Guests: Jeff Park, Bitwise Alpha Strategy Investment Manager; David Kalk, Reflexive Capital CIO
Moderators: Jason Yanowitz, Founder of Blockworks; Santiago R Santos, Investor;
Podcast source: Empire
Mastering the Psychology of Crypto Cycles | David Kalk & Jeff Park
Air Date: August 8, 2024
Summary of key points
In this episode, David Kalk of Reflexive Capital and Jeff Park of Bitwise explore the critical role of psychology in crypto trading. They argue that controlling one's emotions and biases is key to excelling in the highly volatile and reflective crypto markets. They reveal the limitations of traditional venture capital approaches, the potential of liquidity strategies, and why psychological resilience may be the most valuable advantage in the cryptocurrency space today. They share their thoughts on managing trading psychology, adapting to market institutions, and the future of institutional crypto investing.
Introduction of David and Jeff
David Kalk is the founder and chief investment officer of Reflexive Capital, while Jeff Park is the head of Alpha strategy and portfolio manager at Bitwise. The two guests have their own unique backgrounds, especially David’s extensive experience in the field of macroeconomics.
David started his career in 2008 at Goldman Sachs in the interest rate derivatives department, focusing on market structure. His experience working with Peter Thiel taught him the importance of independent thinking and risk management in the macro market. In 2020, he left Goldman Sachs to help start Commonwealth Asset Management, identifying cryptocurrency as a macro asset in the process. David also mentioned that he set up some customized products in 2021 to enter the crypto market, and after observing the policy changes of the Federal Reserve, he decided to focus on the crypto business and eventually founded Reflexive Capital.
An inefficient market with low liquidity for cryptocurrencies
Liquidity and Efficiency in Crypto Markets
David pointed out that the cryptocurrency market is a highly liquid but inefficient market. Typically, liquid markets are more efficient, with crypto markets being a notable exception. Although the crypto market has a certain degree of liquidity, its efficiency is very low. This is mainly due to the composition of market participants, who lack professional trading experience and are more retail and novice investors.
David believes that there is a clear phenomenon of insufficient portfolio adjustment in the market, especially when there are large fluctuations in the crypto cycle, many investors fail to adjust their strategies in time. He compares the current crypto market to the macro market in the 1990s, pointing out that if you can correctly grasp the large-scale market rotation, you will get huge returns.
Investor Psychology and Trading Strategies
David further analyzed the psychological factors of investors in the crypto market and believed that trading and risk management skills are crucial in this market. He pointed out that successful traders are usually able to respond flexibly to market changes, which is in contrast to the long-term thinking of venture capitalists. Venture capitalists are often slow to react to market price changes and may miss the best trading opportunities.
Jeff added that as the head of Bitwise's Alpha strategy, his team is committed to finding unique crypto investment returns through a multi-strategy, multi-manager framework. He emphasized that the inherent volatility of the crypto market is one of its characteristics, and this volatility provides opportunities for professional investors.
Market structure and future prospects
David discussed the structural changes in the crypto market and believed that historical experience could be misleading. With the influx of venture capital funds, the initial token prices in the market were affected, resulting in higher entry costs for liquidity investors. He believed that many investors currently lacked sufficient funds to make effective investments in the face of market fluctuations.
Yano mentioned that many funds fully allocate funds during the bull market, resulting in an inability to respond effectively when the market goes down.
David believes that investors need to re-evaluate their portfolios to cope with different market cycles and recommends adopting flexible strategies to seize new investment opportunities.
Jeff also pointed out that when investors choose managers, they are often influenced by traditional venture capital thinking and ignore the unique value capture mechanism of the crypto market. He believes that the crypto market not only relies on the investment of financial capital, but also includes the contribution of social capital and human capital, which provides investors with new perspectives and opportunities.
Liquidity Providers’ Concerns
Investors’ high return expectations
Santi mentioned that when pitching to liquidity providers (LPs), investors usually expect extremely high returns, such as 30 times the return. They do not care about specific investment strategies or governance participation, but hope to get returns consistent with historical returns. This mentality makes many managers face challenges when pitching to LPs because they need to prove that their strategies can achieve these expected returns.
