Crypto Markets Are Getting Harder: The End of Easy Money

Source: Blockworks Original Title: Links: Trading, valuations, and the end of crypto’s ‘golden age’ Original Link: https://blockworks.co/news/links-trading-valuations-golden-age

The Golden Age of Crypto Is Over

The newsletter writer Zeneca uses his perspective as a former poker player to declare that crypto’s golden era of easy money is over: “It’s only going to get tougher from here on out,” he warns.

When Zeneca started playing poker for money in 2003, he says “the average level of skill was extremely low,” and as a result, “basic strategies worked” to make money. From there, however, the game progressively professionalized, and by 2010 making money in poker required learning math, statistics and game theory.

Today, the game is so efficient that, to have any chance of being profitable, you have to learn to play theoretically perfect poker from AI solvers.

This progression mirrors what happened in equities markets. In the 1990s, you could make money in equities just by being a little quicker or paying a little closer attention than your human competitors. If you saw a positive headline about a company, you had a few seconds to buy some stock that you could probably sell a few minutes later for a profit.

But equities professionalized on about the same timeframe as poker. Starting in about 2000, quantitative and algorithmic trading made markets increasingly efficient at the same time that more and more people were trying to trade them. By about 2005 there were too many traders trading against not enough investors.

Now, equity markets are so efficient you need a doctoral degree in a quantitative science to have any hope of trading them.

The crypto market seems to be progressing along the same path. Zeneca likens crypto now to poker in 2012: “It’s still possible for many people to make it with a bit of work. But it’s no longer like shooting fish in a barrel.” As with poker and equities, that’s partly because you’re now often competing with algorithms — sniper bots being one example. Mostly, though, there are too many traders in crypto relative to the amount of investors in crypto.

Zeneca warns that traders waiting for a new wave of retail enthusiasm to make trading crypto easy again will be disappointed: “Just about anyone that has ever had any interest in speculating on crypto would have done so by now.” Trading crypto won’t get any easier until there are more investors to trade against.

Token Valuations Under Scrutiny

The crypto-native investor Santiago Roel Santos thinks it’s no mystery why tokens have been going down: “We valued casino flow like recurring software revenue.”

Token investors began paying attention to revenue this cycle and protocols began to prioritize, with notable success. An all-time high of $1.9 billion of value was distributed to token holders in Q3. But, perhaps disappointingly, these payouts have not helped token prices much.

Santos says that’s primarily because the quality of the revenue is so low: “You don’t give a Shopify multiple to a business that only makes money when the casino is full every three to four years.”

Critics responded to Santos by calling this a boomer take: Protocols are not businesses, they argue, they’re networks, so traditional metrics don’t apply. Santos responded in turn by arguing that valuing crypto on its network effects leads him to the same conclusion: Tokens are egregiously overpriced.

“Crypto is valued at 5x–50x more market cap per user than Meta,” Santos says, “without having any of the economics that justify it.” That’s surprising, in a way: The purpose of crypto is to disintermediate businesses like Meta by creating peer-to-peer networks controlled by users who can come and go as they please. Surely a user in that kind of network will be less valuable than a user trapped in a network like Facebook?

Alternatively, it might be that crypto investors are paying up for tokens in anticipation of the imminent tokenization of everything — in which case, a huge influx of users will justify today’s valuations even if the open nature of blockchains makes it hard to monetize them. Santos thinks the influx of users is possible, but doesn’t want to pay for it: “Right now,” he concludes, “too much future is priced in upfront.”

Perpetual Futures and Traditional Finance

Patrick McKenzie thinks perpetual futures are unlikely to catch on with equities speculators, mostly because “liquidations are not the business model of traditional brokerages.” Liquidations are a good business for crypto exchanges: certain head platforms charge a 0.5% liquidation fee on the notional value of the perps trades they liquidate. On a trade leveraged 20x, that’s a 10% fee!

McKenzie doesn’t think TradFi customers will pay those kinds of fees — especially as “learning on a day when markets are down 20% that you might be hedged or you might be bankrupt is not a prospect that fills traditional finance professionals with the warm and fuzzies.”

In other words, TradFi professionals are unlikely to accept the perps market practice of auto deleveraging (ADL). McKenzie concisely defines ADL from the perspective of the broker: “You can either force the customer to enter a closing trade or you can assign their position to someone willing to bear their risk in return for a discount.”

ADL is the clever mechanism by which trading venues ensure there are always enough losers to pay the winners. But it’s a messy process: During market crashes, perps venues have liquidated winners far more than necessary. This estimate is highly disputed, but whatever the real ADL numbers are, margining practices are much friendlier in equities.

So it’s hard to argue with McKenzie’s conclusion that the crypto industry is unlikely to “export” its perpetual futures to traditional markets. On the other hand, using perps to import retail speculators in search of easy money might still work. People love to trade.