The Economics Behind Cryptocurrency Market Pullbacks


Cryptocurrencies are known to be volatile; however, even with the constant chanting of “HODL” on Reddit and other social media platforms, people still struggle to not sell during a crash. I believe that this might be a consequence of many first-time investors entering the crypto sphere who concurrently have never witnessed a severe bear market and are unfamiliar with the necessary mindset for investing — i.e. delayed gratification.

Interestingly enough, we can see that Bitcoin crashes roughly once per quarter. But why do we still enter severe modes of panic every time the price drops a little more than we’re used to? In classical economics, people are thought to be, at all times, rational and make the logical decision from iterating past information into concise actions. Yet, this is not empirically the case. With the creation of prospect theory — put forward by Daniel Kahneman and Amos Tversky — it was clear that people often contradict themselves and their beliefs almost immediately. Indeed, this is quite applicable to the current crypto market.

Coinbase, the most popular exchange, and medium to purchase BTC, ETH, and LTC, has aggregated over 13.3 million users at the end of November. The process for buying cryptocurrency has become so simple that even adolescents can download Coinbase from the Apple app store, connect their bank account, and start purchasing. The ease and the hype behind the supposed returns of cryptocurrency results in expectations that the price will skyrocket instantaneously. But, market dynamics result in corrections, which is needed for the price to accurately reflect supply and demand.

Recently, we experienced another of these pullbacks; yet, I believe the damage was overstated, as nothing has fundamentally changed from the initial bullish behavior of Bitcoin or the other altcoins. The people who bought during Thanksgiving from learning about Bitcoin from their nouveau-riché friends experienced their first pullback and perhaps, with a possible lack of investment knowledge, they sold and were dealt massive losses.

As the cryptocurrency market evolves and eventually slows down, ways to assess the fundamentals of coins will evolve. Before the dot-com crash, technology companies were incredibly overpriced; in parallel, the cryptocurrency ecosystem contains coins that are priced much more than they are feasibly worth. But the velocity of money is greater in new, unforeseen fields and when this slows down, the dearth of fresh funding will yield in the weaker companies shuttering and the durable coins will gain vast amounts of market share. With fewer dominant coins, there will be less speculation, and the development of tools to determine the fundamentals of coins will convert the crypto market from the wild-west into a more robust market.

Investors will always irrationally buy and sell: this is a given because we are all human. However, it’s possible that we understand our faults and create ways to move around them by either reading from iconoclastic investing minds like Charlie Munger or Howard Marks or staying in the market for the long run.