Interview with Bitwise Investment Manager: Not Selling During Losses Is a Cognitive Bias; Waiting for Liquidity Recovery Is the Key to Entry
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Interview with Bitwise Investment Manager: Not Selling During Losses Is a Cognitive Bias; Waiting for Liquidity Recovery Is the Key to Entry
Controlling your emotions and biases is key to standing out in the highly volatile and reflexive crypto market.
Navigating Web3 tides with focused insightsCompiled & Translated by TechFlow
Guests: Jeff Park, Strategy Portfolio Manager at Bitwise Alpha; David Kalk, CIO of Reflexive Capital
Hosts: Jason Yanowitz, Founder of Blockworks; Santiago R Santos, Investor;
Podcast Source: Empire
Original Title: Mastering the Psychology of Crypto Cycles | David Kalk & Jeff Park
Release Date: August 8, 2024
Key Takeaways
In this episode, David Kalk from Reflexive Capital and Jeff Park from Bitwise explore the critical role psychology plays in crypto trading. They argue that managing one's emotions and biases is key to standing out in the highly volatile and reflexive cryptocurrency markets. They reveal the limitations of traditional venture capital approaches, the potential of liquidity strategies, and why psychological resilience may be the most valuable edge in crypto today. They share insights on managing trading psychology, adapting to market regimes, and the future of institutional crypto investing.
Introduction to David and Jeff
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David Kalk is the founder and Chief Investment Officer (CIO) of Reflexive Capital, while Jeff Park leads Alpha Strategies and serves as a portfolio manager at Bitwise. The two guests bring unique backgrounds, particularly David’s deep experience in macroeconomics.
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David began his career in 2008 at Goldman Sachs’ interest rate derivatives desk, focusing on market structure. His collaboration with Peter Thiel taught him the importance of independent thinking and risk management in macro markets. In 2020, he left Goldman Sachs to help launch Commonwealth Asset Management, where he identified cryptocurrency as a macro asset class. David also mentioned setting up customized products to enter the crypto space in 2021 and, after observing shifts in Federal Reserve policy, decided to focus fully on crypto, eventually founding Reflexive Capital.
The Inefficient Nature of Low-Liquidity Crypto Markets
Liquidity and Efficiency in Crypto Markets
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David points out that cryptocurrency markets are highly liquid yet inefficient. Typically, liquid markets tend to be more efficient, but crypto stands out as a notable exception. Despite some level of liquidity, crypto markets remain highly inefficient—largely due to the composition of market participants, who often lack professional trading experience and include many retail and novice investors.
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David observes widespread under-adjustment in investor portfolios, especially during sharp swings in crypto cycles. Many investors fail to adapt their strategies timely. He compares today’s crypto market to the macro markets of the 1990s, suggesting massive returns are possible for those who can correctly anticipate major market rotations.
Investor Psychology and Trading Strategy
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David further analyzes psychological factors among crypto investors, emphasizing that trading skills and risk management are crucial in this environment. Successful traders typically demonstrate flexibility in responding to market changes—contrasting sharply with venture capitalists whose long-term mindset may lead them to react too slowly to price movements, potentially missing optimal entry or exit points.
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Jeff adds that as head of Alpha Strategies at Bitwise, his team focuses on generating unique crypto investment returns through a multi-strategy, multi-manager framework. He stresses that inherent volatility is a defining feature of crypto markets—and one that creates opportunities for skilled investors.
Market Structure and Future Outlook
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David discusses structural changes in the crypto market, warning that historical patterns can be misleading. With increasing inflows of venture capital, initial token prices are being pushed higher, raising entry costs for liquidity-driven investors. He notes that many investors currently lack sufficient dry powder to navigate market volatility effectively.
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Yano mentions that many funds deploy all their capital during bull markets, leaving them unprepared when downturns occur.
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David believes investors must reassess their portfolios to adapt to different market cycles and recommends adopting flexible strategies to seize new opportunities.
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Jeff highlights that when selecting fund managers, investors often apply traditional VC thinking, overlooking the unique value-capture mechanisms in crypto. He argues that crypto success depends not just on financial capital, but also on social and human capital—offering investors fresh perspectives and opportunities.
What Liquidity Providers Care About
High Return Expectations from Investors
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Santi notes that when pitching to liquidity providers (LPs), investors often expect extremely high returns—such as 30x gains. They care less about specific strategies or governance involvement and instead demand returns consistent with past performance. This mindset poses challenges for fund managers, who must prove their strategies can deliver such outsized returns.