The relationship between returns and volatility
David further pointed out that liquidity providers are more concerned about returns within the volatility range rather than pursuing maximum returns. The current fund allocation process is often limited to managers who think in line with investors, resulting in a lack of effective return models in the market. Many investors want to keep most of their funds in cash and use a small amount of funds for crypto investments, but such a strategy needs to be packaged in a suitable way, otherwise it will be considered unfeasible.
Clarity of investment strategy
Santi stressed that managers need to clearly distinguish whether their investment strategies are from hedge funds or venture capital, especially when pitching to LPs. If the strategy is seen as "liquid venture capital," investors may be confused and choose to give up. Therefore, managers need to clearly communicate the nature and objectives of their investment strategies.
Psychological factors and risk management
David pointed out that psychological factors play an important role in trading. Successful trading not only relies on market knowledge, but also requires a deep understanding of risk management. He mentioned that many managers from the traditional financial industry may not have the necessary trading skills, which makes them face challenges in the crypto market. Effective risk management can be an advantage, and trading itself is a psychological game that requires flexible response.
Structural issues with investment vehicles
Jeff mentioned that the structure of investment vehicles is crucial to investors' attractiveness. Open-end structures have different incentive mechanisms than closed-end funds, which may have more advantages in risk management. However, structural problems in the current market, such as annual fee burdens, can lead to disappointment for investors after experiencing large fluctuations. Therefore, managers need to consider how to design investment vehicles to better meet the needs of investors.
Comparison between Liquid Market and Private Market
New Trading Mentality and Financialization
Jeff mentioned that with the development of the crypto market, new trading mentality and financialization trends are taking shape. For example, the launch of Bitcoin ETFs may bring more derivative transactions, such as options. The integration of such traditional financial trading tools with the crypto market will gradually increase, providing more paths for risk management trading solutions. He believes that choosing the right investment tool structure to align with liquidity providers (LPs) is a key issue, which may not have received enough attention in the past, but is expected to improve in the future.
Lack of trading skills and data points
David stressed that successful trading requires special skills. He mentioned that while some people may have extensive experience in traditional finance (such as oil trading), this does not mean they can successfully trade crypto. He pointed out that the lack of suitable data points makes it difficult to evaluate a trader's abilities. Moreover, trading is not just a combination of techniques and strategies, but also involves emotional management and an understanding of cognitive biases. He expressed doubts about people who can effectively manage their emotions and develop a trading plan.
Emotional Management and Trading Plans
David further explores the importance of emotion management in trading. He believes that only a small number of traders have enough discipline and emotional self-awareness to effectively use their cognitive biases to develop trading plans.
The Importance of Psychological Advantage
Psychological factors in trading
Santi mentioned that in his exchanges with other traders, the most frequently discussed question is "What can I not see right now? What is my bias?" This self-reflective way of thinking is very important in trading, especially when facing complex markets. Managing emotions and cognitive biases is considered the key to successful trading, and this psychological advantage is particularly prominent in the crypto market.
Cognitive bias and market behavior
David emphasized that psychological advantage is the most significant advantage in the crypto market. He mentioned that many traders are susceptible to cognitive biases when experiencing market volatility. For example, investors may choose not to sell assets because of past losses, resulting in holding on to losing assets when the market declines. Such behavior reflects people's emotional reactions when faced with loss and often leads to irrational decision-making.
Reflection and market response
David further explored the market's reaction mechanism, emphasizing the market's reflexivity. The feedback loop between price changes and fundamentals affects investors' decisions. For example, when the price of Bitcoin rises, market sentiment becomes optimistic, causing more investors to flood into the market, further pushing up prices. This phenomenon is particularly evident in bull markets, while in bear markets it may lead to reverse sentiment and decisions.
Capital Protection and Risk Management
Santi pointed out that many managers, when faced with uncertainty, often dare not tell liquidity providers (LPs) that they are holding cash or major assets. They worry that this will affect their relationship with LPs, but in fact, managers sometimes need to adopt conservative strategies in times of market uncertainty to protect capital. Effective risk management and psychological advantages can help managers stay calm in market fluctuations and make more rational decisions.
Responding to the market environment
Changes in the investment environment
Santi mentioned that the investment environment over the past three to six months has not been easy, and asked how to adjust mental models to achieve market outperformance under such circumstances. Jeff responded that the multi-strategy investment approach over the past six months has demonstrated its importance, especially in the current market conditions.
