The Black Swan Event - A Threat to the Financial System and Cryptocurrencies
Black Swan is used to refer to unforeseeable, unpredictable issues that often lead to serious consequences for the global economy, particularly in the realms of finance and the stock market.
Hello everyone,
The term 'black swan' originates from the Latin language in the form of an expression, referring to a rare species of bird on Earth, similar to the black swan. Over time, this phrase has been applied to describe exceptionally rare events. In the fields of economics and securities, this term is also used to denote unpredictable situations.
The black swan event is a quite common term often mentioned in economic contexts. So, what exactly is a black swan event? What should investors do when a black swan event occurs? Let's delve deeper into these questions in the following article.
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1. Black swan event
The Black Swan event, also known as a Black Swan, is a term coined by professor and former Wall Street trader Nassim Nicholas Taleb, first popularized through his book 'The Black Swan: The Impact of the Highly Improbable'.
It is used to refer to unforeseeable, unpredictable issues that often lead to serious consequences for the global economy, particularly in the realms of finance and the stock market. Therefore, it is crucial for everyone to be prepared for the possibility of Black Swan events and have timely response plans in place.
Typically, investors forecast upcoming price trends based on the historical price data. However, there are occasions when sudden events emerge, causing significant market volatility and inflicting substantial damage to the economy; this is referred to as the Black Swan phenomenon.
Professor Taleb also suggests that whether an event can be considered a Black Swan or not depends on an individual's perspective.
For instance, September 11 attacks had a severe impact on the global stock markets, leading to the collapse of numerous major companies and causing substantial losses for investors. This event is considered a Black Swan for the general public in the United States and the stock market sector in particular. However, it is not a Black Swan event for the terrorists themselves, as they had foreknowledge that these incidents would occur.
2. How does a Black Swan affect things?
We should not underestimate the impact of a Black Swan event. It can lead to significant changes in both the economy and politics, with its effects lasting for many years thereafter. Let's consider some of the most pronounced effects of a Black Swan on the financial market:
2.1. Significant volatility in the financial market
The impact of a Black Swan event on the financial market can be both immediate and long-lasting. These extreme and unexpected events sometimes exhibit initial signs such as volatility in stocks, commodities, bonds, and currencies. Subsequently, sudden instability erupts.
While it might take some time to ascertain the precise impact, it's evident that the underlying structures of the financial market have been disrupted. As panic ensues, investors engage in asset selling and position closures, contributing to the heightened volatility of the market.
2.2. Reduced available credit
Before and after a Black Swan event, economic uncertainty often leads to a decrease in the availability of credit. Banks and financial institutions that offer loans and other forms of credit become more cautious as they attempt to assess the impact of the Black Swan. This causes lenders to tighten their risk controls, making it harder for businesses to access credit.
2.3. Increased demand for insurance
As the impact of the Black Swan event becomes more apparent, companies often experience a heightened demand for insurance. While insurance provides a measure of protection against the financial burdens that events like these can bring, it's important to note that insurance itself is subject to unpredictable fluctuations in demand. This can lead to increased insurance costs, which then have ripple effects on businesses.
2.4. Political and social instability
In addition to financial impacts, Black Swan events can also lead to increased political and social instability. The significance and complexity of Black Swan events often give way to debates and discussions about societal organization and the meaning of public policies. This can result in division and societal shifts, leading to significant changes in the political landscape and creating long-lasting consequences. An example is the Occupy movement that emerged in the aftermath of the 2008 financial crisis and the enactment of the Dodd-Frank Act aimed at enhancing bank supervision in the United States.
3. Some examples of Black Swan events that have occurred include
3.1. The Dotcom Bubble Event of 2001
In 2001, the Dotcom Bubble event erupted, causing the global technology market to collapse, leading to a stock market crash and severe economic recession. The bubbles were formed due to the soaring stock prices of primarily U.S.-based Internet companies, coupled with the emergence of numerous new Internet companies.
Most of these technology-integrated companies' stocks experienced significant value growth, but many of their business models proved ineffective, leading to a wave of bankruptcies.
3.2. The Asian Financial Crisis of 1997
The financial crisis in Asia in 1997-1998 is considered a Black Swan event, causing severe devaluation of the currencies of many countries, numerous bank failures, and resulting in a widespread economic slowdown across the entire Asian region.
The cause of this event can be traced back to the late 20th century when Asian countries like Thailand, Malaysia, Indonesia, South Korea, and others experienced rapid economic growth. This economic expansion was largely driven by these Asian nations receiving substantial credit support from abroad, fueled by the loose monetary policy of the U.S. Federal Reserve. Consequently, these Asian countries became overextended in credit, leading to significant imbalances and ultimately causing a collapse of their entire economies.
