The Man Who Woke Up to a $1.1 Trillion Balance
Dear Rich Lifer,
Christopher Williamson, a nursing student, says he literally fell out of his bed when he checked his Coinbase account and saw a balance of $1.1 trillion.
But Williamson’s dreams of a penguin-shaped mega yacht, quickly disappeared when he realized he couldn’t exit his position through the app.
“I’m gonna need someone to explain what the heck is going on and then write me a check. I got a mega yacht shaped like a penguin on standby,” he scrawled on Twitter.
It turned out, the balance being reflected on Williamson’s account was a ‘technical error’. Coinbase’s team responded on Twitter two days later…
“Sorry — the penguin yacht may have to wait — our team is aware of the display error causing this wishful thinking for some ERC20s. They’re working to fix — in the meantime, trading the asset will reflect its current market value.”
This story didn’t go the way Williamson had hoped for. But at least we can learn some important lessons from his wild emotional rollercoaster…
Paper Profits Don’t Equal Real Profits
First, even if there was no technical error, there’s no way Williamson would have been able to exit his position as a trillionaire or even billionaire. The reason being that paper profits are never equal to actual profits.
That’s because the last price of an asset is only one part of the trade. You also have to factor in trading volume. Trying to sell $1 trillion of Rocket Bunny — or any cryptocurrency — into cash is impossible because the people on the other side of the trade don’t have one trillion dollars.
So, to move a large dollar amount, you’ll likely need to sell at a discount regardless of whether you’re trading cryptocurrency or the most liquid stock.
Take Apple, for example, which was trading at $133.11 as of writing this. About 70 million Apple shares were traded, which is about 0.4% of the stock that day.
Most investors would say that Apple shares are trading for $133.11 today. But it’s more accurate if you say 0.4% of Apple stock is trading for about $133.11 a share. This subtle difference takes into account volume, which is a key detail.
Imagine if a large firm holds 1.5 billion Apple shares, 21 times the amount that was traded that day, and the firm is forced to sell it all immediately. The price would be set by the last person willing to buy the 1.5 billionth share, and we can speculate that would be significantly lower than $133.11.
Prices Equal Marginal Demand
The lesson here is that price is only ever equal to marginal demand. The price for anything is set by the price paid by the person who needs whatever you’re selling the most right now.
When lumber prices skyrocketed in the U.S. this spring, it was because builders were willing to pay 3 to 4 times previous market prices because they needed 2×4’s immediately.
If a cryptocurrency price shoots to the moon, the person holding the most shares will have a hard time exiting their position at the top if there’s not enough trade volume, which is often the case.
How to Lock In Real Profits
To exit any position at the price you want, you first need to make sure you do your diligence to figure out the liquidity risk of that particular asset class.
Liquidity risk can appear as low trade volume and when the bid-offer spread widens. When there’s a lot of market volatility, you may see the bid and ask spread get bigger. As this gap widens the market maker will have a hard time matching up buyers and sellers.
So, even if you wanted to sell your investment at the current market price of $100, but the bid has fallen to $80 due to a bad news story, you won’t actually be able to sell for $100.
You’ll often see wide spreads in thinly traded stocks and bonds. Whereas large, liquid, blue-chip stocks often have spreads as low as a penny or two.
Once you’ve established that the asset you are investing in has low liquidity risk, you should start building your exit plan.
Two exit strategies we recommend for stocks are implementing stop losses and trailing stops. Both ensure you exit your position at the price you want.
By pairing a stop-loss with a trailing stop, you automatically protect your downside risk, while locking in profits if the price continues to climb.
A stop-loss is an order to sell a stock at a particular price in order to stop any further losses if the price drops. A trailing stop loss is a trade order where the stop-loss price is not fixed to a single dollar amount, but rather a percentage or dollar amount below the market price.
When the price increases, it drags the trailing stop along with it. So, when the price finally stops rising, the new stop-loss price remains at the level it was dragged to, which locks in profits and protects you from significant losses. Combining these two strategies can ensure you exit your position profitably or at least minimize your losses.
For cryptocurrency investors, your best bet to lowering your liquidity risk is investing in coins that are deemed liquid. While some alternative coins like Rocket Bunny can look like they will deliver astronomical returns on paper, those returns are not real until you exit your position, and as we learned today, exiting is an art.
To a Richer Life,
The Rich Life Roadmap Team