Of gains, liquidity, and bear market fomo

tl;dr: strategies for navigating a reflating cryptocurrency market (when it comes)

Disclaimer
This is not a solicitation to buy or sell any particular cryptocurrency or crypto asset. Here I share my personal views on the market which you mind find interesting or thoughtful. I don’t sell advice or manage money on a paid-basis at the time of writing this blog.

Summary

  • Why early stage? Gains.
  • Why liquidity? Cashing out.
  • Early stage teams have great valuations, but expect low liquidity and a lot of risk.

This is a continuation of my two most recent blogs. Here I weigh up how to play the reflation of the crypto market, which I don’t expect to be soon, but I consider what strategies I can employ to mitigate “missing out” on a reflating market. Apart from timing, I also about how to allocate capital wisely enough for the next cycle.

There are two broad strategies coming to mind:

  • Look for early stage projects. 🌱
  • Look for mid/large cap projects. 🐂

Both can make sense but there are trade-offs associated with each. While early stage projects are attractive due to huge potential gains, which can’t be ignored, I do think the romantic idea of investing in early stage teams is overdone.

Here and now in 2022

In a recent blog I outlined my thoughts on the continued cyclicality of crypto price cycles. I outlined my belief that there is a reasonable amount of predictability in nature of the cycles, but I also accept that the 4-year cycle model can eventually break. If the model breaks this cycle, then perhaps my timing will be off such that the market reflates when I’m not ready.

I fear that I will miss buying near the bottom. This is basically fomo, but for bear markets. I’m mostly risk-on, so it isn’t terrible, but that wouldn’t necessarily fix any potential misallocation.

So why not buy now? Well, buying something and then watching it decline is painful. I also remember that in the previous bear (2019) I saw an attractively priced asset then waited a week before doing anything and still got close to that price. That’s how dead the market was. I found it a psychologically comfortable time to buy 😌 and those bets eventually did fairly well.

So what if…

… the market shoots up soon and I miss out, then what to do? Well, I think “miss out” is not the correct frame of mind. Missing the pump does not mean perpetually missing the pump on everything. The top-10 might rally, but next top-30 might not, or vice versa. This means that I do need to be somewhat active in reading information from across the industry to make informed guesses.

So let’s begin diving into the two broad strategies that I mentioned above.

I didn’t know apple seeds are poisonous.

Gains vs Liquidity

The two strategies I mentioned above boil down to choosing whether I place greater importance on raw (paper) gains or on liquidity. Fortunately, it isn’t a binary choice so there is the potential to mix and match.

Seed stage projects 🏗️

Seed stage teams are just starting their journey and sometimes when I speak with them they haven’t created even incorporated, nevermind raised any sort of investment. It is actually a lot of fun to speak with such early stage teams are listen to how they think their idea can work.

Unfortunately most seed stage teams raised privately rather than go for an ICO. The SEC has almost killed the ICO, except what happens now is that teams will raise privately first and then have an ICO later (often) at a higher valuation.

So being as early as possible means the largest possible gain, but there are numerous risks that are difficult to fully comprehend at that stage.

Let’s outline the high-level risks:

  • Time delay to launch the product and token (e.g. 2 years+).
  • Risk of failure: project dies.
  • Lack of adoption upon launch.
  • Token lock-up upon launch (linear unlock over 2/3/4 years).
  • General liquidity problems in addition to lock-ups.

How well can I assess these risks in more detail? As one person, I can’t do full due diligence. It is very much possible to see a team succeed for the reasons I think will fail, or fail for the reasons I think it should have made it succeed. This is the nature of seed stage investments.

One big benefit to seed stage investing is that teams are always raising money, both during bull and bear markets. While valuations rise in bull markets they aren’t as crazy as public valuations.

If you are curious to learn more about seed stage raises I made a YouTube video aimed at builders that my prove interesting to a more general audience.

Micro caps 🏠

If retail investors can’t get into seed stage rounds then they are likely to try buying micro cap tokens with the same ambition of achieving huge gains. New projects that finish their private rounds may launch publicly at a fairly low value and hence fit into the micro cap category.

