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Valuing Cryptocurrencies and Blockchain Applications

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Arguably the most interesting financial trend of 2017 is the spreading of cryptocurrencies, especially in the Ethereum ecosystem. With the ICO boom of this year, a lot of different business models have been connected to tokens or blockchains of their own. This brings up several questions in the mind value-conscious investors, as given the special properties of these coins, and especially considering the various distribution and usage schemes of the tokens, valuing them is tricky, to say the least.

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Whether or not we are in a bubble currently is a layered question, as we are definitely in a huge speculative wave that will end badly for several coins, but the segment is in the early phase of adoption, and the market as a whole will likely multiply in the coming years.

As I concluded in my comparison with the Dot-Com bubble, selective investing in the ICO-boom is vital for long-term investors. To make things more complicated, traditional valuation models generally fail with cryptocurrencies, because of the hybrid stock-commodity properties of them and the novelty of the technology, coupled with the questions regarding the future usage patterns.

Is it possible to set up a framework to analyze all the different business models and value the connected coins? Or is it possible to, at least, determine hard guidelines to follow when selecting the coins to hold or forget? I will answer that question below and in the coming second part of the article.

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Where is the Value Coming From?

Valuing Cryptocurrencies

For a traditional analyst, the most interesting question is the source of the value of the tokens. There are several crucial hurdles to clear for a token to be considered valuable on the long-run. Why? Firstly, because as opposed to stocks, holding a token doesn’t give you ownership in the company conducting the ICO, thus the success of the company doesn’t directly increase the value of the coin.

Also, the fact that the blockchain technology and all the main patents and methods are freely available to the public means that an infinite number of tokens and blockchains can be created with no legal hurdle, possibly making the competition fierce, decimating demand for the services behind the token and in turn the token itself.

Another problem with the current ICOs is that even if the idea behind the company is valid, and the demand for the token is organic (we will get back to this soon), there is no guarantee that the execution of the idea won’t be obsolete in a matter of months, let alone years. This is one of the main reasons that a lot of Dot-Com companies failed; it’s nice to be a revolutionary player, but more often than not, markets are ruled by the second or third generation of companies that annihilate the pioneers of a technology, leaving only the nostalgy behind.

Non-Ownership Sources of Value

Of course, besides ownership (which is non-existent in most of the current models) there are several ways that the token can acquire value. The most important, in my opinion, is the organic demand for them, that, together with the inherently limited supply can create an imbalance between demand and supply, driving the price of the “digital commodity” higher.

For the holders of the tokens, a lot of projects also deploy some kind of fixed or variable “rent” or “dividend” (yikes). I am, maybe too much so, skeptical regarding these premiums, as they present an extra cost somewhere in the ecosystem that will create immense incentives to create cheaper “rent-free” alternatives for the given business. So, the existence of such a system, while it might be intriguing, in my opinion, could be the exact reason why that the business will fail. But there is a catch; if a model is strong enough to survive and dominate a, sometimes completely new niche, it could be able to sustain these premiums and give a huge boost to the value of the token. But what will set these winners apart from the rest?

Network Effects

Valuing Cryptocurrencies using network effects

To answer that question, we have to note that both of the above sources of value are based strongly on the network effects. This, sometimes elusive, term is used to describe why in some industries the winner takes all (or at least most of the profits), and some companies enjoy a “natural” monopolistic position.

Think Facebook for social networks, Microsoft for OSs, or a landline phone company in the past. Adding more users to such networks not only decreases the cost of operation per user but actually increases the utility that all (yes, this is a huge simplification here, you geeks out there) users enjoy through the network. Translating that to products according to this great summary:

A product displays positive network effects when more usage of the product by any user increases the product’s value for other users (and sometimes all users)

This makes these networks multiple times more valuable than other ecosystems that don’t sport sustainable network effects. Understanding these effects is very important for judging the future demand for blockchain applications and tokens, and not only because it’s a widely used buzzword in whitepapers, sometimes to blur and ridicule any and every concern regarding the business model. But before we take a closer look at network effects, let’s see the logic behind my valuation approach.

The Logic of Determining The Value of Applications and Tokens

We have to stress that this is only a basic filter, but one that has great heuristical value to move forward in the analysis. According to Fortune:

Jeff Garzik, a leading figure in the blockchain community who runs a consultancy called Bloq, sees ICOs as “transformative” but remains wary. “Ninety-nine percent of these ICOs will be garbage,” he says. “It’s like penny stocks but with less regulation.”

