Do you want to help Iota become money? Don’t HODL

This is the first of a series of articles I plan to write about economic and financial aspects of the IOTA token. If you enjoy it, don’t hesitate to follow me on twitter at @TulipoJM. Needless to say, do your own due diligence before investing in cryptocurrencies and always take into account the huge amount of risk of loss you are assuming when investing. Spanish version of the article coming soon.

Iota is set to become the best cryptocurrency when it comes to fulfilling the physical properties of money. It is durable, fungible, divisible, has almost no transaction costs and, in contrast to many other cryptocurrencies, it has perfect scarcity (no new Iotas will ever be created) and the governance process will not be held hostage by miners with misaligned incentives. However, fulfilling these properties doesn’t turn an asset into money. To become money, an asset has to be monetized, that is, it has to be used by a sufficient number of people to carry out the functions of money. These functions of money are: medium of indirect exchange, store of value and unit of account. This article will be centered around the store of value aspect. We’ll see what it means to be a store of value, how good IOTA and Bitcoin serve this purpose and why a holding culture is detrimental to the process of becoming a store of value (and to your finances).

What is a store of value?

A store of value is an asset used to transfer purchasing power from one period to another. In order to do that successfully, the asset must obviously have a stable price. We can further divide the stable price characteristic in two categories: short term and long term price stability. The short term stability refers to liquidity. You must be able to buy and sell huge quantities of the asset without moving the price. As seen in Bitcoin, liquidity slightly affects long term price stability but high liquidity is not sufficient to ensure long term stability. The key to long term stability is stable demand.

How stable are the prices of cryptocurrencies?

You don’t need to be a genius to realize that cryptocurrencies’ prices are highly unstable, but, how much? And, how stable are assets that are actually a store of value? Let’s have a look at some volatility measures. Here are the annualized volatilities of IOTA and Bitcoin calculated as the annualized standard deviation of the percentage change in price each day. This measure captures the average dispersion of cryptocurrencies’ prices over their mean.

We can also look into a more detailed evolution of the volatility of the two cryptocurrencies by looking at their historical 30 day annualized volatility.

Here we have data from the 2017 and 2021 bull runs. We have the median price of the 12 months prior to the peaks, the lowest prices within the12 months after the peak and the respective price increases and decreases. Please note that the 2021 cycle is not yet over and we are likely to experience larger drawdowns.

With this data at hand we can answer the previous questions. How volatile is Bitcoin and IOTA? Bitcoin, very volatile, Iota, very very very volatile. How stable are assets that are actually a store of value? To answer this we can look at gold. Historically, gold’s volatility has fluctuated between a 10% and 30% annualized volatility band, with temporary peaks of 60% in times of financial stress like march 2020. By now, it should be clear that the digital gold bitcoin narrative is pure bullshit.

Why is the holding mantra detrimental to price stability? (and to your finances)

First, let me be clear, 90% of the current demand for cryptocurrencies is pure speculation and we will not achieve a significant stability in prices until that changes. However, the action of speculators can help alleviate the instability or exacerbate it. Holding exacerbates it. Let’s illustrate how this process might work:

In the start of a bull run, the price of cryptoassets starts to rise. The increase is slow at first but accelerates over time in a sort of reflexive process (a fancy name for a self-reinforcing process) as FOMO kicks in. You tell your family and friends about your gains, some of them might buy and make some decent money on their investment so in turn they tell about it to their family and friends. Everyone is happy and excited about their investment and many people have unrealistic expectations about price increases. These people, because of the hold mentality, refuse to sell even when facing ridiculous high prices. As long as the pace of newcomers continues the price will continue to rise. Ultimately people willing to keep buying crypto decrease and people wanting to sell exceed people wanting to buy. It is then that the reflexive process starts working in the other direction. As the good Michael Burry says, FOMO parabolas don’t resolve sideways. All crypto believers have already bought and no one wants to buy your crypto at these prices. The exit door is very narrow and the price starts collapsing. If you bought prior to the start of the bull run you are likely ok but, if you bought during it, you are rekt.

So, what should speculators do?

‘Ride’ the token, don’t ‘Hodl’ it. First, buy your tokens during quiet times. If the price has increased by 500% YoY it is probably not a good time to buy. Second, sell your tokens gradually as price gets parabolic. If you sell them using limit orders you are providing liquidity to the market. By doing that, you are offering liquidity to newcomers and realizing gains. Worst case scenario, you lose some gains. Best case scenario, the price crashes and then, there you are, with a ton of cash ready to provide some liquidity and increase your token stack. If a sufficient number of people acted that way, the price volatility wouldn’t be so high.

Lastly, I would like to make a brief comment about the state of the market: be careful. The amount of fraud and delusion in the market right now is staggering and everything could come down anytime. Tether is particularly worrisome, as a great part of the liquidity in the cryptocurrency market depends on it. 55B in daily volume, 63B in outstanding tokens, only 3% of those covered by real USD. Right now its peg is sustained on pure faith and faith can vanished in a matter of hours. Funny enough, 2018 lows happened at the same time tether lost its banking. By then the number of outstanding tokens was 2,5B. Beware of having your money in Bitfinex and Binance as they are at the center of all this fraudulent mess.

Last updated: 2/07/2021