It is essentially wrong to think that crypto generated speculation. While it is true that speculation was the subject of many debates, it has a place in investors’ portfolios.
If we look from the angle of the efficient market hypothesis, we will conclude that the market is always fairly priced and that speculation is unreliable. Even some market experts state that speculation equals gambling.
Looking from a different angle, a healthy market, along with the whole financial system, doesn’t consist only of hedgers and arbitrageurs yet also includes speculators. Given that a market fluctuates to a number of variables, there is an opportunity for capital growth.
Sometimes it can be hard to draw the line - the strangest thing about the intersection between gambling, speculation, and investing is that the same asset can theoretically be either an investment or a gamble.
Gamblers' primary goals revolve around winning the bet, without any additional elements. On the other hand, strategy, planning ahead, and monitoring the market behind an asset determines whether you're gambling, speculating, or investing.
John Maynard Keynes, a well-known economist, said once that speculation is knowing the future of the market better than the market itself. The concept can be defined as the act of conducting a financial transaction that encompasses a severe risk of losing value but also holds the potential for significant monetary gains.
It is quite logical – if there was no profit expectation, there would be no motivation for anyone to engage in such an activity.
For example, you can purchase stocks of a high-quality company with forecasted long-term upside potential. In other words, you just made a ‘safe’ investment. On the other hand, a speculator would rather look for opportunities where significant movements of price are likely to happen.
Innovation gave birth to speculation. Back in the 1860s, technological developments in communication, transport, and warehousing added up to the creation of world markets for many commodities such as cotton or wheat. The economic needs of many companies influenced the growth of the market for shares and securities.
As markets became more complex, professional speculators emerged. At first, it was thought that it was just another name for gambling. However, research and scientific literature in the last decade of the 19th century made the case for speculation focusing on its constructive side and the nature of contemporary commodity markets.
Economists played a vital role in convincing policymakers that speculation is more than a bunch of mindless downsides; they managed to present its beneficial effects against hostile public opinion. That change introduced some speculative financial products such as futures, used for the purpose of short selling.
Speculators are engaged in predicting price changes and extracting profit from the asset’s price fluctuations. They typically operate in a shorter time frame than a traditional investor.
In contrast to hedgers as risk-averse investors or arbitrageurs that try to capitalise on the market’s inefficiencies, speculators utilise a fast portfolio diversification buying stocks or futures contracts expecting them to rise in a short period of time such as days, weeks, or months.
There are different types of speculators in the market. Individual traders can be speculators if they acquire a financial instrument for short periods with the intention to profit from price changes.
Proprietary trading firms known as Prop shops can be speculators since they use leverage to purchase securities and make profits from prices going up and down. The same goes for market makers that profit from differences in bid and ask spreads.
It is important to understand that speculators are ordinary actors in all markets. However, it may be hard to understand the key difference between calling someone an investor as opposed to a speculator.
Keep on reading, an explanation is right around the corner.
Starting off with definitions – while an investment refers to acquiring an asset with the objective of generating income or appreciation in the future, speculation is about making a financial transaction that has a substantial risk of losing value, but with the expectation of a significant profit.
As you can see, the difference lies in the term ‘risk’. While it is evident that investment comes along a certain level of risk as well, the potential of losing the entire amount is what differentiates these two concepts.
For example, an investor decides to buy 10 successful companies with a plan to hold their stocks for at least 10 years with the projection that they will continue to perform well on the market. While there are some risks involved, it sounds more like a safe bet on the stock market.
If you’re more into long-term investing, check out some of Warren Buffet’s pearls of wisdom: ‘Applying Warren Buffet’s investing wisdom to crypto’.
Speculators are more dynamic; they normally utilise trading strategies telling them when to buy and when to sell. Investors can turn into speculators if they get caught up in the frenzy of broad ups and downs on the market.
Popular investment choices include bonds, US Treasury Bills, mutual funds, and stocks. Futures, options, cryptocurrency, start-ups, and foreign currencies live in the speculative territory.
