For many years, behavioral economists and scientists studying behavioral finance have tried to understand “Why and When do people buy and sell in financial markets? ” This shift in thinking from trying to directly predict prices of stocks to the behaviors of traders arose is more recent years. Many theories abound in this space – that of a rational investor, that of a greedy investor, that of an arbitrageur, the opportunistic investor, the value investor, etc… Off all these theories, some such as Ray Dalio’s investment theory based on “Principles” and deep analytics have been seen as a successful mechanism to model a large (investment) firm’s behavior and also to base one’s investment philosophy.
These models, however, attempt to mathematically depict investor intentions to buy and sell equities in markets that are a) heavily regulated and monitored by organizations such as SEC, IRS (and their equivalents) b) operate at predetermined times c) have a fixed point of sale and uniform prices (e.g. the share is priced only at the market where it is sold) and d) is usually geographically constrained because buyers and sellers are limited to institutions or individuals who are allowed to trade legally within a geographic boundary. There is a sense of fairness (or imposed fairness) in trade here. As traders, rules of trade, and institutions surrounding markets have evolved over decades, these markets have matured sufficiently so as to reflect capitalistic progress. Buoyed by very little volatility in the indices, robust growth and supported by strong institutions that have been time tested by many black swan events such as the mortgage crises, the 2000 dot-com bubble, these markets indicate progress made by society in encouraging capital markets.
Behaviors in Crypto markets
The nascent Crypto markets, however, are entirely different. Institutions, governments, and regulators are just waking up to the rise of crypto coins that today are worth about 1/2 a trillion dollars in market capitalization. These markets operate on a 24X7-365 day basis and each exchange where such trade occurs can have overlapping users. Assets traded do not have a fixed point of the sale price (meaning a single bitcoin can fetch the seller different prices, depending on which exchange was chosen to sell the bitcoin). Usually, buyers and sellers are not geographically constrained though exchanges operating using fiat currencies sometimes attempt at regulating traders by geography. This lack of regulation, oversight, and global distribution has brought tremendous volatility to these markets. The monthly volatility in these markets is comparable to large black swan event (such as the dot-com crash or the 2008 market correction on account of the housing mortgage crisis). For example in the 2008 crash, the DJIA dropped about 52% and the SnP500 dropped 20% in a single day wiping out wealth to the tunes of billions of dollars. Such crashes and corrections are treated with great alarm in regulated markets, and, all institutions rush to ascertain that there is no market manipulation. The fallout of such an event has a wider economic impact leading to job losses, temporary suspension of economic activity and so on…..
In the face of such uncertainty in the crypto-markets is a large user base of both individuals and institutions who are labeled as HODL – “Hold on to Dear Life” investors, who trust the technology significantly more than all rational thought. The HODL groups behavior is completely irrational and every time the price drops below a certain level, they form a strong support base who purchase more of these assets, bringing both the technology and the price within reasonable ranges.2017 was the year the HODL investors really participated in these markets – buying at times of huge dips and holding without selling when the prices rose. The HODLs are the ones responsible for limited supply of these coins in the markets for trade.
It will be interesting to see what 2018 could bring up to the HODLs and others.