I read a lot of conspiracy theories on how coinbase.com — a popular cryptocurrency exchange — ‘stole people’s money’ last night when Ethereum, a popular cryptocurrency crashed from ~$310 to $0.10 and quickly bounced back. A small amount of people lost all of their money.
How could this be?
First of all, let’s rule out conspiracies. It is doubtful that Coinbase orchestrated a flash crash to steal money. That’s just kind of sort of a little illegal. But of course when these things happen, fingers get pointed.
Flash crashes happen in the NASDAQ all the time, they are usually attributable to a ‘fat finger error’ – somebody presses the wrong button and the price of whatever security they put in an order for goes haywire. Typically, they meant to buy 10,000 or 100,000 shares and instead they entered an order for 1,000,000 or more.
So, let’s assume the game is rigged against you. Now what? Should you just bury your head in the sand and turn a blind eye on one of the greatest investing opportunities this millennium has seen?
The answer is no.
Those who lost money on this flash crash were trading on something called margin, where you borrow a short term loan worth 2-3x the actual cash you have. It is among the riskiest things you can do, because if your investment goes down a small percentage, say, 10%, the house takes back the money it loaned you, and makes up the difference with your remaining physical cash.
Imagine if you started with $100. With margin you can trade with $300. BUT. If your trade goes down 10%, you get a margin call and you have to pay back the loan. You started with $100, received $200 extra, and now you lost $30 of it. So now you have to pay back the $200, plus the $30, leaving you with $70.
Sounds like this could go bad really quick, right?
Now what happens if your investment goes down 50%, or in this case 99.9%. You started out with $100, now you owe $299.90. So you are now -$199 from an investment of $100. Your investment went below zero! YOUR INVESTMENT DID NOT STOP AT ZERO! IT COST YOU MONEY!
That’s what happened last night. Some people had their portfolios vaporized because they took out a short term loan that was 2 or 3x all the money they had!
Does it sound like the market is rigged or does it sound like these people made a mistake? I think you can figure that one out.
Like Howard Lindzon says, the problem is not too much information, it is lack of filtering. By the same logic, the problem is not the risk of the asset you invest in. It is how you manage that risk. If you cannot stomach the swings and rationalize, you do not belong in the game.
However, if you’d still like to try your hand at cryptocurrency, you can sign up here.