Have you noticed that as  the price of Bitcoin goes up, altcoin prices go up? And have you also  noticed that as the price of Bitcoin goes down, altcoin prices go down?  This might seem like basic information if you are already a crypto-enthusiast. But perhaps, like myself, you would like to have a  deeper understanding of what exactly is happening with the price  volatility of alt-coins and why they so closely follow the troughs and  peaks of Bitcoin. I also wanted to play around with concepts from  traditional economic theory, such as supply and demand, and cross-price  elasticity, to help frame what is going on.

The Pattern

Let's  start with the observable phenomenon. Taking a broad view of the crypto  market from 2013, we can see that most cryptocurrencies follow a  similar price movement. [1] And Bitcoin's oscillations are slightly more stable in their volatility than those of the altcoins that accompany it. The pattern is obvious  and is the market indication of an industry that is speculative due to  being in its early stages. There have been multiple waves of entry into  the market by new coins and new adoption as users discover crypto, each  wave larger than the one before. But this growth due to ideation and  discovery is not the same as projects actually differentiating  themselves to the point of establishing their own economies, independent  of Bitcoin. Bitcoin was the forerunner of a new kind of money, allowing  a re-energising of existing industries, particularly those in the  finance sector. What followed, the generation of alternatives to  Bitcoin, altogether created a whole new industry itself. But the fact  that altcoin prices follow Bitcoin's price is the clearest signal that  the industry is still speculative. But how exactly does that work and  what does that mean?

Complementary Goods

Looking  through a traditional economic lens, bitcoin and altcoins are viewed in the minds of consumers (users) as complementary goods (coins). This is  what the price movements show and how the markets behave, even if that's not what projects or users claim. Complementary goods are those that have joint demand. [2] This means that as the demand for Good A, let's say Bitcoin, goes in a  certain direction, the demand for Good B, let's say an altcoin, goes in  the same direction. The same also goes for price, which is directly  related to demand. These relationships between goods are also described  as cross-price elasticity, because the change in demand of one good is  often compared to the change in price of another good. The opposites of  complementary goods are substitute goods, where as demand for one falls,  usually due to higher prices, demand for the other rises since the  buyer can use it as a cheaper substitute. In our example here, the complementary relationship means that users are viewing alternative cryptocurrencies not as substitute goods but complementary goods that  come along with Bitcoin. Examples of complementary goods are cars and  gasoline, where the demand for gasoline is dependent on the number of  cars being used that require it.

For crypto, this complementary  relationship is a sign of dependence and inadequate differentiation in  the market. Many of these altcoins were established to be a better  version of Bitcoin, faster, more private, with more functions. The price  movement should show that these Bitcoin alternatives are substitutes if consumers were really using them as such; but it doesn't. Furthermore,  many of these altcoins are not trying to be used like Bitcoin, but are  tokens for innovative ways of implementing existing types of businesses.  However, the market shows that they are currently considered similar  and serving the same need in the users' minds. If coins are not related  to a cash use like Bitcoin at all, their price activity should be  different, neither perpetually similar or opposite, since they are providing an unrelated service. And if they are to be substitutes to  Bitcoin, then we should see an inverse relationship in ongoing  countertrends.

This is one way of understanding what is going. It  is likely due to the immaturity of the crypto industry, and Bitcoin  being the first-comer, with many people associating cryptocurrency with  Bitcoin itself. Newcomers may enter the market and put their funds in  Bitcoin only, giving Bitcoin dominant market-share, another way of  looking for independence vs. dependence. The users who use Bitcoin may  use other altcoins but leave most of the money that they bring into the  space in Bitcoin. Looking at market behavior, Bitcoin is akin to the  personal computer, the real innovation, and all the other altcoins are  like CDs and DVDs, ideas to play around with. I didn't say it. The  market did.


