Volatility

While speaking at that conference, Mr. Draper was asked about Bitcoin price volatility – how it affects the crypto market, investment, and adoption. He gave a fascinating answer. He said that if you think about it in the opposite direction – that is, it’s not the Bitcoin price that fluctuates around a stable dollar but rather the dollar price that swings around stable Bitcoin – you will stop worrying about it… “These governments are trained to print more money to be more relevant. Well, we all know that as soon as I can buy my food, clothing, and shelter in bitcoin, I’m not going to want to hold – and neither will anyone else – any cryptocurrency or currency tied to any fiat political force,” he also once said.¹ It’s difficult to argue with a man who made more than half a billion dollars on Bitcoin. And it shows us that the volatility is irrelevant if you know that the general direction is growth (Figure 11-1).

A line graph depicts Bitcoin price growth from 2013 to 2021. The line follows an increasing trend with several fluctuations.

However, the trends and dynamics of the Bitcoin and other cryptos’ prices are significant for both crypto investors and traders for different reasons. Investors, once again, leverage the general direction toward growth. They understand that the price of Bitcoin slowly but surely grows with time, despite the fluctuations, simply because, unlike fiat currency like the dollar, Bitcoin has a finite supply. At the same time, more and more people are involved in the crypto business daily. So the more people (potential investors) are exposed to the idea of crypto, the higher the Bitcoin price because the supply is growing slower than the demand. Don’t forget about Bitcoin reward halving that happens every four years, when miners start getting 50% fewer bitcoins for each mining block compared to the previous four years.

Traders, however, have a different view of market dynamics. They don’t care much about Bitcoin and crypto market growth but leverage the fluctuations. They can earn on both ups and downs of the market. It’s easier to make money on trading when the market is moving up. But it does not mean you can’t get gains when it’s falling. There is a method called shorting, which works similarly to the stock market, and we will discuss it later. But now, let’s se e first how investors make money on crypto.

Why People Invest in Crypto

Before all, I should state that the process of crypto investment contradicts its main ideas of decentralization and independence. Investment is typically made by converting fiat currency to crypto using exchanges, and most exchanges are centralized, regulated corporations. But let’s face it, crypto developers wouldn’t be able to develop without investment, so this strange symbiosis of capitalists and cyberpunks exists and propels the crypto tech very fast.

And the second reason (perhaps it should be the first) is the high returns that the crypto market promises compared to the humble average of 10% returns delivered by the stock market (think of Tim Draper’s example at the beginning of this chapter). On some crypto projects, investors get hundreds or even thousands of percent of returns in their investments.

The community of crypto investors is growing fast. 13% of US investors have traded cryptocurrency in 2020.² It only took four months for the crypto population to almost double from 106 million in February to 203 million in May 2021.³ So, you can imagine how many people have already invested in crypto today. Such a speed can also be explained by a phenomenon called FOMO (fear of missing out). It happens when people learn about a new opportunity and rush to leverage it in the nick of time before (as they think) it’s too late to get any gains. FOMO is a successful marketing technology employed by multiple crypto projects, especially those going through ICO (Initial Coin Offering).

I happened to meet the man who coined the term ICO on one of the social media platforms. J.R. Willett came up with the now-famous three-letter abbreviation back in 2013.⁴ The word has its roots in the traditional stock market. IPO (Initial Public Offering ) is an existing tool used by conventional startups to raise capital from institutional investors. Crypto developers took the heavily regulated IPO concept and teleported it into the crypto world, which did not have the burden of government control.

ICO and its derivatives, such as IEO (Initial Exchange Offering ), IDO (Initial DEX Offering), and other forms of Initial “X” Offerings, seek to sell as many coins or tokens as possible. For many crypto projects, IXO is not just the only chance to sell their token to fund the development team but also their only purpose. Some don’t even plan to do any development after the sale is made. So, when investing in an initial offering, you need to understand whether the project has any solid technical white paper and development road map besides just a commercial business plan.

Staking

The term DeFi (Decentralized Finance) was coined relatively recently and came into widespread use at the same time when DeFi staking became a new popular way of crypto investment. First crypto investors were HODLers (HODL stands for Hold On for Dear Life), meaning they buy crypto and hold it for a long time until it (supposedly) significantly raises in price. However, the HODL investment does not bring dividends, so it is more like buying gold or other precious metals than investing in stocks, which, in addition to the growth, provide periodic dividends paid to the shareholders.

