Saturday, January 20, 2018

Bitcoin price moves and networking effects - The difference between social and financial networks is important

Crypto-currencies are in strong market downturn with a 40% decline in the last month and more than 20% in a single day earlier in the week only to be followed by  strong gain of more than 30%. There has been a wide amount of buzz about bitcoins, yet this decline has not really impacted other financial markets. What is clear is that bitcoins are not integrated at this time with other financial markets so there are limited network effects.

It is important to start to think about network effects and  social networking is not the same as networking of financial markets. What separated the Great Financial Crisis was the networking of leverage, financial institutions, and product distribution. When networking of financial markets is high, there will be spill-over effects that impact multiple markets. A bank that is stressed can impact a broad range of financial markets based on their lending arrangements. A shock in one commodity can affect lending and risk-taking across all commodity markets.

A financial shock that is not networked across markets will have limited impact outside of the immediate participants. In the case of crypto-currencies, there are strong social networks with talk on social media, but there is limited leverage and connection to financial institutions. Hence, a bitcoin shock will make news but will not impact the financial wealth process. 

This is important because I believe the "new global macro" thinking is more focused on understanding network effects and how they may affect cross-market price relationships. Understand the networks and you can exploit changes in correlation.

No comments: