“The wolf is chasing the sheep!!!…” Or so they believed.

The villagers ran up to the crying boy only to realize that there was no wolf. They were fooled. 2nd round of cries came again, the villagers ran up again only to realize there was no wolf, once again.

The wolf eventually turned up, the villagers didn’t. The villagers wanted to believe the kid but ended up disappointed on one too many occasions.

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The crypto market has endured more than 11 months of purging. Had you invested in January, your investment will most likely be worth 90% less. Not quite the quick riches many were expecting.

Many have theorized their arguments as to why the crypto market has bled so much:

  1. Market manipulation — Big players suppressing the price of cryptocurrency in order for them to set their large-orders at discounted prices.
  2. BTC Futures — In my “The 2018 Bitcoin crash” in April I highlighted the potential repercussions of a growing futures market leading to BTC price suppression. This argument has been eloquently echoed by Super Crypto, stating that BTCs price suppression is mirroring the price action of precious metals when futures markets were introduced.
  3. Irrational investing — The idea that the bull-run in Q4 2017 was simply not sustainable due to the fickle nature of retail investors. Many were led to believe that this would make them rich quick. The nature of these inexperienced investors engendered a positive feedback loop that was self-reinforcing and unsustainable.

Psychological damage — Every red candle is another test

Most crypto investors in 2018 went down the rabbit hole in Q4 of 2017. This was reflected by the incredible surge in December. Thus, the crypto investment experience for these individuals is mostly in the red. As it stands, their investment has simply been an expensive lesson — for now.

As the market continues to bleed, nascent speculators are becoming increasingly prone to the psychological afflictions of a bear market. The painful process tends to go something like this:

  1. Price declines> 2. Portfolio value decreases> 3. Negative thoughts > 4. Initially ignores negative thoughts >5. Price declines more > 6. Negative thoughts become increasingly prominent — this is exacerbated by clickbait articles by the mainstream media > 7. Eventually cut their losses.

This has fuelled a negative feedback loop:

George Soros popularised the theory of reflexivity to establish the misconceptions of human behavior in financial markets. In a market where irrational behavior is heightened, we’re witnessing this theory being ratified with the promulgation of the positive feedback loop (Q4 2017) and the ongoing negative feedback loop (2018).

Holders of last resort break the negative feedback loop by not panic selling. - Pierre Rochard

Bears are cleaning up whilst they can

The current bear market is prompting erratic movements by the same individuals that were experiencing severe FOMO in the bull market.

When we were amidst the hype of the 2017 bull market, we witnessed many speculators rushing to invest — so much so that Bittrex and Binance closed registrations due to the high demand.

With portfolio values diminishing, speculators are turning to day-trading to make quick returns. Shorting Bitcoin has become the most popular method with many jumping on the bandwagon.

BTC shorts at an all-time high

As we found out in December of 2017, FOMO only leads to an inevitable downfall. And with Bitcoin shorts at an all-time high (ATH), the stage for a short-squeeze is set.

As with most instances where shorts hit an ATH, the asset being shorted tends to go from overvalued to undervalued.

  • Bitcoins fundamentals in the run-up to 2018 did not justify a $20,000 valuation — Overvalued
  • Bitcoins fundamentals in the run-up to 2019 to do not justify a $3,000 valuation. — Undervalued
NVT ratio approaching undervalued territory

Bitcoin has a short history. 10 years is a short time for any analyst to deduce meaningful references that should give us scope for future price movements. However, Bitcoins Network Value to Transaction ratio has been a reliable indicator of bull to bear transitions.

When Bitcoin`s NVT is high, it indicates that its network valuation is outstripping the value being transmitted on its payment network, this can happen when the network is in high growth and investors are valuing it as a high return investment, or alternatively when the price is in an unsustainable bubble.- Woobull charts

As the chart depicts, the NVT ratio (in red) is indicating that Bitcoin is heading into oversold territory, this is also reflected in the BTC shorts chart that I showed earlier. Historically speaking, when the NVT ratio heads into the 100–50 ratio, we witness a transition from a bear to a bull market. This happened in 2011 and 2014. The current NVT ratio stands out 105, and with the BTC shorts piling up, we will be heading into seriously oversold territory.

With retailers using this opportunity to either 1) Cut their losses, or 2) Short BTC with the guidance of ‘paid groups’ - institutions and experienced crypto investors have used this opportunity to stock up on a seemingly undervalued asset. Examples of this are here, here, oh, and here.

Build it and we’ll come

Morgan Stanley recently carried out a survey amongst their clients, the exclusive report that was published reflected the sentiment amongst their clients. The report highlighted 3 major reasons preventing large-scale institutional investment in crypto:

1. Underdeveloped regulation — We’re already seeing a shift in this, especially with SEC identifying Bitcoin as a commodity earlier this year. The potential of an ETF approval would mitigate any feelings of apprehension towards underdeveloped regulation.

2. Lack of custodian solution — The launch of crypto custodian solutions by Fidelity and BitGo should eradicate any feelings of uneasiness when it comes to professional custodianship. Fidelity’s track record of managing over $7trn for the most conservative of investors should provide the answer.

3. Lack of large financial institutions invested — Well we know this to not be entirely true. As of recently, Harvard, MIT, and Standford endowments have all ‘officially’ entered the crypto market. History suggests that college endowments from these three have an incredible track record for yearly returns, so this decision to invest in the crypto market wouldn’t have been taken lightly.

Mea Culpa

The number #1 rule lamented by many successful investors tends to be something along the lines of — investing is 80% psychological. Yet, many struggle psychologically to detach emotion.

Many villagers are leaving. The cries of bull from their idolized influencers are falling on deaf ears. And just as speculators got carried away last year with the bull-run, many are getting carried away with the bear market.

Whether it be stocks, commodities or crypto, human nature will not change. And as the bulls cry wolf again, retail investors are leaving and institutions are entering. They’ve seen this story play out before. When we approach the climax of the next bull-run, the smart money will leave, only for the villagers to return — too late.

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Exploring the unknown. @twitmeserifi