Unlike “traditional” HODL ideology, DeFi staking offers a more pragmatic model of investment similar to short-term CD (certified deposits) provided by traditional financial institutions or even to the stock market, when you lock a particular amount of cryptocurrency (“stake”) for the specific period in exchange to dividends paid to you by the network or by the financial institution such as an exchange.

The original form of staking, or DeFi staking, was provided by PoS and DPoS coins which required validators to deposit a stake to prove their loyalty to the network. The stakeholders received mining rewards and/or transaction fees as dividends generated by their stake. The DeFi staking process is usually based on smart contracts and can be fully decentralized. But centralized crypto exchanges, who constantly search for new revenue sources like any other commercial or financial institutions, liked the idea and started offering staking in collaboration with development teams of new crypto projects. This type of staking is not DeFi because it has nothing to do with decentralization.

The way “CeFi” (centralized finance) staking works is simple. The development team responsible for token XYZ usually owns a significant chunk of their overall token supply, generated by premining or other means and used for marketing, developers’ salaries, and other expenses. The XYZ team partners with a centralized exchange and creates a staking offer by depositing a dividend fund. Investors in the staking need to buy a particular amount of XYZ and deposit it in an exchange account. After some time, as defined by the agreement and can be several months, the participants can unlock the tokens and get a reward from the dividend fund.⁵

It sounds slightly like a Ponzi scheme,⁶ but it’s not. The total supply of XYZ tokens is limited (usually), and both the XYZ team and the exchange leverage the fact that developers have a significant number of XYZ, which they generated out of thin air and which they need to sell to get paid for their hard work. Eventually, it’s a win-win scheme for all participants. Developers sell and promote their tokens. Exchanges get the extra fees. Investors get their dividends , amounting to tens and even hundreds of percent.⁷ They need to be lucky enough not to find the price of XYZ dropped to zero by the time they can unlock their stake and get their dividends.

Crypto Trading

Several different “interest” groups of people are involved in crypto, such as developers, investors, miners, and simple users. However, they have at least one thing in common: they are all traders.

When you start dealing with crypto, the chances are your very first experience looks like trading because you need to acquire some cryptocurrency by exchanging it for your dollars or any other fiat currency. There are ways to get some crypto without spending your money – we talked about it in Chapter 9. But at some point, you will need to trade sooner or later – just to cash out your investment revenue, invest in a “better” coin, or maybe simply “exit” and get your fiat money back.

A one-time exchange from dollars to bitcoins does not make you a trader. Most probably, your first experience will not be the best and most efficient one – you will pay a high fee and get a bad price. But at least you will get the idea.

I have never been a professional trader, so if you’re looking for a serious crypto trading manual, this book is the wrong source. However, if you just need some info to start, you can get it here, as I have done some trading for fun. Let’s start with the definition of what trading is.

Once again, if you just exchange your hundred bucks for some bitcoin – it’s not trading; it’s just a purchase. It might look like trading and have all the fancy attributes of trading, though, if you use one of the existing crypto trading platforms. Even if you buy a significant amount of crypto and pay much more than just a hundred bucks, it is still not trading – it is an investment.

You invest when you buy a crypto asset and wait for a long time until its value grows. But traders don’t wait too long. You do crypto trading when you continuously and frequently exchange one cryptocurrency with another to earn revenue. The frequency ranges from several days, sometimes weeks, months, to milliseconds.

The most common trading method is buying a particular crypto asset when it’s “time to buy” and selling it when it’s “time to sell” – at a higher price. The science (or art?) of trading is just correctly determining (or guessing?) those two times. The right time to buy is when the asset is at a low price and just about to start growing. Accordingly, the right time to sell is when the asset is at a high price which is just about to stop growing and start going down. It sounds pretty simple, but it’s not trivial at all.

First, it’s not even clear whether trading is science or art. There are many “scientific” techniques to predict the price trajectory, and some of them are very convincing. But let’s be realistic – if those methods were reliable, everyone could use them and become a millionaire. So, for many people, trading is still more art than science. It does not mean, however, that it’s impossible to earn money by trading.

