Crypto Volatility, FUD and Some Random Thoughts

“People, it turns out, are not that averse to risk. For many reasons, they are not opposed to risk, but they are opposed to losing and the possibility of loss plays a very significant part in their decision.” - Daniel Kahneman

Some of my long positions has got liquidated. China has really given a tough blow to the crypto industry by banning all crypto transactions and declaring that all such transactions will be considered illicit. The People's Bank of China said, "Virtual currency-related business activities are illegal financial activities”. China is a big market for cryptocurrency trading and Bitcoin fell more than USD 4500 in the last 24 hours. The altcoins are also bleeding naturally as this market reacts very badly when the king tumbles. Cryptocurrency trading through local exchanges was officially banned in China since 2019 but trading continued through foreign exchanges.  The latest crack-down confirms that China wants to shut down cryptocurrency trading permanently.

Surprisingly, things looked quite rosy yesterday as Twitter announced support for tipping with crypto and NFT authentication. Twitter launched its ‘Tip Jar’ as a beta product some months back and the application is going to support Bitcoin tipping very soon. The NFT authentication feature will allow NFT creators to connect their crypto wallets to Twitter so that they can showcase their NFTs on the popular social media platform. The market was responding very well to this positive news but China FUD pulled it down. Heavier sell-off from China can be expected in the next few days. The market is supposed to remain volatile now. Should you sell everything?

Cryptocurrency’s outrageous volatility is not a new issue. The newbies are often petrified in this market before understanding anything. The green candles turn into red very fast with double-digit negative growth. People sell in panic! We can relate this incident to negativity bias which says that negative events have a larger impact on our brain than positive events. Psychologically we become very impacted by negative things as we pay more attention to them and we react more strongly to negative events than positive ones.

“All too often, the rabbit hole is as deep as you have dug it.” - Gary Hopkins

Bitcoin is often called ‘digital gold’ but the critics argue to not call it so due to its extreme volatility. Gold is considered a safe investment due to its stability. Bitcoin is the best performing asset class in the last ten years but the volatility factor has remained notorious. March 12, 2020, is known as ‘Black Thursday’. The cryptocurrency market witnessed a historical crash on that day and Bitcoin’s price fell from USD 7300 to a low of USD 3900. On some exchanges, the price of Bitcoin even fell below USD 3400. Long term believers of Bitcoin might have filled their bags on that day and they are laughing today at the stupidity of panic sellers.

Is price volatility bad? Volatility plays a role in market making. Every peak or bottom draws a new set of investors. Volatility is related to risk and return. For a trader, volatility can be a big opportunity or it can be a reason for his/her loss. Volatility does not scare a trader but the fear of loss creates heavy fright. When we expect a high return from investment, we should be prepared for high losses too. But alas! We get shocks quickly and do not absorb that.

Volatility moves the market. Without volatility, there would not be any trader in the market. The cryptocurrency market is unregulated and trading is happening the whole day. High-level market manipulation happens here as there is no watchdogs. Imagine Elon Musk selling all Tesla stocks in the morning to buying at a cheaper rate in the evening! How will that impact market? In the regulated stock market, such a situation does not occur but it can happen in crypto. High leveraged trading is another issue. Major cryptocurrency exchanges offer 100-125X leverage in futures trading and they make a lot of money out of it. A leveraged market is basically a bubble kingdom and it can burst with a simple pinch due to automatic liquidations.

Schrödinger's cat is a famous thought experiment of Quantum Mechanics that illustrates a paradox of quantum superposition. A hypothetical cat may be considered simultaneously both alive and dead in the thought experiment. A quantum-like superposition is prevalent in our economy also. Stocks and cryptocurrencies are skyrocketing now. Some assets inflate in value while we are seeing aggregate demand is getting reduced post-pandemic. A deflationary tailspin has been predicted by many economists. What goes up, often goes down. Is it time to be cautious?

It is always wise to be cautious with large amounts. A free-market equilibrium takes place after ages and cryptocurrency is a very new asset class. Adam Smith introduced the ‘invisible hand’ theory in 1759. It is a metaphor that refers to the invisible market force which balances supply and demand by actions of self-interested individuals. Price discovery is a social process to maximise social benefits and the benefits derived from the free market lasts long. Cryptocurrency is a fundamentally radical concept and it is not part of a planned economy. While past volatility may not be an indicator of future volatility, the investment ride can be full of bumps. It is cool to be motivated with a profit-maximising objective but it is important to understand what you are trading. A mango trader should know that mango can be sweet, sour or rotten. Greed and fear are the basic instincts that drive our investment behaviour but your faith in the invested asset is very important. The frequent blips of the crypto market are going to stay! Get accustomed to the noise.

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