Advantages of multi-strategy investing
Jeff emphasized that adopting a multi-manager investment strategy can better cope with market fluctuations. He mentioned that as the market changes, different trading strategies (such as macro trading, trend strategies, and high-frequency trading) perform well in different time periods. For example, with the launch of the Bitcoin ETF, both macro trading and computer-driven trend strategies can capture market opportunities. At the same time, innovations in the DeFi field (such as Pendle and Athena) have also become the focus of investors.
Understanding Market Liquidity
David mentioned that understanding changes in market liquidity is the key to successful investment. He pointed out that there were significant differences in capital flows between the first and second quarters, which was particularly evident in liquidity indicators for Bitcoin ETFs and stablecoins. In addition, he emphasized that the market will experience technical selling pressure under certain circumstances and investors need to carefully assess risks.
Dynamics of old and new coins
Santi discussed the performance of old coins, pointing out that some old coins are healthy in circulation supply, while others have performed poorly during the unlocking process. He believes that the market has realized the impact of unlocking, and many investors prefer projects that have been unlocked and have fundamental support when choosing assets.
Reflection and Future Outlook
David mentioned that although many old coins have performed well in past cycles, the future market may not attract investors as much as before. He believes that new investment opportunities will come from new projects and innovations, rather than relying solely on hot assets in the past.
How to manage emotions in the markets
Sentiment and market reaction
Santi mentioned that how to quantify growth in the market is an important question. Jeff explained their research methods, focusing on two indicators: the ratio of total locked value (TBL) to market value, and weekly user growth and engagement. These indicators can help investors identify which assets may be at risk of depreciation.
Reflexivity and emotion management
David emphasized that the reflexive nature of the market means that certain factors, such as new wallet creation and user growth, can significantly affect market sentiment and asset prices. When these factors change upward or downward at the same time, investors need to adjust their strategies in a timely manner. He mentioned that emotions play an important role in trading decisions, especially when the market is volatile.
Identifying market changes
Santi believes that the key to understanding market changes is to admit that you are not smarter than the market. He mentioned that many investors tend to be overconfident when facing market changes, which may lead to wrong decisions. On the contrary, acknowledging the complexity and uncertainty of the market can help investors better cope with challenges.
The impact of emotions on decision making
When market sentiment changes, investors often face the confusion of whether to continue holding positions. David believes that emotion management is the key to successful trading. He mentioned that investors need to make plans to deal with changes in market sentiment rather than simply relying on intuition. Emotional fluctuations can cause investors to make wrong decisions, so it is crucial to identify and manage these emotions.
Emotion management in practice
Santi shared his experience in this cycle, emphasizing the importance of gradually adding positions. He mentioned that although he sometimes missed the best entry time, by gradually adding positions, he was able to get better returns when the market rebounded. This strategy helped him overcome the emotional pressure caused by not being able to enter the market at the lowest point.
Is cryptocurrency worth investing in?
The importance of liquidity
Santi stressed that liquidity is crucial in the cryptocurrency market because liquidity can disappear quickly and can also be restored quickly. He mentioned that in the current market environment, over-trading may lead to losses, so he prefers to wait for the opportunity for liquidity to pick up.
Investment strategies and psychological factors
David believes that many investors do not actually crave liquidity because it means they need to trade frequently. He mentioned that many investors feel overwhelmed when faced with market fluctuations and therefore prefer to avoid making decisions. Relatively speaking, the risk tolerance of traditional financial markets may be higher because investors can usually wait longer for results.
Adapting to market changes
Santi said that investors should learn to embrace volatility rather than avoid it. He suggested that when facing a market decline, investors should view it as a buying opportunity and maintain cash flow to seize these opportunities. At the same time, he emphasized that investors need to have a clear plan and adjust according to market information.
Long-term investment perspective
Jeff mentioned that despite the fierce competition in the crypto market, it still provides unique opportunities. He believes that liquidity and volatility are factors that must be considered when investing in cryptocurrencies. With the right strategy, investors can find profitable opportunities in the market. He also mentioned that good investment returns are often associated with liquidity risks, so in the crypto field, it is very important to find the right investment opportunities.
Emotional management and decision making
Santi mentioned that one of the challenges investors face in the crypto market is emotional management. He believes that understanding your emotions and learning to control them is the key to successful investing. Many investors may become overly cautious after experiencing significant losses, so it is essential to develop good psychological qualities and investment habits.