Once a project has launched some of the risks mentioned above disappear, however there are still a lot of risks involved. This is fair given that they can offer great return.

There is a place for publicly-traded micro caps alongside seed stage investments, but they also suffer from low liquidity which is a bigger problem than most people realize.

a micro cap

I find that price cycles of micro cap projects are less correlated to the larger market, they can still do well when the whole market is, but the timing of movement can either lead or lag the rest of the market. This is beneficial for that feeling of having missed the pump, but I will add caution that the overall risks may not make it worthwhile.

Liquidity risk ⛈️

Tokens with low valuations fit well with the idea of “buy low, sell high”, but this always means there are issues with liquidity. This can be due to a lack of trading venues and so a limited number of buyers and sellers. The biggest factor will is the mechanical necessity that a low valuation project can’t offer high liquidity.

On paper you made good gains, let’s even say something wild like $1000 went to $100k. I’d be fairly certain in saying that cashing out $100k of a newly launched team is hard. Expect multiple trades over multiple days.

Moreover, teams are rightfully adding lock-ups such prevent dumping by the earliest investors who made huge (paper) gains. As teams structure their fundraising over multiple private rounds the later you get in, the more you reinforce a higher value of the earliest investors.

There can actually be a terrible situation where the project has a huge valuation (Filly Diluted Value), but low liquidity. This will lead to a lot of pain for anyone trying to cash out as we saw with many projects that did sales via IDOs.

On this topic, I would suggest reading Cobie’s blog that covers the problem of over-inflated token FDVs:

Issues of liquidity become less pronounced the higher you look at the market cap list. Improved liquidity and the reduced risks of buying tokens in a project with a proven track record should not be eschewed while chasing gains.

Mid/large cap projects 🏭

Now that I have my complaints of small cap projects out of the way, I can turn to mid and large cap projects. These projects make up the main cryptocurrency market and tend to be fairly correlated in their price action: if Bitcoin is up, then Ether is up, and everything else is following.

The four largest market caps — 18/05/2022

Certain themes can have their own idiosyncratic cycle that overalls the larger market movement: e.g. blockchain gaming could go up with the market, but then have an earlier increase / decrease due to specific market demand. This phase lead/ lag is, as I said, beneficial to avoid the bear market fomo of missing the bottom.

When looking at mid/large cap projects we are hoping to find projects with proven track records. It would be nice to think these teams have found their product market fit and already have users. During the euphoria phase of a bull market these projects will necessarily be over-valued.

Now that we are in a bear market, these tokens can be down 50/60/70/80%, which now makes them more attractive. The upside won’t be 100x, but even 10x is nothing to sneeze at. For BTC and ETH I suspect

Intra-cycle, the very biggest projects probably have weakest returns but inter-cycle I suspect they have better survivability so the long-term return could be better.

Once the bull market comes back the liquidity of the mid and large cap projects is far higher then the small caps. Older projects tend to be on more exchanges and be available in a greater number of pairs (e.g. token/usd, token/usdt, token/btc etc).

This is incredibly useful as it offers an easy way to trade out. This is valuable if you are looking to exit some of your risk in the frothy euphoric phase which I’m guessing is due in 2025.

I should caution that even if you are looking at a mid or large cap project, it isn’t necessarily true that the token will have liquidity on your preferred exchange or in your preferred pair. Consequently, this means structuring the exit as multiple trades and potentially over multiple exchanges and multiple pairs.

Mixing it all together 🍲

So my overall approach will be to consider a range of market caps, across a range of themes, and hope that my multi-pronged and active approach will mean suppressing any problems of missing the bottom of this bear market.

Before we have a full-blown bull market I actually wonder if we will have a bull trap first then sucks in less experienced players before spitting them out again.

I suppose I should also say that it is wise not put all of your capital into one project, nor to put in all your money on a single day.

About me🎯

I spend the majority of my time worrying about not being wiped out by the crypto market. When I find spare time I enjoy chatting to new teams just starting their journey in the industry.

Previously, I work at the Web3 Foundation (mainly running the grants program) which launched the Polkadot network.

I’m on Twitter: @EAThomson.

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