What is a «black swan»

Definition of "black swan"

"Black Swan" is used to refer to events that are characterized by extreme rarity, outstanding impact and difficult predictability.
A black swan represents unexpected and often catastrophic events that have a significant impact on the market or economy, yet are difficult to predict. Examples of black swans include financial crises, terrorist attacks, natural disasters, and other events that do not fit into conventional forecasting models.

The idea of a black swan emphasizes the limitations in our knowledge and ability to anticipate complex and extreme scenarios in the economy.

Origin of the expression "black swan"

The term "black swan" has a long history. It was first used by the ancient Roman satirical poet Juvenal in the first century AD in the expression "rara avis in terris, nigroque simillima cygno" (a rare bird on earth like a black swan). At the time, swans were thought to only come in white, so the appearance of a black swan would have been something completely unexpected and unusual. The term grew out of a European metaphor where it was long believed that all swans were white. Therefore, the appearance of a black swan was synonymous with an extremely rare and unexpected event.

The term "black swan" became widespread because of the Lebanese-American writer Nassim Nicholas Taleb, who wrote the book "The Black Swan: The Impact of the Highly Improbable" ("The Black Swan: The Impact of the Highly Improbable").

Taleb used the expression "black swan" to refer to events that have three main characteristics: they are extremely rare, they have a significant impact, and they are extremely difficult to predict. Taleb argued that black swans are an integral part of human life. He also argued that people tend to underestimate the likelihood of black swans, which can lead to serious consequences.

The black swans theory reminds us that the future is unpredictable and that we should be prepared for unexpected events as well.

Thus, the black swan has come to symbolize unexpected and catastrophic events in risk and finance theory.

Main characteristics of the "black swan"

Nassim Taleb believes that the black swan is a phenomenon that has three key characteristics:

• The event is anomalous in nature - it has no prior analogs and was not predicted based on previous experience.
• The forceful impact of the event is exceptionally significant, capable of having a major impact on the course of events on a human or individual scale.
• After the occurrence of such an event, people strive to find or invent a logical explanation for what happened, even if it initially seems unexpected and can be perceived as a pleasant or unpleasant surprise. This means that it was possible to identify the preconditions of the event retrospectively.

The lack of ability to predict anomalies entails an inability to predict the course of history. Here Nassim Taleb raises the issue of the role of experts and especially of forecasters. Because we live in a world saturated with "black swans," we are forced to adapt to their existence and focus on what we don't know - anti-knowledge - instead of relying on predictions and knowledge. All of the important discoveries were merely "black swans" and unforeseen events, which emphasizes the need for scientists and business people to rely less on strategic planning, according to the author. We often limit ourselves to the known, to learning what is known, while it is important to learn our own impossibility of learning - what remains unlearned. We do not master the rules, we master only the facts.

The importance of conceptual understanding for investors and traders

Understanding the concept of black swans is important for investors and traders for several reasons. First, black swans can have significant consequences for financial markets. For example, the 2008 crisis led to the collapse of the stock and bond markets and a global recession. Investors and traders who were unprepared for this event suffered significant losses. Second, black swans can lead to severe losses for investors and traders who use forecasting models based on the assumption that the future will be similar to the past. These models may be effective for predicting normal events, but they are unable to predict black swans. Third, understanding the concept of black swans can help investors and traders develop more effective risk management strategies. Investors and traders, given the risk of black swans, can take measures to mitigate potential losses, such as portfolio diversification, hedging, use of insurance instruments, and risk management. The black swan concept plays an important role in developing a more sustainable and adaptive approach to investing and trading.

Possible implications for markets and economies

Because black swans are difficult to predict, yet highly significant events, they can affect markets in very significant ways. First of all, the occurrence of black swans can cause sharp fluctuations in financial markets. Investors react to unexpected events, which can lead to dramatic changes in asset prices.

In addition, depending on what happened, unpredictable events can result in significant losses for investors, especially those who do not take appropriate risk management measures.

Black swans can set off chain reactions across industries, creating cascading effects in the economy. Recall the domino effect and the dot-com crisis when US banks and the US economy suffered, but the chain reaction spread to global financial markets. Banks in various countries began to experience liquidity problems, lending slowed down, and investors lost confidence in the financial system.

However, while black swans can pose a threat, they can also create new opportunities for enterprising investors who can adapt and win in a volatile environment.
Analyzing historical stock market statistics leads to the following key conclusions:

• Black swans and crises: the impact of black swans on stock markets is substantially similar to the impact of other crisis events. This emphasizes that extreme and unexpected situations can trigger similar reactions and consequences.
• Recovery time: the recovery time of stock markets depends on the length of the recession, but in most cases it rarely exceeds one year. This indicates the relative resilience of markets and their ability to recover quickly from difficult periods.
• Long-term uptrend: An important observation is that the long-term trend of broad market indices is always upward. Despite temporary fluctuations and crises, stock markets tend to recover and show growth over time.