Trading is pretty straightforward when the entire crypto market continuously goes up (“bull market”). You just buy, wait, and sell. But when the market is going down (“bear market”) like during uncertain times such as “crypto winter,” trading might become too risky unless you short your positions. Shorting is a more sophisticated trading technique that allows traders to earn money when the price falls. It sounds counterintuitive, but it works well if you know what you’re doing. I don’t recommend starting from shorting if you're a beginner, but we can at least see how it works. So when the price is falling, how can you even earn anything?

The way shorting is usually done is the trader, instead of buying the asset, gets it as a loan (traders can use their own assets as well). Then you sell it at the current price, presumably about to go down soon, wait until the price falls, buy the same amount of asset at a lower price, and finally return the loan (the same amount of crypto assets you initially got from the loaner). Since you purchased the same amount of crypto for a lower price, you spent less than you got when you sold them. The difference is your trader’s revenue!

Sounds interesting, but let’s go back to the “standard” way of trading and see how to determine the right time to buy and sell. Surprisingly, there are people (professional traders) who can provide this information to you in the form of signals. Of course, in most cases, they want you to pay for this info as, in their opinion, it helps you earn big bucks so you can share your revenues with them to show your appreciation. There are buy and sell signals which tell you it's the right time to buy or sell particular crypt o.

Trading Bots

Crypto trading bots are based on a straightforward principle of automated placement of buy and sell orders. To get some profit, you (or the bot) need to buy something at one price and sell it at a higher price (note that the bots can do shorting as well, but we simplify the use case). The difference between the buying and selling price multiplied by the number of coins/tokens is your revenue, as simple as that. The tricky part is determining the right time to buy and sell. Multiple techniques help traders answer those questions, and many use those methods successfully. But what if you don’t want to spend a lot of time researching and monitoring the market but have significant assets and still want to utilize them for trading? Here come the trading bots – a software that allows you to “fire and forget,” that is, set up the requirements and conditions and let the app do the work for you.

Unlike human traders, trading bots can work 24/7, which resolves the issue related to the fact that the crypto market is open around the clock and not just during specific work hours and days like the stock market. So how do trading bots know when to buy and sell? They are not that smart, but some people are. Experienced traders monitor the market using various indicators telling them whether it’s time to buy or sell a particular asset. Once they are sure this is the time, they issue a signal to everyone who is subscribed to their service. Bots are configured to listen for particular signals, which come as free or paid subscriptions. The only work you need to do as the bot operator is to find the most reliable signal sources and set up your bot to follow them. The bot will do the rest.

Various crypto trading bots are available for free or as paid licenses or subscriptions.⁸ You can choose the one that best fits your needs and your wallet. Some bots require much time to configure and set up, and you must host them on your machine (or cloud server if you want to ensure uninterrupted 24/7 operations). For a newbie trader, starting from a bot hosted by the owner is probably easier and requires minimum configuration and maintenance effort .

Cryptohopper

Cryptohopper , in my opinion, is one of the best trading bots. It is hosted in the cloud, so the only thing you need to do to start trading is just create an account. You can even start with a free subscription if you want to play with it a little bit before starting serious trading. One exciting feature is called paper trading , which is an exchange simulator. You can test-drive your trading strategy, whether based on your own methodology or fully automated and based on signal subscriptions (Figure 11-2).

A screenshot depicts the Cryptohopper dashboard with the paper trading template selected. It is divided into five sections and shows several currencies and a panic button.

In any case, the advantage of paper trading is that you don’t risk any real money besides just a relatively small fee for the Cryptohopper and signal subscriptions (unfortunately, paper trading is not included in the free Cryptohopper tier). Paper trading allows you to self-learn the basics and the nuances of trading before investing your real crypto assets. Once you feel confident and your trading strategy is polished, you can deploy the same rules to the actual exchange. Cryptohopper supports various exchanges⁹, including the two I mentioned already – Coinbase Pro and Kraken.