While the 99% might be a bit rough, it is safe to say that most of the current ICOs will end up left behind, while the survivors will multiply several times in value and create the infrastructure for a new crop of businesses that will thrive in the blossoming industry. Still, investors’ primary job in such a nascent segment is to efficiently filter out obvious and less obvious scams, losers, and laggards. For that, the first step is to really understand what’s driving the revolution in the first place.

The Most Important Advantages of the Blockchain Technology

In order to create a framework for valuing cryptocurrencies, we have to be, at least vaguely, aware of the current and possible use cases of the technology. The novelty of the tech makes this very hard and in some cases impossible, but if we keep track of the main advantages of the blockchain we can identify projects and business models that are built upon the real strength of the technology rather than on the hype.

  • Permanent and verified transaction records
  • Simplified databases and tracking functionalities
  • Lower transaction costs and times
  • Security of a decentralized and redundant system
  • Peer-to-peer transmissions
  • Smart-contract logic: rule-based business models and ecosystems

Matching these virtues with the business models is only the first step; while you can identify potential winners, aligning with the strength of the technology doesn’t mean that a venture will be a long-term winner, not to mention the exact “valuation” of the token. These advantages will also take effect in several different levels of the economy, from private, limited user-base blockchains to global transformational systems that might be used by the majority of the citizens of the world. You can see a model of adoption with examples below from the great article of Marco Iansiti and Karim Lakhani.

The Adoption Cycle’s Role in Valuing Cryptocurrencies and Blockchain Applications

While that sounds chilling and revolutionary, there is an investment problem here; even if you went back to the 80’s with the knowledge about Google, you couldn’t have directly invested in the company, as not only the founders of the firm were in kindergarten, the infrastructure that the business was based was non-existent. So are we in the 80’s of the blockchain technology? Well, in a way yes, global transformational adoption will likely take at least another decade. That said, my gut feeling is that this adoption cycle, although it will resemble the Internet’s will provide huge surprises; both positive and negative ones.

The Looming Coin-Regulation Storm

It’s hard to overstate the regulatory hurdles that the segment will soon face. The ICOs legal framework is shaky, to say the least, and somehow regulators will try to curb the boom and divert in into a more traditional direction. And in a lot of ways, that would be good for investors as well. A more regulated market would be beneficial in avoiding scams, while letting the currently left-out investors participate in the rise of the new industry.

For the current crop of coins, this is probably the biggest risks out there, as whole ICOs could be deemed illegal, leaving holders of the tokens out in the cold, or facing an uncertain transition into another legal framework that would likely push the value of the ventures and the tokens down.

In the next part of the article, I will take a look at this and other risks that blockchains and systems built upon them face. I will also set-up actionable guidelines to weigh the advantages and the risks of certain applications and cryptocurrencies while forecasting the actual demand for the service and the attached token. To make it more robust, I will integrate some of the traditional valuation methods as well.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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12 Comments

12 Comments

  1. icm_24

    July 12, 2017 at 3:49 pm

    can’t wait for the rest. the current crypto market is really depressing and I could use some light at the end of this deep dark tunnel.

  2. Chris G

    July 12, 2017 at 4:07 pm

    In spite of the price crash in Ethereum, I def. still see plenty of potential applied value in that coin. I have a solid long-term position, and set up a modest mining operation to hedge volatility. I’m confident that my equipment investment will be covered in a reasonable time-frame, and am viewing Ethereum within a 3-5 year investment window.

    My largest long-term position is in Litecoin, I really think the Litecoin development team is ahead of the curve. Particularly in terms of scalability confounds, my money is on Litecoin.

  3. pradz

    July 12, 2017 at 5:06 pm

    This article came right out of the caution cauldron where excitement was previously prepped. It pinches the excitement out of cryptocurrencies and gives the reader less legroom(in emotion) for those wanting to really go all out, given the current uncertainty in the market.

    But the 10 year universal adoption is almost possible, maybe even faster, since the infrastructure is in place and we’re still figuring out the networking part, while the answer might lie within the mind of a kindergartner who could well go on to create a bigger tech that gobbles up alt coins like m&m’s.

    Nice piece Mate Cser, wonder where you’ll be in 2027 rewinding all your predictions that went right and those that didn’t. One things’ for sure – Interesting times ahead.

    • Mate Cser

      July 12, 2017 at 5:20 pm

      Hi Pradz,

      I am as excited as ever for the segment, I truly believe blockchain tech is huge thing for productivity growth, which is the key for the coming demographic “autumn”. I have my money in the sector, mostly in BTC and ETH with a few smaller bets elsewhere.

      That said, I am not a believer in predicting the future, just probabilites, and placing careful investments according to them, that’s the point of these articles.