For example, this chart shows the long-term uptrend of the S&P 500 Index since January 1928. Despite several drops caused by crises, the index has always recovered and continued to rise. This shows that stock markets tend to rise in the long run.

Examples of "black swans" in history

Black swans occur throughout history. A prime example of a black swan in the market would be the 1987 stock market crash.
On October 19, 1987, after a four-year period of steady gains, the world stock market experienced a colossal crash. The Dow Jones Industrial Average fell by a record 22.6%, and by the end of October, the stock markets in Hong Kong and Australia were down 45.8% and 41.8% respectively. Immediately after the collapse, trading on stock markets was temporarily suspended because the computing equipment of the time was unable to process the huge number of incoming orders. The main causes of the crisis are considered to be market overvaluation, software trading failure and peculiarities of trading psychology.

The event was beyond normal expectations and was a surprise for the financial world, which corresponds to the ideology of black swans. However, after the event occurred, experts noticed that it was not so unpredictable, as the precursor of the collapse was 1986, when a smooth economic recession began. Nevertheless, many market participants neglected this signal. In addition, during the period of steady growth of the preceding collapse, investors overvalued assets. Market prices became overvalued relative to the real fundamentals of companies. This is why it is so important to use a fundamental analysis approach to asset valuation, because it can help you determine whether a market or a particular asset is highly overbought or oversold.

Read more about fundamental analysis.

Among the latest black swans that have affected the economy, we can consider the emergence of the coronavirus: the emergence of the coronavirus in 2020 was a global pandemic that led to the death of millions of people and serious economic consequences. Interestingly, the markets did not start their decline until 2021 because when the first news of an unknown virus in China began to emerge, people around the world did not react. The coronavirus that caused the COVID-19 pandemic can be considered a "black swan" for several reasons:

• Unexpectedness: the emergence of a new virus with such a high degree of contagiousness and serious health consequences was an unexpected event.
• Global impact: the pandemic affected the entire world, impacting health care, the economy, people's lifestyles and many other aspects. This global impact makes the event characteristic of black swans.
• Difficulty in prediction: although there was a risk of pandemics, the exact time, location and nature of the virus was difficult to predict. This is also consistent with the concept of black swans, which are difficult to predict because of their rarity and complexity.

Coronavirus is a prime example of how black swans can have a significant impact on the world. It has shown that the future is unpredictable and that we must be prepared for the unexpected.

Now let's look at an example of a black swan in crypto markets - the so-called Black Thursday. It stems specifically from the coronavirus pandemic. Black Thursday is the term used to describe the sharp drop in cryptocurrency prices that occurred on March 12, 2020. On that day, the price of bitcoin dropped 37% and the price of ether dropped 40%. Black Thursday was caused by a combination of factors, including:

• The coronavirus pandemic: the coronavirus pandemic caused global economic uncertainty, leading to a decrease in demand for cryptocurrencies.
• Tightened regulation: some countries started to tighten regulation on cryptocurrencies, which also led to a decrease in demand.
• Technical issues: the day also saw some technical issues at major crypto exchanges, which exacerbated the situation.

Now back to prediction: on March 10, 2020, crypto analyst Willy Wu posted a chart of investor activity in the cryptocurrency market on his Twitter, where he found unusual fluctuations. Wu speculated that this could be due to the coronavirus spreading around the world. And on March 12, 2020, the World Health Organization officially declared the COVID-19 epidemic a pandemic, after which the markets crashed.
Black Thursday is a prime example of how black swans can have a significant impact on crypto markets. It showed that crypto markets are also vulnerable to unexpected events, and that investors should be prepared for such events.

Examples of "black swans" in the crypto industry

One prominent example of a black swan in the crypto industry is China's ban on mining: China was one of the largest cryptocurrency mining centers in the world. In 2021, it was estimated that China accounted for about 65% of global bitcoin mining. In May 2021, Chinese authorities began to tighten regulation of cryptocurrencies. In particular, they banned financial institutions from providing cryptocurrency-related services and increased oversight of mining. Already at this point we could expect further tightening and something wrong in the markets, only three months passed and in September 2021 the Chinese Central Bank announced a complete ban on mining and any transactions with cryptocurrency. This decision was seen as a major black swan by the market. China's ban on mining had a significant impact on the crypto markets. Within days of the announcement of the ban, the price of bitcoin fell by 20%.

