to predict
  • Investing needn't be about making grandiose forecasts. No one has a crystal ball
  • A cost-effective safe haven doesn't just slash risk, it actually lets you take more risk in other parts of the portfolio
  • Aristotle pointed out that, while it is easy to make a couple lucky rolls of a die, with 10,000 repeated rolls, the "luck" of the die evens out
  • When your sample size is small, and even worse, unique and unrepeatable, no matter your subjective probabilities, there is so much noise in sample you can hardly know anything. You are hoping for good luck. Your Number (N) is 1
  • But if your success or failure relying on many outcomes, over many rolls of the dice. Your Number (N) is large. You are acting as the "House" exploiting the house edge through repetition to quash randomness. The house doesn't gamble. We are as Poker theorist David Sklansky said, "at war with luck."
  • Cost-effective risk mitigation or raising our compound growth rates (CAGR) and thus wealth through lower risk is really our comprehensive goal as investors.
  • Golden Theorem – As you accumulate more and more data in a random sample, you should expect the sample's average to converge to the true average.
    • The more you roll a fair 6-sided die, the more the percentage of all those rolls in which you see any particular number will converge toward 1/6 or 16.66%
  • It isn't just the single wager that matters, it is the iterative, multiplicative impact of that result on the next wager, and on the next! A large loss disproportionately lowers our geometric average return, because it leaves us with a much lower stake, or capital base to reinvest and compound on the next wager.
  • We cannot only judge our decisions by their outcomes. As good decisions can have bad outcomes. But we only get 1 outcome.
  • We have just one life (N=1), but our fate is a range of outcomes.
  • The most intuitive way for us to think about the meaning of the expected geometric average return and, equivalently, the geometric average ending wealth outcome under multiplicative growth is simply as the expected median ending wealth outcome
  • The geometric average return, rather than the arithmetic average return is close to what you should expect from random samples from all possible ending outcomes
  • By giving all the weight to this path(N=1), we essentially need to have gotten pretty much every possible path right. We must be robust to the realized path or "covered all the bases." We don't know what "path" we are going to get
  • Not all losses and not all risks are created equal, so not all risk mitigation is created equal
  • We need a risk-mitigation strategy that makes our returns both more accurate and more precise to win the bloody "war with luck." We want a tighter grouping of our expected return or a reduced variance.
  • You have 2 options for achieving this. The store of value method or the insurance method. These 2 strategies can be very different in their cost-effectiveness
  • What makes something a safe haven vs a non-safe haven?
    • How does it do during a Crash? +/-
    • How does it do during normal times? +/-
    • What is the expected payoff during a crash and how does it achieve it?
  • You have 3 different types of safe havens.
    • Store of Value – Fixed in time and space. Key is low to no correlation. It provides both a cushion and "dry powder" should a crash take place. It is basically a matter of diluting risk. Crash return is +/0, Non-Crash Return is +/-, and Payoff type is low correlation
    • Alpha – Is like store of value, but its correlation is now expected to be negative. That means during a crash, it is expected to generate a positive return. Think of the flight to quality we see during a crash. Crash return is +, non-Crash return is +/-, Payoff type is negative correlation
    • Insurance – What Mark Spitznagel does, don't try. Extreme version of the Alpha payoff. Needs to make a very large profit during a crash, relative to its expected losses the rest of the time. Needs to be highly convex to crashes or have an explosive payoff to justify its costs. Crash return is ++++, non-Crash return is -, Payoff type is "Convexity"
  • Safe Havens can be exceedingly costly, so much so that, as a cure, they can be worse than the disease.
  • Some safe havens require a very large asset allocation within the portfolio. The problem is large AA comes at a very large cost (drag) when times are good (which is most of the time). Gold has this problem.
  • Strategic vs Tactical Safe Haven
    • Strategic – Mitigates systemic risks in a more fixed way and letting it play out
    • Tactical – Requires moving into and out of safe havens. This requires timing and short-term forecasting skill (which people don't have)
  • The problem is no one possess a "crystal ball" to know when to do this.
    • If you risk-mitigation strategy requires a crystal ball to work, then you are doing it all wrong. Don't try to predict the market. Cost effective safe haven investing needs to be agnostic investing
  • Cassandras typically and ironically lose more in their safety from looming crashes than those crashes would have even harmed them.