      I hope to be here in 2027,discussing our investments in hindsight. That’s real fun 🙂

    • Chris G

      July 12, 2017 at 7:00 pm

      I particularly like the m&m metaphor *chuckle* …

  4. Chris G

    July 12, 2017 at 8:08 pm

    Nice to see a little ethereum bounce today – wake me up when we hit $1000 🙂 …

    • gafty

      July 12, 2017 at 11:44 pm

      1000 at the end of the year will be for sure!

      • Chris G

        July 13, 2017 at 2:38 pm

        that’d sure be nice 😉

  5. csinkey

    July 13, 2017 at 2:05 am

    Mate Czar – would you share your “smaller bets”? I’m REALLY interested to see which ones you thought were worth taking a bet on given the above thinking

  6. P. H. Madore

    July 24, 2017 at 12:06 am

    “For the holders of the tokens, a lot of projects also deploy some kind of fixed or variable “rent” or “dividend” (yikes). I am, maybe too much so, skeptical regarding these premiums, as they present an extra cost somewhere in the ecosystem that will create immense incentives to create cheaper “rent-free” alternatives for the given business. So, the existence of such a system, while it might be intriguing, in my opinion, could be the exact reason why that the business will fail. But there is a catch; if a model is strong enough to survive and dominate a, sometimes completely new niche, it could be able to sustain these premiums and give a huge boost to the value of the token. But what will set these winners apart from the rest?”

    If the payment is fixed and not dependent on the actual revenues of the firm in question, of course issuing p2p shares through tokenization is a mistake. However, if the dividend payment — part of the proceeds intended to keep the network afloat, not bloated costs — is built into the business model and the figure is reasonable, it’s more of a shareholder + situation. Not only do you have a stake in the firm, but you have premium access to its innards, and, as you mention, limited supply makes you the holder of a potentially even more valuable commodity. Yes, we’ve seen that proof of stake and interest rates do encourage people to horde, but this is not a problem in a supply-demand ecosystem. The cost of the services simply goes up, and the actual numerical derivative payments go down while their value goes up. As such, I think this is actually a feature we need to see more of. But it’s not the main fix that we need to see.

    The main fix that would improve ICOs in our era would be one in which they do not issue themselves any shares at all. Instead, they sell as many tokens as they wish, and buy back as much stake in the company as they wish to have from the token holders. This would mitigate so many problems it’s hard to pretend I need to justify the notion. If your goal is not to hold 100% of the company, but merely to increase its value, buying in at post-ICO rates should be no problem for you, especially since you have the most influence over what goes right and goes wrong — and if the market actually kills you, you’re a rarity. This burgeoning industry can support 100 of any given thing if all 100 are operated correctly. Unfortunately only 2 or 3 ever will be.

  7. Mate Cser

    July 24, 2017 at 7:54 am

    Thanks Paul for the addition! I still feel that this dividend model, while we agree that it’s good for the “shareholder”, is only viable if you already have a strong market position or a competitive advantage in providing the actual service that justifies the extra cost for the users.

    In a blossoming industry, you won’t see huge profits in the growth phase, and the companies have to pour everything into increasing their market share. So, if I have two similar businesses with the only difference being the dividend, I would choose the dividend-less company without a question. I would actually like to see them leveraging growth, not distributing profits; a good business should have a large ROI, why would they give back valuable capital when they see growth ahead? For me, that’s a suspicious sign.

    You are right that the industry can support 100 of any given thing, but still, there is one Facebook, Google, Microsoft… That’s where network effects come in strongly, and fierce competition is guaranteed for the leadership. I want to hold the winners, the really efficient ones (Google vs Yahoo to simplify it). And to be honest, I don’t care too much about the bad reputation of ICOs, market cycles, or bubbles as an investor, if you can choose the real winners with a good percentage and stick to them, you will be rewarded. Wait for a big correction and buy, simple as that.

    I believe that in itself issuing shares or a share-token hybrid of some sorts is not a bad thing. It’s a simple way to distribute the increase in valuation, but of course, your solution is basically the same.

  8. febrocas

    September 12, 2017 at 12:07 am

    Doesn’t seem so terrible after all.