In the crypto world, the speculative nature is more visible because of the state of the market. It is a highly volatile market, so the cycles of hope and disappointment are more extreme than in its traditional counterparts.
Going quickly from bull to bear markets and crypto winters, the speculation periods turn out to be longer. Since the crypto market is still in its early stages, speculative periods have to follow the process a particular technology goes through before reaching massive adoption.
Since speculation periods are longer, the general public perceives the whole market as being unreliable. However, speculation, either on crypto or traditional markets, has produced overnight success stories, medium profits, or total losses.
If you’re thinking about investing in crypto, check out this article first: ‘Five tips for crypto investing (and staying sane)’.
For example, a Tulip Mania hype took place in the 1630s in Holland. Tulips rapidly exploded in price, specifically those that were rare or interestingly coloured. Tulip farmers started selling off their bulbs at unreasonable prices, pushing the market into a frenzied state.
Long story short, the demand for tulips fell as fast as it emerged. Speculators that saw a good opportunity were left with empty hands.
A logical question arises – why is crypto speculation bad and the tulip one is forgotten? Maybe because a lot of time passed, tulips managed to become a stable market. We often forget that crypto is happening now, that it is trending, along with technological innovations emerging fast and a currently unregulated cryptocurrency market.
The EU has taken the first step towards comprehensive crypto regulation. You can read about it here: ‘What is Markets in Crypto Assets (MiCA)? Europe’s crypto law’.
The problem is that users are not educated enough; crypto newbies are vulnerable to security and investment-related risks. Speculation is a technique that requires a high degree of knowledge and market monitoring before putting it all in. If not, it would be an evident gamble.
Both speculation and gambling are risky activities as you can never really be sure which way the wind is going to blow. In that sense, they may be siblings, but speculating and betting for sure aren’t twins.
If those two were synonyms, we could compare crypto speculating with playing poker. It helps if you are dealt a good hand and if you are good at counting cards. Therefore, you have better chances of making profits out of crypto speculations if a cryptocurrency upholds a good reputation and if you can closely track the market.
Lack of regulation isn’t the main difference because gambling is widely regulated and follows a lot of rules worldwide. Casinos and sports betting are subjected to regulations in each state.
The original cryptocurrency Bitcoin, as any type of cryptocurrency, can be used for gambling but it is indeed a decentralised currency. For example, the U.S. dollar is a fiat currency; you can gamble with it, but you can also buy stocks, groceries, or a piece of real estate.
The real difference comes from the traditional definition of speculation – it is closer to risky investing than to gambling. What crypto traders are doing sometimes looks a lot like gambling but at a higher level, it is speculating.
Carlota Perez, an economist, demonstrated the connection between financial bubbles and technological development. At important technological milestones in history, speculative bubbles have been vital to how society incorporates new technologies into the economy.
As a new technology fuels hype, big price fluctuations and momentum trading take a stand. All the money generated by investor speculation flows right into new projects. This eventually adds up to the establishment of the technology on the market.
The crypto bubble market is often compared to the famous dot.com bubble back in the 90s.
The dot.com bubble refers to a fast rise of U.S. technology stock equity variations generated by investments in tech companies in the late 90s. The value grew exponentially during the bubble but entered a bear market in 2001.
The bubble caused the crash of several companies and a lot of attention went to speculative investors’ losses from unsuccessful projects.
On the other hand, there was less discussion of how the financial capital market unlocked and how the money invested in the midst of the bubble amounted to the development of fibre-optic cable, algorithmic search, and other important technologies.
Many financial experts stated that crypto is the new dot.com bubble. The fact is that the cryptocurrency market is driven by technological advancements and speculations as two main factors underpinning its growth.
One difference between crypto and the inventions of the late 1990s can be spotted in the fact that crypto-related products are mostly based on open-source code. When creators don’t need to ask for permission to build something new, that is a powerful tool for market success.
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