Brief thoughts - Saturday, October 4, 2014

[Steve Sokolowski]

A few brief thoughts as I continue work on merge mining support:

Why so many market sells?

Some people in /r/bitcoinmarkets are mystified about why there would be so many market sells where the people selling are not worried about slippage. It's important to note that the sells are usually smaller amounts, like 50-500 coins, but they repeat over time pretty regularly.

To provide a possible explanation of why someone would make sales in such a fashion, I thought that it would be worthwhile to explain the algorithm I designed for our pool. For those who are not aware, the pool mines one or more currencies at the same time, and allows people to be paid out in one or more currencies at the same time. The profits from mining are converted to payout coins using exchanges. Mined coins are currently usually scrypt coins of low difficulty and value, and people tend to select payout coins of other algorithms with high value, like bitcoins. Dollars are also supported as a payout "coin."

We've found that most of the payout coins that people select are different than the mined coins. Therefore, we need to sell the mined coins and buy the payout coins. We could theoretically make the transaction at any time, since payouts don't occur until two days later. However, because coins are extremely volatile, one of the ways we minimize risk is to sell mined coins immediately. As soon as possible, the algorithm sends them to an exchange, sell them at the market price, and buys the payout coins at the market price. The only limitation is that we never make transactions where the value is under 400 satoshi, because there is a minimum 0.00000001 fee.

This causes slippage in some coins. There was one coin a few weeks back that we caused to crash from 9000 satoshi to somewhere near 2000 before we stopped mining it. But our customers don't care about that. They want to make the most money, and they want to be paid in bitcoins, litecoins, darkcoins, and other coins, but not the coin we mined. We account for such slippage in our payouts, and crashing these markets is still the most profitable thing to do (or else we wouldn't do it).

Consider that you are a bitcoin pool operator who, instead of not believing in the future of Grandcoins, instead doesn't believe in the future of bitcoins. He simply wants to make as much money as possible because his customers want dollars. Slippage is irrelevant to this operator; he just wants to lock in his profits as soon as possible. Observers would see this as the value of entire blocks being sold at any cost, until the pool reaches the point where it is no longer profitable to operate and miners stop mining. There's no grand "manipulation" plan; he's simply like us, selling the currencies we don't want to get those that we do. If there is someone like this, then the price would continue to fall until mining is no longer profitable.

Keep in mind that this sort of thing has probably been going on for a while. However, I believe that the bubble cycle still plays a role in this; when sentiment is down, nobody buys the coins that faithless miners are selling. At the time the cycle was up, nobody was looking for this sort of activity. When the bottom of this cycle is reached (and late October historically aligns with the length of cycles), then there will be more people buying the pool's coins as sentiment turns around. But don't start buying yet; there still hasn't been the major capitulation that has happened about five times before.

[cryptorific]

Do you think we've seen capitulation yet? or would it really take us going down to under a $100 or something psychologically dramatic?

[Steve Sokolowski]

I'd say that the answer is, for the first time, more likely to be "yes" than "no," but not with enough confidence that I would be willing to make a prediction on it.

There are several reasons why I think a trend reversal might have occurred. First, the volume yesterday was astronomical, and the volatility amazing. That only happens during major crashes. Coins were flying at all sorts of prices.

Second, that huge sell wall was destroyed by buyers rather quickly. The market has been far oversold, but it couldn't go up with that enormous wall in place. With it gone, it can return, at least temporarily, to more reasonable levels.

Third, for the first time this cycle, there was a big crash, followed by a big rebound. That's the signal that has ended each previous cycle. In every previous step downwards, there was no recovery afterwards. To confirm this, we would expect there to be a period of stability of $320-$360 or so for a few weeks.

There are also some pieces of supporting evidence in historical data: first, the timing for the capitulation is about right, just over 4 months since the high of the cycle (although it could still go a few more weeks and still be within reason). Second, the price has never fallen below the highs from previous large bubbles, and sure enough, the crash ended at $275.

The reason I don't have enough confidence in this assessment is because stability needs to descend before we can declare a reversal, and that hasn't happened yet. It's possible that sellers are still around with many coins waiting to unload them at any price. On the other hand, if walls appear again, it's an opportunity for people with big money, who otherwise would have to go through the huge trouble of locating buyers off-exchange, to get in without any slippage. That's why I don't see these walls as a big deal. They simply attract off-exchange volume to the exchanges, because why wouldn't an institutional investor take the easy route to buy 20,000 bitcoins instead of having to locate someone and trust that seller?