If there’s one thing we can pretty much all agree on, it’s that crypto is not the most predictable investment. One day, things are going so well that your biggest worry seems to be narrowing down which color Lambo you’ll buy with your earnings.
Then Russia declares war, China imposes a massive crypto crackdown, or (God forbid) Elon Musk sends out a tweet. Suddenly, you find yourself minimizing the Lambo dealership page and heading over to Craiglist to peruse the used bicycle offerings.
The question becomes…
Why Is Crypto So Volatile?
Unlike stocks, crypto has no earnings to inspect, no sales figures to scrutinize, and no CEO to blame if things ultimately head south. All the average crypto investor can really do is read up on different coins, back the ones that sound like the best ideas, and hope for the best.
Then there’s the fact that, unlike the dollar, cryptocurrency isn’t actually backed by anything tangible. This is a fact that some of the loudest crypto skeptics refuse to let the world forget. Some, such as Senator Elizabeth Warren, have gone as far as comparing investing in Bitcoin to “buying air.” Ouch.
At the end of the day, are crypto valuations completely random from one day to the next?
Some financial experts say nay… or at least “not necessarily.”
Among them, you’ll find financial analysts like Goldman Sach’s former fund manager Raoul Pal. Pal says that the valuation of cryptos all goes back to a little something called Metcalfe’s law.
Metcalfe’s What Now?
Don’t worry, while it may initially sound like something you ignored during a high school physics lecture, Metcalfe’s law isn’t actually all that complicated. The term is still a relatively new one and was first coined by Robert Metcalfe, one of the co-inventors of Ethernet.
Metcalfe’s law is “the principle that the value of a network is proportional to the square of the number of connected users: the more users there are in a system, the more value an individual perceives, considered against the cost of joining a network community.”
In plain English, Metcalfe’s law goes back to the idea that there’s strength in numbers. It’s sort of like supply and demand for networks, or in this case, cryptos. Basically, the more people there who participate in a network, the more valuable it will become.
Metcalfe’s Law in Action
Here’s a real-world example of how Metcalfe’s law works.
Back in the day, when social media platforms were still a relatively new concept, Facebook had a major rival called MySpace. Given that no one really knew which network would triumph in the end, everybody signed up for both and waited to see how things would pan out.
Over time, Facebook kept evolving as Zuckerberg came up with new and more maniacal ways to weave it into every single fiber of society. MySpace, on the other hand, stayed pretty stagnant and began to lose users as a result.
Given that the whole point was to stay connected to friends and family, the fewer users MySpace had, the further it slid down everyone’s list of priorities. Ultimately, MySpace became a Metcalfe’s Law fail because there was nobody left on it to interact with.
Facebook triumphed in the end by simply being the most popular and relevant, hence the most valuable in the eyes of social media beholders.
So How Does All of This Relate to Crypto?
According to Raoul Pal, BTC, ETH, and other cryptos are sort of like the Facebook and MySpace of the crypto world.
Their value doesn’t necessarily come from anything tangible, but from how popular they are and how many people use them. A handful of other analysts have backed Pal’s argument, including a guy named Timothy Peterson who wrote this entire high-brow paper about the concept.
The bottom line seems to be that the more investors crypto continues to draw, the more valuable it will become. Pal explains that crypto’s recent rut is the result of an overall crappy global economy, which has slowed down the number of new crypto converts.
But according to Pal, the future looks bright for those who buckle down and HODL.
“New capital will flow in over time and a broader rally, when it arrives, will bring retail investors and a reflexive loop of institutional investors FOMO’ing in. That day will come. You just have to not over extend yourself, don’t use leverage and sit tight. Play the long game,” Pal Tweeted.
How to use these insights largely depends on your trading style. If you’re more of a short trader, then keeping an eye on volume in correlation with the economy at large seems to be the play. If you’re in it for the long haul, then simply fasten your seatbelt and know that Metcalfe is on your side.