  • Markets scare us more than they harm us
  • Markets are very, very good at making us feel safe when we shouldn't and scared when we needn't
  • Risk mitigation therefore needs to be a sustained way of life or habit, not a transient one
  • Imposter Safe Havens
    • Hopeful
    • Unsafe
    • Diworsification (Diversification)
  • Hopeful – Payoff is very unreliable. Requires a lot of luck to pay off in a crash. Sometimes requires good timing. It is like jumping out of an airplane with a parachute that only sometimes deploys, you are better off not wearing one in the first place and making a more informed decision. Crash return is (don't know??), non-Crash return is +/- and the Payoff type is "Fingers Crossed"
  • Unsafe – This asset or strategy has so far always gone up, so it likely has a good story for why that should always be the case. This logic is then extended to their performance in a crash. They are often vulnerable in a crash, perhaps they have even shown some evidence of that vulnerability, but this doesn't change the optimism around their safe haven status. It is like jumping out of an airplane and thinking you can fly. Crash return is -, non-Crash return is +, and payoff type is "Always goes up so it must be safe"
  • Diworsifier – Most common form you see in modern finance. It is pervasive throughout almost all investment portfolios. Diversification is fundamentally a dilution of risk, not a solution to risk. It is about evading risk. Diversification never tends to be as great (lower correlations) as it appears. When the investing herd heads for the exits in a crisis, most strategies and assets tend to get swept away. Strategies that were once uncorrelated, stable and liquid become the opposite of all those things as investors are forced to sell what they are able to, all at the same time. Diversification is "NOT A FREE LUNCH" as mentioned in modern finance theory. Crash return is -, non-Crash return is +, Payoff type is "Loses less, so it is worth it"
  • Diversification lowers returns in the name of higher Sharpe ratios, some investors who use this strategy but aren't content with the lower returns are then forced to apply leverage in hopes of raising them back up. True risk mitigation should not require financial engineering and leverage in order to both lower risk and raise CAGR. Doing so adds a different kind of risk by magnifying the portfolio's sensitivity to errors in those correlation estimates.
  • Aristotle – "The whole is not the same as the sum of its parts."
    • This is true in finance. You can move a portion of your portfolio to an asset with zero expected return and away from an asset with a high expected return and raise the whole of your wealth, even though it lowered your average. All of this is due to compounding. Key Point of Book!!!
  • The properties emerge from the interactions of those component assets as they are rebalanced and compounded. Safe Havens adding so much ending wealth to the portfolio (geometric return) is due to the iterative nature of the game. They provide capital for the next "dice roll" by resetting or rebalancing the size of the wager at the end of each "dice roll". Safe havens can thus top up or feed the wagers in the main game (large part of portfolio), particularly if the previous roll resulted in a big loss, without costing the frequent positive wagers enough to matter. The assets now interact, rather than act independently. Thus, an entirely new whole is formed, one that is very different from the sum of its parts.
  • If we only look at the way that things happened and obsess over it as the only likely outcome, then we are engaged in naïve empiricism. IE - we over-extrapolate the past
  • To avoid that we need to look at the past in the context of the many other paths that COULD HAVE happened, but never did, as well as our sensitivities to those outcomes
  • Most investors add a risk-mitigation strategy for its effect, but don't properly account for the cost paid to gain that effect and thus don't account for the net portfolio effect
  • There is always this risk-mitigation tension or tradeoff between the two contrary forces of cost and effectiveness (IE – arithmetic costs and geometric return). That tradeoff is between lower arithmetic returns (costs) as payment for the geometric pickup (effect). There is NO FREE LUNCH!!! But if can tilt that tradeoff in your favor, with an effect that outpaces the costs resulting in a positive net portfolio effect, then risk mitigation on net raises compounding and consequently, wealth. This is cost effective risk mitigation.
  • Remember, anyone can develop an asset or strategy that does well in a crash, the trick though is to do it while also raising the median return. Most risk mitigation strategies fail this portion
  • We cannot judge the cost effectiveness of a given risk mitigation strategy on its own, in a vacuum, based solely on its attributes.
  • The bigger the crash bang for the buck, the less that is needed and the less its potential drag or cost when it isn't needed.
  • Mechanical vs Statistical payoff
    • Mechanical – is one that happens as a direct, intrinsic consequence. IE – an option going into the money from out of the money. It must go up in value.
    • Statistical – is one that only tends to be so, based on observed history, but it needn't be so. It is more extrinsic and thus noisier. This would be like a flight to quality or safety that we see during a crash
  • You also have other possibilities for payoff warping, like counterparty risk (or the risk of not getting paid). Gold bullion has no counter park risk.
