How money moves cross the cryptocurrency ecosystem
by Adam Haeems
Introduction to Cryptocurrency Market Analysis and Fund Flow
The cryptocurrency market is a dynamic and rapidly evolving ecosystem. To successfully navigate this landscape, it is helpful to understand the flow of funds across various market segments. By analysing the movement of money within the market, investors can identify 'waves' of price increases as funds trickle from one segment to another. Recognising this cycle offers allows for more informed decision-making when investing in this space.
The key benefits of understanding the flow of funds cycle within the cryptocurrency market include:
Anticipating significant market movements: By identifying patterns in fund flows, investors can predict price trends and capitalise on potential opportunities.
Gaining insight into larger players' actions: A deeper understanding of fund flows provides valuable information about the strategies and positions of major market participants.
Determining the current market cycle stage: Recognising the current stage in the flow of funds cycle can improve asset allocation and timing across different market segments.
The flow of funds cycle typically begins with an influx of money into Bitcoin, leading to a surge in its price. As funds move from one segment to the next, new waves of price increases are triggered in those respective markets. In the following sections, we will delve deeper into this phenomenon, exploring each stage of the cycle and examining the benefits of staying attuned to these market dynamics.
1. The Flow of Funds Cycle – Fiat Onboarding
The flow of funds cycle is a multi-stage process that generally involves six to seven distinct stages.
The cycle begins with fiat onboarding, where investors convert traditional currencies, such as GBP, EUR, and USD, into cryptocurrencies (inc Stables) via fiat on-ramps like Coinbase, Bitstamp, as well as through stablecoin issuers like Tether and Circle.
Fiat onboarding plays a crucial role in the cycle as it initiates the process and sets the stage for subsequent price appreciations across various market segments. The cash injection that occurs during fiat onboarding acts as a catalyst, driving the flow of funds from one stage to the next and generating opportunities for investors in the cryptocurrency market. In the following sections, we will explore the remaining stages of the flow of funds cycle, highlighting the key characteristics and implications of each step.
2. Bitcoin as the First Investment
After fiat onboarding, investors typically turn to Bitcoin (BTC) as their first cryptocurrency investment. Due to its widespread popularity, significant market capitalisation, and frequent media coverage, Bitcoin is often the most attractive option for newcomers entering the market.
As the flow of funds into Bitcoin increases, so does its price. This uptrend prompts some investors to realise some profits and start searching for additional opportunities within the cryptocurrency space, aiming to further amplify their returns. With newfound profits in hand, these investors become more inclined to explore alternative investment options beyond Bitcoin.
To summarise this stage of the flow of funds cycle:
Investors deposit cash with a broker and purchase Bitcoin as their initial investment.
As more people invest in Bitcoin, its price rises.
Profits accumulate, and investors start looking for other opportunities in the market to enhance their returns.
This stage sets the stage for the funds to flow into other market segments, contributing to the 'waves' of price increases observed throughout the cryptocurrency ecosystem.
Image showing flow of funds from Fiat into Crypto
The flow of funds in the cryptocurrency market can be visualised through snapshots that track the movement of investments across various segments. An example of this above reveals the dominant position of Bitcoin as the primary recipient of funds flowing from fiat currencies like the US Dollar and Japanese Yen.
In the snapshot, Bitcoin (depicted in green) attracts the majority of investments originating from fiat currencies, demonstrating its continued popularity as the first investment choice for many entering the cryptocurrency market. This further supports the observation that Bitcoin is the go-to option for newcomers and serves as the initial entry point into the world of digital assets.
This snapshot provides valuable insights into the early stages of the flow of funds cycle, illustrating how funds move from traditional currencies into Bitcoin.
3. Diversification into Large Cap Altcoins and the Emergence of 'Alt Season'
As investors accumulate profits from their Bitcoin investments, their focus shifts toward seeking higher returns through diversification. Large cap altcoins, such as Ethereum (ETH), often become the primary beneficiaries of this new investment flow, as they represent the next tier of cryptocurrency assets in terms of market capitalisation and are widely paired directly against BTC (e.g ETH/BTC) to make trading easy.
The process of diversification typically unfolds as follows:
Investors, driven by their desire for increased returns, explore altcoins as an alternative investment option.
Ethereum, being the largest altcoin by market cap, attracts a significant portion of this new investment flow.
The inflow of funds into large cap altcoins leads to price appreciation, often coinciding with a plateau or decline in Bitcoin's price.
This shift marks the beginning of the so-called 'Alt Season'.
The transition from Bitcoin to altcoins is facilitated by the convenience of trading pairs that allow investors to directly exchange their Bitcoin for altcoins on the same broker or exchange platform, without needing to convert back to fiat currency.
It is important to note that large cap altcoins tend to exhibit higher volatility than Bitcoin due to their smaller market capitalisation, making them a higher-risk investment. However, this increased risk is sometimes often offset by the potential for greater returns, as price movements in these assets can be more pronounced.
During this stage of the flow of funds cycle, investors' risk appetite evolves as they become more willing to explore higher-risk, higher-reward opportunities in their pursuit of greater returns.
Image showing flow from BTC into Major Alts
The Flow of Funds Cycle in Action – The 2017/2018 Bull Run
Image showing timing of BTC and ETH during 17/18 bull run
A prime example of the flow of funds cycle at work can be observed in the bull run of 2017/2018. A comparative chart of Bitcoin and Ethereum's prices during this period provides valuable insights into the dynamics of the cycle.