To simplify initial setup, configuration, and ongoing maintenance, Cryptohopper developers introduced the concept of templates, strategies, and signals. When you create a new Cryptohopper account, it comes as bare metal, without any configuration. Since the bot has a lot of bells and whistles to play with, it’s better to start with one of the predefined templates, which defines at least what exchange and base currency you will work with, along with some other essential parameters. For example, you want to connect to the Coinbase Pro exchange and start trading from US dollars (that’s going to be the currency your bot will buy other currencies with and sell to). You can select a corresponding template that will enable Coinbase Pro as an exchange and USD as the base currency (Figure 11-3).

A screenshot depicts the Cryptohopper template for trading on Coinbase Pro with U S D. Names, exchange, quota currency, and paper trading are the labels shown.

Trading Strategy and Paper Trading

The next step is selecting your trading strategy . You can choose signals only (if you rely exclusively on recommendations provided by the third-party analysts), a marketplace strategy (if you want to have your own strategy but initially buy it from a third-party expert), or a strategy you’ve designed yourself.

You can select signals if you don’t have time to learn all the nuances of numerous crypto projects and sit day and night monitoring their technical indicators. Templates, strategies, and signals are free or for sale on the Cryptohopper marketplace (Figure 11-4).

A screenshot depicts the subscriptions for trading signals on the Cryptohopper marketplace. The left side of the screenshot depicts various categories.

The Cryptohopper user interface is very intuitive and user-friendly, and there are a lot of instructions and training videos provided by the development team and third-party developers available for the users.

If you want to play with Cryptohopper, you can do the following:

• Start with a minimum paid subscription level that enables the paper trading feature.

• Select a template with the exchange and base currency that you would use in reality.

• Subscribe to free and paid signals that support your exchange, and deposit the amount of paper money equal to the one you would invest if it were actual trading.

• Play with it for several days or weeks until you see it’s working out for you.

Paper trading is not the same as actual trading, but at least it will give you some idea of how it works and what to expect.

Fake Exchange Volumes

There is another interesting and important application area of trading bots, which is being kept out of the public eye for the most part. The fact is that many crypto exchanges use trading bots to create fake trade volumes. These bots differ from those that help traders, which we reviewed before. Their primary purposes are market making and volume making. Market making allows the exchange to create an effect of sufficient traders’ interest by filling up the order book with buy and sell orders.

Let’s say an exchange lists a new token that generates little to zero interest from investors. If they list such a token for trading with Bitcoin or USDT, there will be no or a few orders, especially buy orders, making it difficult to form the price, not to mention the bad impression. What exchanges do is ask the project development team to create a trading pair fund that would allow placing multiple buy and sell orders over the price spectrum to make it look like many buyers and sellers for the token. In some cases, the market-making bot can even help manipulate the price by spending more on buy orders and gradually increasing the buy order price.

Another type of trading automation used by exchanges is the volume-making bot. Trading volume is one of the main parameters used to rank exchanges, significantly influencing the exchange's reputation. The overall exchange trading volume is calculated as the amount of all trades for all trading pairs within 24 hours. If you look at CoinMarketCap, you can see billions of dollars in daily trading volumes for highly ranking exchanges. I must tell you the truth: most of these volumes are fake, even on very popular and top-rated exchanges. Even if the exchanges themselves don’t fake the volumes, it’s done by the project teams as many exchanges require them to maintain minimum daily volumes for their tokens. If the token or coin is not traded enough , the exchange does not make enough money on it and therefore can decide to pause the trading temporarily or even delist it permanently. That’s why we (crypto users) better switch from CEX to DEX – decentralized exchanges don’t have such demanding requirements, so their activities are more transparent, and their reports are more honest.

What’s Next?

Cryptocurrencies are still one big technological and economic experiment. Most cryptos were created in an attempt to enhance Bitcoin, which is by far still a winner today. If not an absolute winner, then at least a strong leader, with just under half of the total crypto market capitalization (Bitcoin dominance) that includes several thousand altcoins and tokens.

But the stakes are still high. As it is sung in one famous song, the winner takes it all.¹⁰ Those projects that do not offer new technological solutions exploit the trend. They elevate the overall cost of the FinTech revolution by taking somebody else’s share of the financial crypto pie.

This chapter concludes the second part of the book, which talks about the practical aspects of cryptocurrencies. I believe you are well prepared to move to the final part, where I will walk you through the main steps of the crypto project and share some tips that will become handy if you decide to create your own money.