  • The question to ask yourself is do you need a lot of things to go right for a safe-haven to be effective? Is their history a good guide to their future, or is everything always different?
  • An ideal safe-haven is more mechanical but real-world payoffs tend to be much less so. They tend to fall somewhere on a spectrum between mechanical and statical.
  • Not Safe Havens
    • VIX futures – Volatility index but they are always in contango which causes them to have a very steep "roll" making them a really bad trade
    • High-Dividend Stocks
    • Hedge Funds
    • Fine Art
    • US Farmland
  • Only 2 safe havens are worthy of that name – Gold and Equity Tail Hedge
  • Store of Value
    • Cash (3-Month Treasury Bill) – Less interest rate risks than longer dated maturities. Not a safe haven
    • 10-20 Year Bonds (Typical of "Balanced" portfolio) – More interest rate risks vs shorter maturities (as of 2021 those rates are extremely low which hurts their current safe haven status), classic flight to safety asset when things turn bad for the stock market and the economy. They are a hopeful haven or a Diworsification
  • Alpha
    • CTA (Commodity Trading Advisors) – Active managed strategies (usually hedge funds) and trend following strategies. Attempt to capture Alpha by using momentum. Other derivatives-based strategies use similar strategies like long volatility and generic tail hedging. Not a safe haven
  • Insurance
    • Gold
    • Hedge against the banking system.
    • No counter party risk.
    • Historically thought of as a hedge against inflation. But, is a very noisy hedge against inflation.
      • It is mostly tied to movements in real interest rates (When inflation goes up faster than nominal interest rates, real rates go down, pushing up gold prices).
    • Mildly explosive crash (market down 15%) payoff on average (30% in the 1970's and 7% since) but, it has had a very wide range of returns since the 1970's.
    • Gold is all about investors' expectations of value, it has no yield and has no intrinsic value.
      • It is for that reason impossible to fundamentally value. Its payoff profile is largely statistical as expected.
    • During the 1970's, golds payoff profile made it very cost effective as a safe haven, outside of that, gold has been much less cost effective.
      • Gold has required a tactical call regarding inflation or real interest rates in order to be a cost-effective safe haven.
      • This means we need certain things to go right for gold to be an effective safe haven in mitigating systemic risk (of a crash), much less cost-effective.
      • The amount of gold needed to fully hedge our portfolio is very high adding to its carry costs.
    • Generic Tail Risk Hedge Strategy – What Mark Spitznagel does
    • An extremely simplified version of his strategy. He does not describe his strategy is this book in any way. He says the academics are right when they say generic tail risk hedging fails to increase portfolio returns. He does not recommend using this strategy as a retail investor.
    • Each month spend a fixed amount of capital on way OTM four month puts on S+P 500 futures (with a straightforward constraint to avoid the priciest options) and mechanically delta hedge those; the puts are kept until expiration or sold if they explode to a high level.
  • Cryptocurrencies
    • Some people are saying that Cryptocurrencies are "Digital Gold" and destined to take golds role, but their payoff profiles are currently too sparse and too noisy evaluate intelligently (though the early indication is that they look more like unsafe havens or a hopeful haven at best.)
    • Cryptocurrencies are thought of as insurance policies against the failure of central bankers.
    • This, by extension, has also given them the presumed role of being an insurance policy against economic crises.
    • Cryptos are a significant technology platform (the blockchain). They are like secure, virtual safety deposit boxes that only you can access. It will change the world. But the stuff inside those boxes, just by virtue of the secure, convenient, cool boxes, is now presumed to have value – by decree or fiat
    • The Austrian economist Robert Murphy argues that in Mises framework, we have no choice but to call all crypto fiat currencies.
    • Worst of all, as a highly speculative vehicle, it is symptom of the liquidity-fueled environment that crated it.
    • Every further new high in the price of Bitcoin brings ever more claims that it is destined to become the preeminent safe haven investment of the modern age — the new gold.
    • But there's no getting around the fact that Bitcoin is essentially a speculative investment in a new technology, specifically the blockchain. Think of the blockchain, very basically, as layers of independent electronic security that encapsulate a cryptocurrency and keep it frozen in time and space — like layers of amber around a fly. This is what makes a cryptocurrency "crypto."
    • That's not to say that the price of Bitcoin cannot make further (and further…) new highs. After all, that is what speculative bubbles do (until they don't).
