Biases and Emotions Affect the Crypto Market

7 min readNov 3, 2023

The cryptocurrency market is often characterized as an emotionally-driven environment prone to volatility. More than most asset classes, crypto seems to see-saw between extreme greed and fear. What causes this? Research suggests innate human psychological biases and emotional reactions play a key role in amplifying crypto’s volatility. By better understanding how biases impact trading decisions, we can aim to separate logic from emotion in pursuing a balanced crypto investment strategy.

This comprehensive guide will explore how biases like FOMO (fear of missing out), loss aversion, confirmation bias, and overconfidence as well as emotions like excitement, panic, and greed/fear cycles manifest in crypto investor behavior. We’ll also provide tips for mitigating bias through mindful reflection. Mastering our mental shortcuts and knee-jerk reactions is key to avoiding poor crypto investments ruled by feeling rather than reason.

Key Biases Affecting Crypto Investors

Before exploring specific crypto-relevant cases, let’s review some textbook definitions of common biases known to influence investment choices:

FOMO Bias: The fear of missing out that compels joining crowd trends to avoid regret.
Loss Aversion: Weighing losses heavier than equal gains when making decisions.
Confirmation Bias: Preferring information confirming pre-existing views versus challenging them.
Overconfidence: Overestimating investing skill and underestimating risks.
Anchoring Bias: Relying too heavily on arbitrary price points or events.
Gambler’s Fallacy: Believing future probabilities are affected by past events.
Availability Bias: Estimating probability based on how easily examples come to mind.

These shortcuts helped humans evolve but lead us astray investing. Now let’s examine crypto-specific cases of how each bias manifests.

FOMO

Crypto’s volatility already incites urgency to buy during price spikes or sell on crashes before missing out on gains or losses. But crypto’s 24/7 hyper-connected nature amplifies normal FOMO. News spreads in minutes, and price reactions are instant. Seeing coins pump on social media fuels FOMO pressure to chase gains before it’s “too late.”

This persuasive feeling often overrides logic. During Bitcoin’s rally to nearly $20,000 in late 2017, mainstream FOMO drove a buying frenzy. The same dynamic replicated in 2021 as prices soared again to new highs. Friends, celebrities and companies talking about sudden crypto riches stokes anxiety about being left behind the crowd. But buying at the height of a FOMO-fueled peak leads to overpayment and likely losses as excitement fades.

A classic example is Dogecoin soaring 15,000% in 2021’s meme-coin mania. FOMO-driven purchases as prices peaked left late buyers deep in the red. Disciplined investors wait for hype to settle before re-evaluating assets objectively.

Loss Aversion

Many newer investors check crypto prices compulsively, feeling daily losses deeply while quickly forgetting gains. This reflects loss aversion — losses feel roughly twice as painful as equal gains feel pleasurable.

When crypto markets plunge, loss aversion causes investors to panic and sell at the bottom to cut losses. Selling low then means missing the recovery rebound. Loss aversion can also trap investors in poor positions by motivating endless averaging down of losing trades rather than accepting small losses. A better strategy is determining entry/exit points in advance before emotionally-driven reactions take over.

Confirmation Bias

Crypto communities tend to create echo chambers because holders seek validation of their preferences and decisions. This confirmation bias causes investors to prefer information confirming pre-existing views over contradictory facts or opinions.

Seeking only positive perspectives on held crypto assets while ignoring critical ones leads to biased evaluation. Actively pursuing objective, balanced information sources rather than comforting bias confirmation is essential to make informed crypto decisions.

Overconfidence

Various studies reveal over 80% of investors rate themselves above average in investing skill. Crypto traders checking apps hundreds of times daily can develop an inflated sense of control over highly volatile assets. But markets quickly humble this overconfidence.

The Dunning-Kruger effect demonstrates unskilled investors often overestimate their expertise. Countless traders have boldly predicted imminent Bitcoin prices of $100K or $1M by certain dates — and been proven wrong time and again. Avoiding the temptation of overconfidence bias is key to crypto investing with clear eyes.

Gambler’s Fallacy

Crypto’s random volatility tricks our brains with the gambler’s fallacy. Investors may think that because Bitcoin has dropped dramatically for a week straight, it’s “due” to bounce back soon. Or if a coin just pumped 500%, its run must end quickly. In reality, future price movements have no relation to what just occurred.

Probability remains constant — the coin flip is still 50/50 no matter how many heads have spun consecutively. Crypto gains or losses tell us nothing about tomorrow’s returns. But detecting illusory patterns gives us false confidence in erratic markets.

Availability Bias

When prices collapse suddenly, past crashes like 2018 or Mt. Gox easily come to mind. Or when crypto surges, we envision past bull runs repeating endlessly. But ease of recalling vivid examples creates availability bias, distorting probability.

In reality, history never repeats exactly, and past performance does not guarantee future results. Judging odds based on most readily available memories overrepresents extremes versus reasonable outcomes. Every environment has unique variables shaping crypto markets.