In this chart, Bitcoin is represented in blue, and Ethereum is shown in orange. Key observations include:
Bitcoin reached its all-time high of approximately $20,000 on 11 December 2017.
As investors began to convert their Bitcoin profits into Ethereum, Bitcoin's price started to decline.
In contrast, Ethereum's bull run continued, reaching its peak of around $1,400 on 8 January 2018, 28 days after Bitcoin reached its high.
The 2017/2018 bull run clearly demonstrates the significant impact that the flow of funds can have on price action. As investors shifted their profits from Bitcoin into Ethereum, the price of Ethereum continued to rise, even as Bitcoin's price began to retreat. This example highlights the importance of understanding the flow of funds cycle, as it can guide investors in determining which assets to hold for optimal returns during different stages of the cycle.
4. Diversification into Mid Cap Altcoins and Increased Risk Appetite
As investors realise profits from their ETH investments, they begin to search for even higher returns by diversifying into mid cap altcoins, such as Stellar (XLM), IOTA, Dash, and Dogecoin. This diversification leads to substantial price appreciation in these mid cap cryptocurrencies.
The key aspects of this stage in the flow of funds cycle include:
Profits from Ethereum investments are rolled into mid cap altcoins in pursuit of higher returns.
Mid cap altcoins, often built on the Ethereum platform, have smaller market capitalisations than Ethereum.
Many mid cap altcoins are conveniently paired with Ethereum on exchanges, making trading between them relatively easy (e.g., XLMETH).
Due to their lower public profile, mid cap altcoins attract less attention; however, when funds flow into this market segment, their small market caps can result in impressive price changes, with 100-200% gains not uncommon.
Mid cap altcoins experience greater volatility than large cap altcoins, making them riskier investments. This stage of the flow of funds cycle reflects the increasing risk appetite of investors, as they seek ever-greater returns in more volatile, higher-risk assets.
Diversification into Low Cap Altcoins and the Pursuit of Exponential Gains
Investors seeking even higher returns continue to diversify their portfolios by shifting profits from their mid cap altcoin positions into low cap altcoins, such as Kyber Network (KNC), Theta, and Steem. This stage of the flow of funds cycle is characterised by significantly higher risk, as low cap altcoins are the most volatile and unpredictable segment of the cryptocurrency market.
The key features of this stage include:
Profits from mid cap altcoin investments are rolled into low cap altcoins, marking the final stage of the flow of funds cycle.
Low cap altcoins, with their extremely small market capitalisations, can experience exponential price appreciation when funds flow into this market segment.
Price increases of 3-5x or even 10x are not uncommon in low cap altcoins during bull markets, reflecting the potential for impressive gains for investors.
Despite the increased risk associated with low cap altcoins, the potential for exponential gains in this market segment can be highly attractive to investors. By understanding the flow of funds cycle and the dynamics of each stage, investors can better position themselves to capitalise on the opportunities presented by each market segment, from Bitcoin to low cap altcoins.
The End of the Flow of Funds Cycle and the Decision to Convert or Hold
At the end of the flow of funds cycle, investors face a decision regarding the profits they've accumulated from their low cap altcoin investments. They typically choose one of two options:
Convert their profits back into Bitcoin (or other major cryptocurrencies) and hold their positions, potentially fuelling another uptrend and initiating a new flow of funds cycle. This is more common in bull markets, where multiple smaller crypto cycles may occur before significant price corrections take place.
Sell all their cryptocurrency holdings, converting them back into fiat currencies (e.g., USD, EUR, GBP) and exiting the market entirely. This option can lead to substantial price corrections in the wider market, as investors withdraw their profits and leave the market. A notable example of this was the 2018 market collapse, during which Bitcoin's price dropped by over 80%.
Understanding the flow of funds cycle and recognising when it comes to an end can help investors make informed decisions about whether to hold or convert their cryptocurrency holdings. By anticipating the actions of other market participants, investors can better position themselves to navigate the volatile and unpredictable world of cryptocurrencies.
Key Takeaways from the Flow of Funds Cycle
Understanding the flow of funds cycle provides valuable insights for investors seeking to navigate the complex world of cryptocurrencies. Key takeaways include:
Funds flow across market segments: As the flow of funds moves through different market segments, from Bitcoin to low cap altcoins, it can create a cycle of price increases and subsequent profit-taking.
Inferring future market movements: Observing significant positive price moves in a particular market segment may provide clues about what could happen next in the cycle.
Risk associated with holding positions at the end of the cycle: Holding cryptocurrency assets at the end of the flow of funds cycle might be risky, as market conditions can change rapidly, leading to potential losses.
Variation in cycle timings: The duration of each stage in the flow of funds cycle can vary significantly, making it difficult to predict the precise timing of market movements.
Asset allocation decisions based on the cycle: Investors may be able to use the flow of funds cycle to inform their asset allocation decisions, following the cycle to enhance returns while adhering to their own trading plan.
By keeping these key takeaways in mind, investors can make more informed decisions in the volatile cryptocurrency market, potentially capitalising on opportunities for enhanced returns and mitigating risks associated with the flow of funds cycle.