    “According to the human resources consulting firm Challenger Gray & Christmas Inc., some 22,267 dot.com job cuts have been announced since December 1999, when the firm began tracking such data. Of the 274 companies tracked from December 1999 through October 2000, 44 of them — or 16 percent of the total — have since failed. Still, people fired from dot.coms should have no problem finding another job, said John Challenger, the company’s CEO.”

    http://money.cnn.com/2000/11/09/technology/overview/

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Analysis

Crypto Update: Coins Hit 6-Week Highs as Rally Continues

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Bullish price action is still dominant in the cryptocurrency segment today, despite the recent lofty gains, and the overbought short-term picture in the ace of most of the majors. Correlations continue to break down, as more and more coins are in confirmed uptrends, with the total value of the market hitting $400 billion for the first time since early March.

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The top digital currencies are mixed today in the generally positive environment, with Bitcoin Cash, IOTA, Ethereum Classic, Dash, and Monero showing relative strength, in the face of the slightly overbought short-term momentum readings. While this is not the best moment to enter new short-term trades with regards to the majority of the coins, the long-term setup favors further gains in the coming weeks.

BTC/USD, 4-Hour Chart Analysis

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Altcoins have been leading the market higher in the last couple of weeks, and Bitcoin is still stuck below the $9000 level, as it continues to slightly lag behind from a short-term perspective. The coin ran into the strong resistance zone between $9000 and $9200 after breaking out of the broad declining trend.

Now a pullback is likely, given the slight weakness, with a possible test of the prior swing high at $8400. In case of a bullish move, the next target is at $10,000, and long-term investors should still add to their holdings on the short-term dips.

ETH/USD, 4-Hour Chart Analysis

Ethereum kept on creeping higher to marginal no rally highs in the last couple of days, nearing the $650 level despite the overbought short-term picture. Short-term traders should still not enter new positions here until the overbought readings are cleared, while long-term investors could still add to their holdings during the pullbacks.  Resistance zones are ahead near $735 and $780, while primary support is between $555 and $575.

Altcoins Diverging but Bulls Remain in Control

XRP/USDT, 4-Hour Chart Analysis

As we noted, the correlation between the coins is lower than during the downswing, and that confirms the bullish price action in the segment. Ripple is trading in a consolidation pattern near the $0.84 level, and although the overbought momentum readings are not yet fully cleared, the trend is clearly bullish and a new short-term buy signal is likely in the coming days.

Among the other recent leaders, IOTA triggered short-term sell signal, reaching the strong resistance zone near $2.2. EOS, Stellar, Cardano, and NEO are consolidating their gains, while Dash, Monero, and ETC are trading slightly above last week’s highs, but traders shouldn’t chase them higher here, as a short-term correction is likely soon.

Stay tuned for our detailed long-term technical analysis coming out later on today.

Featured image from Shutterstock

Disclaimer:  The analyst owns cryptocurrencies. He holds investment positions in the coins, but doesn’t engage in short-term or day-trading, nor does he hold short positions on any of the coins.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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Analysis

Bitcoin and Gold are Trading Inversely With One Another

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Advocates of bitcoin often compare the digital currency to gold for its finite supply and store-of-value characteristics. While BTC hasn’t come close to dethroning gold as the world’s most trusted safe-haven, it has steadily outperformed bullion amid the latest recovery. This has some people asking whether virtual currencies are eating away into gold’s demand.

Inverse Relationship

Strategists have identified a strong inverse trading pattern between gold and bullion stretching all the way back to the fall, right around the time that cryptocurrencies rebounded from a China-induced selloff. As bitcoin and other cryptos surged, gold experienced a steep fall from a high above $1,351 in early September to a low of $1,241 just three months later.

As bitcoin cooled down in the new year, gold resumed its upward trajectory and eventually peaked near $1,370 at the end of January.

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Below are the charting patterns for gold and bitcoin going back one full year.

The latest divergence is easy to spot. Since hitting a settlement high of $1,360 on Apr. 11, bullion has declined 2%. Over the same period, bitcoin surged 27%.

Bitcoin’s oversized percentage move relative to gold is a reflection of underlying volatility in the cryptocurrency market. Crypto assets as a whole are but a tiny fraction of gold’s $7.8 trillion worth. That said, the digital asset class peaked above $830 billion earlier this year, making the case for a trillion-dollar market more believable.

Systemic Risks

Proponents of bitcoin’s safe-haven status generally agree that the cryptocurrency is well suited to outperform the market during periods of heightened economic and political instability. This is generally believed to be the period in which gold prices thrive. However, unlike gold, bitcoin has also outperformed during periods of relative calm.

The second-largest bull market in history started off as a positive for gold as prices crossed $1,900 a troy ounce in 2011. However, bullion hasn’t been able to hit anywhere near those levels ever since. Bitcoin, on the other hand, has been the world’s best-performing currency (if one calls it that) in six of the past eight years.