    • Bitcoin and each new initial coin offering (ICO) should be thought of as software infrastructure innovation tools, not competing currencies. It's the amber that determines their value, not the flies. Cryptocurrencies are a very significant value-added technological innovation that calls directly into question the government monopoly over money. This insurrection against government-manipulated fiat money will only grow more pronounced as cryptocurrencies catch on as transactional fiduciary media; at that point, who will need government money? The blockchain, though still in its infancy, is a really big deal.
    • While governments can't control cryptocurrencies directly, why shouldn't we expect cryptocurrencies to face the same fate as what started happening to numbered Swiss bank accounts (whose secrecy remain legally enforced by Swiss law)? All local governments had to do was make it illegal to hide, and thus force law-abiding citizens to become criminals if they fail to disclose such accounts. We should expect similar anti-money laundering hygiene and taxation among the cryptocurrencies. The more electronic security layers inherent in a cryptocurrency's perceived value, the more vulnerable its price is to such an eventual decree.
    • Bitcoins should be regarded as assets, or really equities, not as currencies. They are each little business plans — each perceived to create future value. They are not stores-of-value, but rather volatile expectations on the future success of these business plans. But most ICOs probably don't have viable business plans; they are truly castles in the sky, relying only on momentum effects among the growing herd of crypto-investors. (The Securities and Exchange Commission is correct in looking at them as equities.) Thus, we should expect their current value to be derived by the same razor-thin equity risk premiums and bubbly growth expectations that we see throughout markets today. And we should expect that value to suffer the same fate as occurs at the end of every speculative bubble.
    • If you wanted to create your own private country with your own currency, no matter how safe you were from outside invaders, you'd be wise to start with some pre-existing store-of-value, such as a foreign currency, gold, or land. Otherwise, why would anyone trade for your new currency? Arbitrarily assigning a store-of-value component to a cryptocurrency, no matter how secure it is, is trying to do the same thing (except much easier than starting a new country). And somehow, it's been working.
    • Moreover, as competing cryptocurrencies are created, whether for specific applications (such as automating contracts, for instance), these ICOs seem to have the effect of driving up all cryptocurrencies. Clearly, there is the potential for additional cryptocurrencies to bolster the transactional value of each other—perhaps even adding to the fungibility of all cryptocurrencies. But as various cryptocurrencies start competing with each other, they will not be additive in value. The technology, like new innovations, can, in fact, create some value from thin air. But not so any underlying store-of-value component in the cryptocurrencies. As a new cryptocurrency is assigned units of a store-of-value, those units must, by necessity, leave other stores-of-value, whether gold or another cryptocurrency. New depositories of value must siphon off the existing depositories of value. On a global scale, it is very much a zero-sum game.
    • Or, as we might say, we can improve the layers of amber, but we can't create more flies.
    • This competition, both in the technology and the underlying store-of-value, must, by definition, constrain each specific cryptocurrency's price appreciation. Put simply, cryptocurrencies have an enormous scarcity problem. The constraints on any one cryptocurrency's supply are an enormous improvement over the lack of any constraint whatsoever on governments when it comes to printing currencies. However, unlike physical assets such as gold and silver that have unique physical attributes endowing them with monetary importance for millennia, the problem is that there is no barrier to entry for cryptocurrencies; as each new competing cryptocurrency finds success, it dilutes or inflates the universe of the others.
    • The store-of-value component of cryptocurrencies — which is, at a bare-minimum, a fundamental requirement for safe haven status — is a minuscule part of its value and appreciation. After all, stores of value are just that: stable and reliable holding places of value. They do not create new value, but are finite in supply and are merely intended to hold value that has already been created through savings and productive investment. To miss this point is to perpetuate the very same fallacy that global central banks blindly follow today. You simply cannot create money, or capital, from thin air (whether it be credit or a new cool cryptocurrency). Rather, it represents resources that have been created and saved for future consumption. There is simply no way around this fundamental truth.
    • Viewing cryptocurrencies as having safe haven status opens investors to layering more risk on their portfolios. Holding Bitcoins and other cryptocurrencies likely constitutes a bigger bet on the same central bank-driven bubble that some hope to protect themselves against. The great irony is that both the libertarian supporters of cryptocurrencies and the interventionist supporters of central bank-manipulated fiat money both fall for this very same fallacy.
    • Cryptocurrencies are a very important development, and an enormous step in the direction toward the decentralization of monetary power. This has enormously positive potential, and I am a big cheerleader for their success. But _caveat emptor_—thinking that we are magically creating new stores-of-value and thus a new safe haven is a profound mistake.