Time To Take Profits On Cryptocurrencies

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Includes: BTC-USD, BTCS, GBTC
by: Geoffrey Caveney
Summary

I wrote positive articles about Bitcoin, Ethereum, and Litecoin on Seeking Alpha earlier this year.

Now I feel the need to say: Please sell down your cryptocurrency holdings to 1%-2% of your total portfolio.

It is very hard to say what value people will attach to each particular cryptocurrency decades in the future.

I am very concerned that Bitcoin and cryptocurrencies have gotten too popular, too fast, for their own good as long term stores of value.

Beware big-time short sellers on the Bitcoin futures market jumping in en masse some time after the holiday season has passed.

I have written positive articles about Bitcoin (GBTC) (OTCQB:BTCS), Ethereum, and Litecoin on Seeking Alpha earlier this year, so now that cryptocurrency mania is in full swing, I feel the need to make this public service announcement:

Please sell down your cryptocurrency holdings to 1%-2% of your total portfolio. Please.

That was the level I always recommended. But after a year of unimaginably huge gains in cryptocurrencies, if you started at 1%-2% of your portfolio, you may be up to 10% or more of your portfolio now. And that is way too much to risk leaving in cryptos, especially at the current elevated levels.

So please, sell down your cryptocurrency holdings until they are back at the 1%-2% of your portfolio level.

Take the profits you make on these sales and reinvest them elsewhere.

Questions About Future Value

Look, the technology behind cryptocurrencies is clearly and undoubtedly valuable. As for the currencies themselves, that depends entirely on the level of confidence that other people have in them: What will another person pay for them? Will another person accept them as payment for goods & services?

As a long-term store of value, the same questions apply to the future: What will other people be willing to pay for them 10, 20, or 30 years from now? Will other people accept them as payment 10, 20, or 30 years from now?

Bitcoin clearly has "first mover" and name brand recognition as its advantages over all other cryptocurrencies. But as the volume and volatility of transactions heats up, users have questioned Bitcoin's transaction costs and speed. Many specialists in the field believe that Ethereum, Litecoin, and Bitcoin Cash have superior technology for more efficient transactions.

The honest answer is that it is very hard to say what value people will attach to each particular cryptocurrency decades in the future. I tend to think the Bitcoin name brand will prevail. But it is not at all clear how exactly future investors and users will value each particular cryptocurrency, and cryptocurrencies as a whole.

Too Many Multi-Billion Dollar Cryptocurrencies

I can believe that in the future people will store trillions of dollars worth of wealth in Bitcoin. That is why I think a 1%-2% allocation today is still a good idea.

But it is harder for me to believe that in the future so many different cryptocurrencies will all have people storing tens of billions or hundreds of billions of dollars worth of wealth in each of them.

Here is some perspective: the total value of all above-ground silver stocks and reserves today is estimated at around $16 billion.

And right now, Litecoin's total market cap is as high as $16.36 billion.

That's right: At this very moment, the market is already valuing all the world's Litecoin as more valuable than all the world's silver.

And Litecoin is only the 5th most valuable cryptocurrency on the market today: Bitcoin ($280 billion), Ethereum ($69 billion), Bitcoin Cash ($33 billion), and Ripple ($22 billion) have higher values.

We can talk about Bitcoin's first mover advantage and name brand recognition value, but it is much harder to argue that 5 or more different cryptocurrencies all have such a lasting name brand value.

Why should we not expect other new cryptocurrencies, perhaps some that have not been created yet, to supplant some of these existing cryptocurrencies in the top 5? And if and when that occurs, what will happen to the present market value of today's top 5?

Signs of a Bubble in Cryptocurrencies

I had thought before that the creation of a Bitcoin ETF would be the catalyst for a massive increase in investors putting money into Bitcoin: Many people had been waiting for a convenient and cost-efficient investment vehicle available through regular brokerage accounts.

But it turns out that mass popularity of cryptocurrencies has done an end run around the regular financial markets entirely: The enthusiasm has become so widespread that Coinbase has become the No. 1 App in iPhone's App Store, and at least two other cryptocurrency trading apps were in the top 10.

In recent weeks, especially since Thanksgiving in the holiday season rush, it seems that everyone has an anecdote about cryptocurrency mania all around them. Here's mine:

I was at a college basketball game at Madison Square Garden last week. A college student and his parents were sitting in the row in front of me. They were spending the whole time talking about Bitcoin. The father was talking about the "chainlink" technology behind Bitcoin (I hope he meant "blockchain") and also about keeping your Bitcoins in "cold storage" (at least this time he got the terminology right).