Although the charts seem to indicate an inverse relationship between gold and bitcoin, it’s much more difficult to prove that investors are swapping one asset for the other at any given time. There’s some anecdotal evidence to suggest this is the case but a lack of trading data makes it difficult to conclude definitively one way or the other.

Supply and demand factors must also be weighed in analyzing the price trajectory of both assets. Gold’s total supply is increasing by an average of less than 2% annually, according to the World Gold Council. At the other end of the spectrum, the final bitcoin is expected to be mined in 2140, with total supplies engineered to decline until that date.

On the demand side, gold has been losing its allure as investors continued to pile into stocks. In 2017, appetite for bullion fell by 7%, with gold-backed ETFs plunging to one-third of the previous year’s demand. On the other hand, bitcoin’s demand has skyrocketed as more traders noticed its meteoric rise.

One area in which bitcoin has an advantage over gold is non-correlation. As the above examples clearly demonstrate, BTC is not correlated with the broader market. Gold, on the other hand, is influenced by risk-off sentiment, geopolitics, interest rates and inflation, among others. At present, these factors may play into the hands of bullion as investors prepare for the new business cycle.

Disclaimer: The author owns bitcoin, Ethereum and other cryptocurrencies. He holds investment positions in the coins, but does not engage in short-term or day-trading.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.5 stars on average, based on 343 rated postsSam Bourgi is Chief Editor to Hacked.com, where he specializes in cryptocurrency, economics and the broader financial markets. Sam has nearly eight years of progressive experience as an analyst, writer and financial market commentator where he has contributed to the world's foremost newscasts.




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Altcoins

Cryptocurrency Market Approaching $400 Billion as Bitcoin Tests $9,000

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The cryptocurrency market extended its bullish rally on Sunday, as bitcoin and the major altcoins continued to test multi-month highs. Buy orders accounted for the overwhelming majority of transactions, giving rise to expectations of a more sustained upswing in prices.

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Cryptocurrency Rally Continues

The combined value of all cryptocurrencies peaked at $397.2 billion on Sunday, the highest since Mar. 8. At press time, the market was valued just below $394 billion.

Transaction volumes ebbed on Sunday, with daily turnover amounting to $20.8 billion. Volumes were up around $25 billion on Saturday.

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In terms of individual currencies, bitcoin crossed the $9,000 mark for the second time in as many days. The digital currency was last seen trading at $8,932, having gained 4.8%. However, its share of the total market decline to around 38%.

All major altcoins contributed positively to the rally, with Ethereum gaining nearly 5% to $632. The value of Ripple XRP rose 2.6% to $0.886. Bitcoin cash also extended its bullish rally, climbing nearly 7% to $1,226.

Since bottoming at $249 billion on Apr. 6, the cryptocurrency market has added nearly $150 billion in value. Since the market crash of early February, coins have crossed the $500 billion mark on only one occasion, and that was roughly two weeks later. The total market has been capped below $400 billion since early March.

Bulls in Firm Control

The dramatic recovery in cryptocurrency prices can be summed up in one vital statistic: nine out of every ten trades have been buy orders. That figure was as high as 92.9% on Thursday, according to TurtleBTC.

Cryptocurrency trading is largely governed by investor sentiment, especially among speculators entering the market for a quick profit. This environment, when combined with thin volumes, often generates sporadic trading conditions that are characterized by extreme volatility.

Sentiment has been overwhelmingly positive over the last two weeks as investors looked to capitalize on extreme oversold conditions. Traders have seemingly shrugged off negative news headlines concerning India’s crackdown on cryptocurrency trading as well as the state of New York’s inquiry into exchanges.

There’s strong reason to believe that South Korean traders are playing a major role in the price recovery. According to the most recent volume rankings, three South Korean exchanges are among the top-five in total trading volumes.  They are: OKEx ($1.8 billion in daily volume), Upbit ($965 million) and Bithumb ($751 million).

With the recent spike in volume, cryptocurrencies are once again trading at a large premium in South Korea. This is generally the norm during bull cycles due to high demand and supply constraints. These premiums drew negative attention to exchanges last year as government officials began equating cryptocurrency trading with gambling.

Disclaimer: The author owns bitcoin, Ethereum and other cryptocurrencies. He holds investment positions in the coins, but does not engage in short-term or day-trading.

Featured image courtesy of Shutterstock.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.5 stars on average, based on 343 rated postsSam Bourgi is Chief Editor to Hacked.com, where he specializes in cryptocurrency, economics and the broader financial markets. Sam has nearly eight years of progressive experience as an analyst, writer and financial market commentator where he has contributed to the world's foremost newscasts.




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