Stabilizing traditional financial markets currently falls to governments and large consortiums. What can we do to stabilize the cryptocurrency markets, intentionally built on the premise of decentralization and non-government control?
Since Bitcoin was created in 2008, the strategy for stabilizing crypto markets has been to ride out the volatility and embrace the chaos. Traders are so accustomed to violent swings that there are new terms created for investors brave enough to not panic but “hodl” on in the belief that markets will rebound. There are even jokes made on popular TV shows like HBO’s Silicon Valley about the instability of crypto markets. But it may not always be like this. In this article, we will explore a few ways that the cryptocurrency market could be self-stabilizing and eventually reach a point where it can be used by any individual as a fully adequate currency.
Why does stability even matter? According to Obi Nwosu, CEO of Coinfloor, “Stability of price is needed for a currency to be a currency. To be a store of value, it can’t be speculative, it has to be relatively stable and predictable.” Without relative stability, people cannot rely on cryptocurrency for general uses such as buying groceries or paying rent. As shown by countries hit with hyperinflation, it is impossible for a society to function properly when the amount the populace is paid at the end of the day is worth half that the very next day. If we want any cryptocurrency to truly be a global currency, usable by any individual, then stability is essential.
Achieving stability is a complex and long-term problem that cannot be solved overnight. There are a few different approaches that are currently being taken by businesses and individuals that will lead to eventual stability. Three approaches that will help in this cause are mass adoption, traditional financial infrastructure, and government regulation. Successfully stabilizing the markets will depend on a combination of these methods.
One of the many reasons for excessive volatility in the crypto markets is because it is still small enough that it can be manipulated by large-scale trades and pump and dump schemes. Smaller coins can be sent spiraling upwards or downwards by a single large market order. As more investors enter the markets and the trade volume increases, markets will naturally reduce this extreme behavior.
Mass adoption will assist stabilization, but will not eliminate extreme volatility because people are known to create runs of panic-based sell-offs when their positions are losing money quickly. A full “run on the bank” cannot be stopped for any single currency, as there is no central point of control. Mass adoption is also needed for the prices to actually be backed by real world usage. It will mean digital currency projects are being used for daily transactions and normal use cases rather than purely as a speculative investment vehicle.
Traditional Financial Infrastructure
Another path to stability relies on institutional systems that exist in traditional markets. By building up the same infrastructure that exists for securities, bonds, and derivatives (ie: futures, options, forwards and swaps), cryptocurrency markets can become more comfortable for institutional investors to enter the market. With institutional investment comes a large influx of capital that also stabilizes the price.
As Obi Nwosu said, “If you looked at the traditional markets [the issue of stability] has been solved and the solution is to use futures. In a low liquidity market like this, physically delivered futures offer greater transparency and reduce market manipulation.”
For those less familiar with how futures work, Mr Nwosu explains, “A future is a mechanism for people to enter a contract now to lock in prices to buy or sell in one month, 6 months or longer. There are two main types and they differ around settlement. When it comes time to close the contract and you settle, are you going to deliver the physical asset, which can be bales of corn or bitcoin, or are you going to deliver the cash-equivalent at that time of the physical asset? …In terms of technical implementation, cash settlement is simpler, which is why the existing futures exchanges in the crypto market (there are a few currently) have all been cash settled. Now, physical delivery is much simpler to understand – I’ve got a contract to deliver the physical item, and it has a number of benefits, mainly being that there are no risks of price manipulation around the time of settlement.”
Futures also allow multiple players to approach from different sides and on different timelines for a similar investment. This adds needed complexity to the liquidity and ultimate stability of the markets.
Government regulations are needed and desired to stabilize the crypto markets. While the core value of remaining decentralized is an essential part of most cryptocurrencies, that does not countermand the need for regulation. Regulations can eliminate some of the scams currently in the markets, protecting investors and providing a needed signal to the general public that cryptocurrency is legitimate and legal. Many people ignorant of crypto investing still question the legality of it or only think of cryptocurrency in terms of the dark web, used by hackers and nefarious criminals. These potential investors rely on government regulations and approval to act on this unfamiliar market, which would engender further adoption.
As seen above, there is no one easy answer to price stabilization. Still, there is exciting progress being made on multiple fronts to bring additional individuals and institutions into the crypto markets. At Rootmont Research, we are proud to further the maturity of these markets and solve our clients’ investment concerns.