Herd Mentality

Beyond personal biases, crowd manias often heavily influence crypto trading. Humans feel evolutionary pressure to fit into group behaviors. Crypto discourse is dominated by maxis declaring “Bitcoin will hit $100K” or tribes passionately advocating their altcoin.

This herd mentality of going with the crowd for fear of standing out manifests in buying hype coins because others are. But groupthink overrides individual reason, caution, and responsibility. As John Maynard Keynes wisely noted, “Markets can remain irrational longer than you can remain solvent.”

Tribalism

Related to herd mentality, intense tribalism pervades crypto as users passionately defend their chosen assets and attack others. BTC maxis feud with altcoin fans, Bitcoin Cash supporters clash with BTC believers, and coin devotees deride “shitcoins.”

This tribalistic tunnel vision blinds investors to facts contradicting their biases. Membership in a community sharing unquestioning belief similarly distorts evaluation. Rather than rationally comparing pros and cons of assets, tribal biases pressure buying into a chosen group and hating outsiders.

Additional Behavioral Biases

Dozens of other biases also subtly sway crypto trading, including:

Bandwagon effect (following market momentum)
Projection bias (assuming others share our views)
Illusion of control (believing we dictate random outcomes)
Status quo bias (preferring things to stay the same)
Survivorship bias (forgetting lost coins/investors)
Neglect of probability (underweighting randomness)

While covering every bias exceeds this article’s scope, being aware of our brains’ common shortcuts is a key first step to overcoming them through mindful reflection. When aware of our tendency toward certain biases, we can intentionally question our assumptions in pursuit of balanced perspectives.

How Emotions Drive Crypto Market Cycles

In addition to cognitive biases, swings between euphoria and despair also drive crypto’s booms and busts based on emotional reactions. Let’s examine the rotation of excitement, greed, optimism, fear, and panic that fuels crypto’s volatility.

Euphoria

During cryptocurrency bull runs, prices can surge hundreds of percent in weeks, triggering a euphoric emotional state. As gains stack, enthusiasm builds, often accelerated by mainstream media coverage stirring up excitement.

This euphoria, particularly for newer investors experiencing their first crypto boom, leads to manic buying. At market peaks, joyous rallies feature costumed characters, music, and unbridled optimism — before losses inevitably sober the enthusiasm.

Greed

The elation of swiftly multiplying one’s money in crypto bull markets breeds greed. Speculators obsessed with profits frequently overtrade and amplify positioning to chase further gains. The crypto mantra of “HODL” gives way to greed-fueled risk-taking.

This collective greed feeds off itself, with traders boasting about gains and extravagant profits during bubbles. But unchecked greed results in buying overextended assets and irresponsible risk levels. Eventually, selling initiates, triggering downward panic cycles.

Fear

After sharp rallies inevitably witness corrections, sentiment shifts from greed to fear. Steep drops stoke anxieties about further crashing prices and losing portfolio value. Loss aversion can accelerate this panic as investors rush for the exits to avoid deepening losses.

Crypto crashes in 2018 and 2022 illustrate this emotional transition from euphoria to fear. As leverage liquidations trigger avalanches of selling, volatility spikes massively. Without derisking precautions in place pre-crash, panic selling accelerates capitulation.

Despair

Extreme crypto bear markets after massive bull runs often reach despairing lows amid accumulated fear. Lengthy downtrends lasting months or years crush sentiment. This depressed environment can leave long-term holders emotionally exhausted and drained.

But just as despairing pessimism reaches its bleakest point, markets tend to reverse and start rebuilding. Despite feeling logically like gains may never return, time and time again, cryptos recover from excessive pessimism. Maintaining composure during despair enables capitalizing on sentiment mean reversion.

Discipline Over Emotion

Mastering the emotional rollercoaster of crypto requires self-discipline learned through experience. Bettering our understanding of common biases and knee-jerk emotional reactions is the first step. But self-awareness must be paired with pre-planned systematic strategies.

When entering positions, pre-determine security protocols like position sizing limits and stop losses. Set risk management rules like enforcing time outs after losses. Strategies like dollar cost averaging can override the temptation to go “all-in” during excitement or despair. The more instincts we can replace with systems, the less emotions will undermine returns.

Research also shows traders with strong self-control outperform impulsive investors by as much as 200 basis points annually. Developing detached discipline requires practice — but pays enormous dividends in crypto.

Conclusion

In conclusion, the emerging crypto asset class seems exceptionally vulnerable thus far to emotional hysteria and mental shortcut biases. But acknowledging this tendency is the first step toward mastering it. Setting systems and habits in place to counter knee-jerk impulses through self-discipline takes time but can profoundly benefit crypto investing outcomes.

As crypto investors grow beyond novice bubbles of euphoria and capitulation, the market will continue its gradual maturation. Yet while crypto will likely always retain higher volatility than stocks, reducing the outsized influence of biases and emotions remains key to avoiding poor decisions. The traders who manage to trade rationally and shun hysteria are most often rewarded in the long run.

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