China's mining ban has had several consequences:

• A decrease in the hash rate of the bitcoin network. Hashrate is a measure of the processing power of the network used to mine bitcoin. After China's mining ban, the hashrate of the bitcoin network decreased by 50%.
• Redistribution of mining. After China banned mining in China, miners from China were forced to move their operations to other countries. This led to the redistribution of mining to other regions such as the US, Kazakhstan, and Canada.
• Change in cryptocurrency prices. The ban on mining in China led to a decrease in the prices of cryptocurrencies as there was less demand for them from Chinese miners.

Interestingly, this was not the first time China banned BTC.

Why is this particular event a black swan? Chinese authorities had expressed threats about banning the mining and use of BTC, but just a month before the mining ban, Li Bo, deputy governor of the People's Bank of China, praised BTC and other cryptocurrencies, calling them an important part of the future. Bo suggested that BTC and cryptocurrencies should be viewed as alternative investments and said that China was developing regulatory policies for these assets. This is why such a drastic ban came as a surprise to the market.

Overall, China's mining ban had a negative impact on crypto markets. However, over time, the market adapted to the new conditions and cryptocurrency prices recovered - this is what emphasizes the fact we talked about before - markets always recover from black swans.

Application to everyday life: how "black swans" can affect personal finances

Black swans can affect personal finances in a number of ways. They can lead to:

• Loss of income: black swans such as job loss, illness or accident can lead to loss of income.
• Increased expenses: black swans such as natural disasters or economic crises can lead to increased expenses. This may be due to the need to repair or replace damaged property, or due to an increase in the prices of goods and services.
• Decrease in savings: black swans can lead to a decrease in savings. This could be due to the need to use savings to cover unexpected expenses, or a decrease in income, making it difficult to save.

How can I protect myself from black swans?

• Build a safety cushion: try to accumulate at least six months of expenses as a safety cushion. This will help you cover unexpected expenses without resorting to a loan.
• Diversify your income: try to earn income from multiple sources. This will help you reduce the risk of losing income if one source is lost.
• Getinsured: insurance can help you protect yourself against some of the financial losses caused by black swans.
• Be prepared for change: black swans can cause dramatic changes in your life.

If you lose your job, you may find it difficult to meet basic expenses. You may need to take out a loan to cover rent, food and utilities.
If there is a natural disaster, you may need to repair or replace damaged property. This can be expensive, especially if you don't have insurance.
If there is an economic crisis, prices for goods and services may rise. This can make it difficult to cover basic expenses, especially if you have a low income.
Black swans can have a significant impact on personal finances. It is important to be prepared for them and take steps to protect your finances.

However, a very interesting piece of advice is given by Nassim Taleb in his book, "Quitting a high-paying job, if that is your decision, will do more good than the money you make (such an act may seem crazy, but I've tried it, it works). It's the first step to having the courage to send fate to hell. You have a lot more power over life if you choose your own criteria," says Taleb, "The hardest game to lose is the one where you make the rules.

There is no need to be afraid of black swans, you just need to be prepared for them and understand what to do if something unexpected happens. To successfully navigate black swans, you should always have a plan B that you can follow.

How to react to "black swans": CRYPTOLOGY team's opinion

The essence of the black swans concept is that there are events that are extremely difficult to predict due to their uniqueness and rarity. However, despite their unpredictability, it would be unwise to ignore the possibility of their occurrence. It is important to realize that black swans can dramatically change the course of events in our lives, in the economy or in any other area. Therefore, in order to minimize the potential damage from such events, it is advisable to take precautionary measures.

One key strategy is asset diversification: you should not concentrate all your resources in one area or asset. A variety of investments can soften the blow if one market suddenly collapses. It is also important to have a financial safety cushion: having a sufficient reserve of funds that can help you survive times of economic turmoil or personal crisis. Generating income from multiple sources is also an effective way to cope with emergencies. If one source of income becomes unreliable, others can provide financial stability.

It is equally important not to keep all your savings in one place: a variety of bank and investment accounts can protect you in case of financial crises related to specific financial institutions, such as what happened in 2022 when the FTX exchange collapsed: people who kept all their funds there lost them in the moment, while those who spread their assets across different platforms were not as badly affected. In addition, insurance is another way to reduce potential losses. Whether it is life, health or property insurance, it can prove to be a lifeline in the event of unforeseen circumstances.

In addition to this, it is important to be able to adapt quickly to new circumstances. One should always be prepared for black swans. Markets are cyclical and if you keep track of what is happening in them, it will be possible to prepare for and maybe even predict black swans. Black swans always have objective preconditions that only manifest themselves over time. The analysis of previous significant declines and black swans in financial and cryptocurrency markets will help to recognize the formation of general trends in time. Moreover, historically, big crises occur with a period of about 7-11 years. It is this kind of knowledge and study of the processes occurring in the markets that can help recognize the next black swan. While black swans are inherently unpredictable and can lead to significant disruption, you can always minimize the risks and thus the potential damage.