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Welcome to the world's largest gambling den

"This is the nature of capitalism, get over it." - Kevin O'Leary

After nearly two decades of being in finance I still don't think I appreciate how capital markets work. It's not that I don't know how it works. There is a fine difference between not knowing and not appreciating.


In 2008, most of the world lost faith in Wall Street: The housing market crash, the financial bailouts, quantitative easing... Sure, a few banks went under and were eliminated, but there was so much greed and risk taking followed by cheap money being flooded into the financial system.


The events that followed made a lot of people lose faith in the traditional financial markets as we knew it. And so most of bitcoin and cryptocurrency came into existence as investors started to look for an alternative store of wealth.


Cryptocurrency and digital assets were meant to be a good thing. It would be digitally secure and essentially "un-fraudable".


But human nature eventually catches up.


The series of unfortunate events that led to the downfall of SBF in late 2022, the poster boy for cryptocurrency, just goes to show that the process of trying to do a good thing can sometimes turn out bad, if not executed under the right moral guidance.


FTX, once touted as one of the world's largest cryptocurrency exchange used to be valued at more than the NASDAQ. Its recent bankruptcy is a rude wake up call for those who religiously believe cryptocurrency is the future.


Look, I'm not dismissing the credibility of crypto assets and bitcoin.


But all of the digital tokens that changed hands on the platform had to start from somewhere: Cold hard cash being used to buy tokens.


Someone who trades on any cryptocurrency platform ultimately believes that at some point of time in the future, those tokens can be exchanged for cash, ideally at a higher value.


The buying and selling of stocks, listed options and contracts for difference work pretty much in the same way.


Aside from the issuance of new shares, none of the money in those transactions flow to the company for expanding its business, or used towards investing in innovation or research. It just stays on the platform in circulation amongst the punters and speculators, creating a whole lot of flow volume, which translates to revenue for the intermediaries who facilitate this flow.


The secondary market is the world's largest legalised gambling den.


Anyone can make a bet on anything.


The possibility of a business achieving a certain milestone, hitting a certain profit target, releasing a certain product. And people further make bets on those bets through structuring warrants, put and call options, CFDs, products that don't require people to come up with all the capital, just enough cash margin to buffer any unexpected losses. It's just comes down to finding enough buyers and sellers on both ends of the trade, effectively making the market.

As long as those in the game keep the ball rolling i.e. someone is buying those shares and someone else is getting their capital back, prices continue to hold up and no one gets hurt. Sounds like a Ponzi scheme no?


All crashes in the market happen primarily due to a crisis of confidence: A whole lot of people just wanting to get out.


 


Here is why I could never wrap my head around putting money in the markets:


Investors (typically) pay the price of a share based on the amount of dividends the company pays in the future (this is essentially the dividend discount model).


Let's just say this company one day receives a huge order from a customer which could potentially double its revenue, but unfortunately it doesn't have that much manufacturing capacity. It decides to raise money from shareholders or banks, in which those proceeds would be used to buy or build a new factory, thereby solving for the shortfall in production capacity.


Investors then do the math involving the costs and benefits of putting their money into this initiative and decide how much to put in. With this new factory in place, the business now generates twice as much revenue, but it also implies that profits could potentially double, as with the value of the business. Suddenly, the idea of ownership in a larger company, the prospect of the business being a market leader and the reputation of being part of a billion-dollar enterprise with a high market value dawns on shareh