There  is another important factor to consider when it comes to price  activity, however, that could be obscuring signals of actual consumer  behavior. Something else is occurring on exchanges as Bitcoin falls and  rises. You would think that when someone in Paris sells Bitcoin to  someone else in Europe, assuming they are on a regional exchange, that  the price of another unrelated altcoin couldn't fall because no one has  the speed to actually sell something at exactly that time. How could the  sale of an altcoin match up perfectly with the sale of Bitcoin? The answer is trading bots. There are trading bots that are constantly  arbitraging against Bitcoin. What this means is that there are a  significant number of exchange transactions that aren't real buys and  sells from real people using these tokens for real things, depending on  your perspective. That's why altcoins can follow the price so closely.  Take a look at your favorite altcoin in a chart that's matched up with a  Bitcoin chart in its observable time period and units of time. For  example, as the price of BTC goes up sharply, a bot will often sell an  altcoin in order to get BTC as it is going up. Then, once BTC flatlines  it immediately buys back the altcoin it sold. This is in an effort to  get more of either coin, trying to suck the equity out of the gap. It  also happens when BTC goes down, where an altcoin will be dumped to buy  BTC. In general, the volume of the movement may differ but the timing is  always the same, even in small units of time. (I am not a trader and  this is not trading advice.) Many altcoins are at the whim of what  trading bots do, if not at the whim of human traders as well who trade  against BTC. Regardless, if authentic consumer behavior can be obscured  by this kind of trading, that in itself is an indicator of a lack of  true adoption and creation of an independent economy.

The "Network Effect"

One  final thing to consider is the higher volatility that altcoins can have  compared to BTC, which is volatile itself. On top of arbitrage bots  linking pairs together, most altcoins tend to be valued against BTC and  are only able to be bought with BTC. There are much more BTC pairings  than altcoin pairings. So altcoins tend to be more volatile, due to what  I call a network effect, that depends on the number of exchanges  available for an altcoin and the number of pairings it has available. The more pairings you have to go through to exchange an altcoin for  fiat, the more transaction fees have to be paid. Going from BTC to USD  is longer and costlier than going from ETH to BTC to USD. This is one  hindrance of buying and selling an altcoin, compared to BTC. Altcoins  also have fewer exchanges available for buying or selling. This makes  their swings more extreme. When you decide to sell an altcoin, lowering  the price, there are less buyers available to bring the price back.  Buyers compete in numbers and speed to affect how low the price is able  to get. But someone who decides to sell BTC has more choices available,  due to the number of exchanges. The amount of 'points' on the network  available to respond to your transaction request, due to exchanges,  affects how long transactions take and quickly prices can be bid back  up, or vice versa. Minor fluctuations for BTC become depressing  consequences for altcoins. To put it into perspective, Bitcoin's availability of buyers and exchanges is still limited compared to those  of fiat currencies, which less volatile, with much more volume and  choices available to immediately counter bid, up or down, when someone  posts a transaction.

Altcoins with Independent Economies

So  what's the takeaway after understanding why altcoins have such a  devotion to Bitcoin? Whenever we see a sustained counter trend of an  altcoin, that is when we will know that a coin has differentiated itself  enough to establish its own independent economy. This is different from  a temporary pump and dump. It can only happen when adoption begins to  occur, allowing the volume of buying and selling between humans to  outrun the arbitrage, potentially showing an inverse relationship as a  substitute to Bitcoin, or unrelated price movements if it has nothing to  do with what Bitcoin offers. This is when you will know, apart from what I or the media or your favorite crypto news source says, that true differentiation and adoption is occurring, and crypto is finally exiting  the era of speculative trades.

There are many projects that have  the potential to form their own independent economies. But projects are  at different stages of speculation versus substantive development that  will bring adoption. How many crypto projects are being used or traded  for the application itself? There are almost none. Bitcoin itself is the closest. Ethereum was one of the first coins to break away from  Bitcoin's movement. It was, at one point, bringing in outside money from  its ERC20 tokens, enabling it to have some of its own economy for some  time. It could truly breakaway from crypto speculation in time as  projects develop. But its price independence did not sustain itself and  continuously reduces as projects cash out their Ethereum to pay for  development in the bear market. EOS, due to its similarity to Ethereum,  is also likely to establish an independent economy. One coin I am  bullish on is Particl, as with the right volume of sales per day on its marketplace, public or private, trading bots can no longer drag the  price wherever Bitcoin goes. It's my hope that Particl is among the  first real wave of adoption outside of speculation projects. Nothing  says independent economy quite like a marketplace, and it is already in  its testing phase. There are substitutes to Bitcoin such as Bitcoin Cash  that for a moment also displayed counter trends. There are coins that  you will have more insight on than I do. Eventually, there will be other anchor or reserve currencies because they will have their own use  cases, regardless of whatever is happening with other projects. For now,  altcoins are tethered to Bitcoin because cryptocurrency technology is  in a phase of early development, and they lack independent economies of  their own. It's no wonder that if Bitcoin fell off a cliff, all of crypto would too.

Originally published at www.cryptoramble.com on December 29, 2018.

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