3.3. The Global Economic Crisis of 2008
Another Black Swan event was the global economic crisis of 2008. In 2008, the S&P 500 index, comprising the 500 largest U.S. companies, plummeted by around 38.49%. The severe economic recession led to the bankruptcy of the investment bank Lehman Brothers.
This resulted in 25,000 people losing their jobs and the company losing $46 billion in market value. Furthermore, the impact of the 2008 crisis had a significant ripple effect on the global stock market, causing a loss of around $10 trillion.
3.4. Brexit event
The Brexit event is also one of the most prominent Black Swan events. On June 23, 2016, the British electorate voted in favor of the United Kingdom's withdrawal from the European Union. Brexit is a portmanteau of 'British' and 'Exit,' signifying the UK's departure from the European Union (EU). This event officially took place on January 31, 2020, marking the end of the UK's 47-year membership in the European Union and its associated institutions.
The most noticeable impact of the Brexit event was the largest devaluation of the British Pound in the past 30 years. This was followed by two more significant declines, with sustained depreciation in 2017 and 2019.
As a result, it pushed the GBP to new lows against the EUR and USD by August 2021.
4. Black Swan in the Cryptocurrency Market in 2022
The success of the crypto market largely depends on the global acceptance level of this digital asset class by various countries. For instance, during the crypto boom of 2021, numerous prominent U.S. companies such as Tesla, The Block, Microstrategy, and PayPal invested in Bitcoin.
Additionally, El Salvador became the first nation to officially adopt Bitcoin as a legal tender.
These developments propelled the prices of various cryptocurrencies to historic highs in 2021. However, the volatility stemming from geopolitical and macroeconomic conditions led the cryptocurrency market into a year-long bearish trend in 2022.
Firstly, the notable collapse of Terra (LUNA) began with the de-pegging of the UST stablecoin in May 2022, causing the crypto market to lose over $400 billion in market capitalization.
Next came the world's second-largest cryptocurrency exchange, FTX, filing for bankruptcy in November 2022, triggering the collapse of the high-risk investment fund 3AC, in which FTX held a major stake. Subsequently, the former CEO of FTX, Sam Bankman-Fried, was arrested in the Bahamas at the request of the U.S. government to investigate charges including financial fraud, money laundering, and more.
Following that, BlockFi, one of the world's largest cryptocurrency lending companies, also filed for bankruptcy at the end of November 2022. These events prompted countries to further tighten regulations for managing the crypto market while creating a sense of apprehension among investors worldwide.
According to information from CNBC, the U.S. government and the European Union are taking steps to force participants in the cryptocurrency market to adhere to regulations and ensure financial transparency. This could place greater pressure on the cryptocurrency market and potentially lead to a contraction in the ecosystem.
5. How to Protect Against Black Swan Events?
It's evident that Black Swan events are nearly impossible to predict and can result in significant losses for investors. So, what should you do to safeguard yourself in the marketplace?
5.1. Hope for the Best, Prepare for the Worst
According to economic experts who study market volatility, Black Swan events can occur at any time. In his book, Professor Taleb wrote that the best way to mitigate the impact of a Black Swan is not to try to predict it. Instead, it's essential to understand that Black Swans are inevitable and to build stable, resilient plans to protect your investment portfolio and manage their aftermath effectively. This approach can help minimize losses to the maximum extent possible.
5.2. Seizing Opportunities from Black Swans
When a Black Swan event occurs, the economy experiences severe impacts, causing both the stock market and the cryptocurrency market to plummet. Therefore, investing in stable and sustainable projects becomes highly necessary. Larger projects often possess the ability to navigate crises and recover swiftly.
Conversely, smaller projects are at a higher risk of bankruptcy, and some might even abscond with investors' funds. Thus, make the most of the opportunities presented by the Black Swan event to assess, filter projects, and scientifically restructure your investment portfolio. This proactive approach ensures you are better prepared to manage the aftermath and make informed decisions.
5.3. Diversify your investment portfolio
"Never put all your eggs in one basket" is a saying advised in every financial market. Remember that having only a single asset in your investment portfolio makes you vulnerable when a Black Swan event occurs. To ensure the safety of your capital, diversify your investment portfolio. In every circumstance, diversification remains a valuable piece of advice.
6. Closing thoughts
We cannot be certain when the next Black Swan event will unfold. What matters most is your readiness to handle any unforeseeable situation. Ensure stability and recovery from unexpected changes by preparing strategies to navigate the unknown.
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