If you haven't invested in any cryptocurrencies yet, you might find it quite tempting to dive in. On the other hand, those who have bought some cryptocurrencies might be thinking that the grass looks greener in some of the crypto coins or tokens they didn't buy. So is it worth trading cryptocurrencies?
Studies suggest that crypto critics' argument against trading this asset class, which is that it's purely speculative, is true. In fact, crypto and especially NFT buyers are statistically more likely to gamble on sports than the average non-buyer.
Think you can time the crypto market? Think again
Like any asset class, not every cryptocurrency will make a good investment. When investing in stocks, bonds, or other assets, you can generally make educated predictions about what might send prices up or down, but it's far more difficult with cryptocurrencies.
While bitcoin has been around a long time, many investors find lesser-known altcoins more appealing because they're less expensive and prone to massive price spikes at different times. Some investors think they can successfully buy low and sell high, but studies show just how impossible it is to do that with cryptocurrencies.
Well-known investors tell others not to try to time the market because it's impossible to do so, and this advice holds even more true for cryptocurrencies. The primary reason it's harder to predict cryptocurrency prices is that it's unclear what drives prices. So why is that?
What are you buying when you buy cryptocurrencies?
In a recent post for the CFA Institute, Nicolas Rabener noted that money and talent are flooding the cryptocurrency market. Software developers are jumping ship from Google, and JPMorgan financiers are fleeing the investment bank to join crypto startups.
Additionally, the market cap of the global crypto market continues to hover around $2 trillion. That puts it on par with or sometimes larger than Germany's entire stock market, which contains many blue chips like Volkswagen and BMW.
Investing in cryptocurrencies is as easy as buying stocks, with popular retail trading platforms like Robinhood providing access. However, that doesn't necessarily mean you should dive into the crypto market. For one thing, Rabener said that when investors buy tokens like Shiba Inu, which has a $15 billion market cap, it's unclear what they're actually buying.
While it's true that the purchase results in SHIB tokens being deposited into the investor's digital wallet, what they own is unclear. When you buy a stock, you own a piece of the company, but this isn't true of cryptocurrencies. Critics point out that cryptocurrencies are only worth what people think they are worth because they have no inherent value, so is that true?
What drives crypto performance?
Rabener started with definitions for the purpose of his piece. He defined tokens as blockchain-based smart contracts and crypto coins as the native token of a blockchain. Those definitions mean ether, or ETH, is the native token of the Ethereum blockchain, while Shiba Inu, or SHIB, is an Ethereum-based token. Rabener clarified that all coins are tokens, but not all tokens are coins.
He noted that every token and crypto coin represents a currency, which means that supply and demand should dictate the price, just as it does in the foreign exchange market. Of course, the issuers influence supply. For example, Bitcoin developers have capped the network at 21 million, while Ethereum developers have bought back ether and "burned" them.
In the currency market, the values of in-demand currencies like the U.S. dollar are higher than less-popular currencies due to increased demand. Rabener argues that the same principle should hold true in the cryptocurrency market, so he examined the correlation between crypto prices and volumes.
However, he discovered that higher volumes do not necessarily mean higher prices in the crypto markets. Rabener found an almost zero rolling correlation between volume and price across all tokens between 2014 and 2022 on both a monthly and annual basis. That lack of correlation demonstrated no positive relationship between popularity and price.
Gambling on cryptocurrencies
Thus, Rabener concludes that speculation is what's driving crypto prices. He added that this is particularly clear with Shiba Inu, a meme token with no underlying product. He said that investors are merely gambling on other investors continuing to drive up the price.
According to Rabener, "Investors are simply playing a game of musical chairs and betting that they will find a seat before the music stops."
A separate study offers more concrete evidence than Rabener's conclusion that speculation is what's driving crypto prices. In a recent report, S&P Global Market Intelligence provided the results of a study in which it tried to determine who is buying cryptocurrencies and non-fungible tokens.
According to S&P, digital asset traders are "huge sports betters." The firm found that only 20% of all the study participants it polled had bet on a live sports game in the last 60 days. However, 62% of those who trade cryptocurrencies had bet on live sports within the last two months. In fact, the rate of gambling on sports was even higher among NFT buyers, at 81%.
"The notorious volatility associated with digital asset trading probably fits well with the risk profiles needed to place bets on sports," S&P Global Market Intelligence concluded.
Is it worth gambling on new cryptocurrencies?
With such a high correlation between gambling and buying cryptocurrencies, investors must ask themselves whether it's worth it to speculate on digital currencies, especially new ones. While it's true that some investors have made millions of dollars speculating on cryptocurrencies, such successes may not be typical, especially when it comes to hot new cryptocurrencies.
In a recent report, Jump Crypto, the crypto division of quant trading firm Jump Trading Group, provided the results of a study that looked at returns on buying new tokens relative to bitcoin. It found that the market for new tokens appears "surprisingly efficient, in that returns are neither systematic nor predictable."
As any value investor will tell you, market efficiency can make it difficult to generate alpha on investments. Value investors typically look to exploit market inefficiencies. And as it turns out, Jump Crypto found that average returns on new tokens are close to zero when looking at a variety of time horizons and entry points.
The firm found that individual returns are highly skewed in either direction, resulting in an average return of around zero. Jump Crypto added that these returns don't depend on the entry strategies used by the investors except in some extreme cases.
It also discovered that returns on new tokens could not be predicted based on the underlying crypto environment in which they are launched, except in some extreme cases. The returns also couldn't be predicted based on their peers' relative performances.
According to Jump Crypto, 80% of new token purchases have generated negative returns after one year. When you add the lack of predictability, it looks even more like gambling.
As the old investment adage goes, with great risk comes the possibility of great reward, and this certainly holds up in the crypto markets just as much in the traditional markets. For example, Axie Infinity's tokens had returned 9,000% at the one-year mark. Stories like this are why so many investors are willing to try their hand at investing in cryptocurrency markets.
However, investors who do decide to take a chance on this asset class should go in with their eyes wide open, understanding just how much speculation is involved and how great the risk of losing money is.