Bottom line: I think Bitcoin and cryptocurrencies have gotten too popular, too fast.

This pace of manic growth is not healthy for a newly emerging and developing market. I would be more confident about the future of Bitcoin and cryptocurrencies if they were growing more slowly and steadily.

But as it is, the popular mania has me very concerned. People are buying cryptos in the holiday season as if they were the latest fad, like Cabbage Patch Kids dolls or Beanie Babies. This is not healthy for the market of an asset class that intends to become a new type of permanent store of value.

Forecast for Bitcoin Futures

Many analysts expected the launch of Bitcoin futures this past week to be the spark for a selloff that would drive down Bitcoin and cryptocurrency prices. The futures give many powerful financial institutions the opportunity to effectively bet against Bitcoin by selling futures contracts and taking short positions. So far, a price crash has not happened, and now many analysts are impressed with the Bitcoin price's holding power in the face of this new development.

I have a different analysis of the situation: I think the big-time Bitcoin short sellers did not jump into the futures market right at the beginning. They are biding their time, lying in wait. For now, the Bitcoin shorts are happy to let all the longs and bulls take their positions first, and let them drive up the price even higher. Moreover, they are waiting to let the ongoing popular mania and holiday season Bitcoin buying play itself out, also driving up the price even higher.

Then, some time after Christmas or New Year's, when the popular holiday momentum has exhausted itself, the Bitcoin shorts will pounce on the futures market en masse. That is when I expect to see a selloff and a price crash.

Some cryptocurrency enthusiasts have argued that the Bitcoin futures market should not affect the Bitcoin price itself, because the futures are settled in cash, not in Bitcoin. But this belief is naive, and fails to recognize the interconnected nature of markets.

Here is how it will work: If and when the value of Bitcoin futures begin to fall, that will create a discrepancy between the higher Bitcoin price and the lower Bitcoin futures price. This will open up a simple and easy arbitrage opportunity: traders can simultaneously buy Bitcoin futures and sell the same amount of Bitcoin to guarantee a profit. This action will drive down the price of Bitcoin itself. By the way, this chain reaction between the futures price and the underlying asset price is exactly how the October 1987 stock market crash unfolded.

Caution: No Downside Protection in Cryptocurrency Markets

And while the Bitcoin futures market has "circuit breakers" that temporarily halt trading after big price moves to slow down the pace of market movements, please beware that the cryptocurrency markets themselves have no such circuit breakers or trading halts. However, they do have glitches and they can and do freeze or crash unpredictably at times of heavy volume and high volatility. Coinbase users have found this out, with great frustration, in recent weeks.

This is very dangerous: It means that once a panic or crash begins, you may not have any opportunity to sell your cryptocurrencies at all until the entire panic or crash has completely played out. This is different from the stock market, where even after the worst day ever you could sell your stocks for a 20% loss if you wanted to.

But if and when there is a panic and crash on the cryptocurrency markets, no market regulator can step in and halt trading for an hour. There is no end of the trading day so market participants can digest the day's action overnight and plan for the next day's market activity. There are no institutional buyers who will necessarily step in to prop up the market.

So you may not be able to say, "Ok, I'll just sell when the market falls 10% or 20% or 30%." There may be no buyers at all at those levels during a crash. Or the app or site you use to buy and sell cryptos may freeze or crash or simply not process any transactions when the price hits those levels.

Finally, the cryptocurrency markets never close, so a panic or crash could happen at any time. Above I described a scenario where big-time short sellers flood the Bitcoin futures market some time after the holidays. Well, if I can think of that danger, I'm sure the "Bitcoin whales" who own a large portion of the currency have thought of it too.

Maybe they will decide to take some big profits and start selling after they think the holiday surge is done, but before the short sellers hit the futures market. In that case, they might even decide it makes sense to do their big-time selling on Christmas Eve or Christmas Day or the day after Christmas. The cryptocurrency markets never close -- there will be nothing to stop them from doing this if they so choose.

Summary

For all of these reasons, I urge you to please sell down your cryptocurrency holdings to 1%-2% of your total portfolio. Don't risk any more than that, especially at the current inflated price levels.

I would suggest just keeping that 1%-2% in Bitcoin, rather than the other cryptocurrencies. But the main thing is to keep your total holdings down to the 1%-2% level.

Disclosure: I am/we are long BITCOIN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long Bitcoin, but I sold most of my Bitcoin and all of my Ethereum and Litecoin.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.