Return vs. Volatility Trade-Off
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David elaborates that LPs are more concerned with returns within acceptable volatility ranges rather than maximizing absolute returns. Current capital allocation tends to favor managers whose thinking aligns closely with LPs, resulting in a lack of effective return models in the market. Many investors prefer holding most of their capital in cash while allocating only a small portion to crypto—but such strategies need to be properly framed, otherwise they’re seen as impractical.
Clarity in Investment Strategy
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Santi emphasizes that managers must clearly distinguish whether their strategy stems from hedge funds or venture capital, especially when pitching to LPs. If labeled as “liquid venture,” investors may become confused and opt out. Therefore, managers must clearly communicate the nature and objectives of their investment approach.
Psychological Factors and Risk Management
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David stresses that psychology plays a vital role in trading. Success depends not only on market knowledge but also on a deep understanding of risk management. He notes that many professionals from traditional finance may lack essential trading skills, putting them at a disadvantage in crypto markets. Effective risk management can serve as a competitive advantage, and trading itself is fundamentally a psychological game requiring mental agility.
Structural Issues in Investment Vehicles
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Jeff mentions that the structure of investment vehicles significantly impacts investor appeal. Open-ended structures differ from closed-end funds in incentive alignment, with the latter potentially offering better risk management. However, existing structural issues—like annual fee burdens—can leave investors disappointed after experiencing large drawdowns. Managers must therefore consider how to design vehicles that better meet investor needs.
Comparing Liquid and Private Markets
Emerging Trading Mindset and Financialization
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Jeff notes that as the crypto market evolves, new trading mindsets and financialization trends are emerging. For example, the launch of Bitcoin ETFs could drive increased derivative activity, including options trading. The integration of traditional financial instruments into crypto will expand pathways for risk-managed trading solutions. Aligning vehicle structure with LP expectations is a critical issue—one that hasn’t received enough attention historically but is likely to improve in the future.
Lack of Trading Skills and Data Points
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David emphasizes that successful trading requires specialized skills. He notes that even individuals with extensive experience in traditional finance (e.g., oil trading) may not succeed in crypto trading. A lack of relevant data points makes it difficult to assess trader capability. Moreover, trading isn’t just technical—it involves emotional regulation and awareness of cognitive biases. He expresses skepticism toward those who claim they can easily manage their emotions and stick to a trading plan.
Emotional Control and Trading Plans
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David further explores the importance of emotional management in trading. He believes only a minority of traders possess the discipline and self-awareness needed to effectively leverage their cognitive biases in crafting trading plans.
The Importance of Psychological Edge
Psychology in Trading
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Santi shares that in conversations with other traders, the most common question is: “What am I not seeing right now? What are my biases?” This reflective mindset is crucial, especially in complex markets. Managing emotions and cognitive biases is considered key to successful trading—a psychological edge that stands out prominently in crypto markets.
Cognitive Biases and Market Behavior
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David stresses that psychological advantage is the most significant edge in crypto markets. He notes that many traders fall victim to cognitive biases during volatility. For instance, investors who previously suffered losses might avoid selling assets again, continuing to hold losing positions during downturns. Such behavior reflects emotional responses to loss, often leading to irrational decisions.
Reflection and Market Reaction
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David further examines market reaction mechanisms, highlighting reflexivity. Feedback loops between price movements and fundamentals influence investor decisions. For example, rising Bitcoin prices boost market optimism, attracting more investors and further driving up prices—a phenomenon especially pronounced in bull markets. Conversely, bear markets can trigger negative sentiment and counterproductive decision-making.
Capital Preservation and Risk Management
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Santi points out that many managers hesitate to inform LPs when they are holding cash or core assets amid uncertainty. They fear damaging relationships, yet sometimes conservative positioning is necessary during volatile periods to protect capital. Strong risk management and psychological resilience enable managers to stay calm and make rational decisions amid turbulence.
Navigating the Market Environment
Changing Investment Landscape
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Santi observes that the investment environment over the past three to six months has been challenging, asking how one should adjust their mental models to outperform. Jeff responds that multi-strategy investing has proven its value over the past six months, particularly under current market conditions.
Advantages of Multi-Strategy Investing
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Jeff emphasizes that a multi-manager, multi-strategy approach helps navigate market volatility. As markets evolve, different strategies—macro trading, trend following, high-frequency trading—excel at different times. For example, the introduction of Bitcoin ETFs has enabled both macro and algorithm-driven trend strategies to capture opportunities. Meanwhile, innovations in DeFi—such as Pendle and Athena—have drawn growing investor interest.
Understanding Market Liquidity
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David highlights that understanding shifts in market liquidity is key to successful investing. He notes significant differences in capital flows between Q1 and Q2, evident in liquidity indicators for Bitcoin ETFs and stablecoins. Additionally, he warns of potential technical selling pressure in certain scenarios, urging investors to carefully assess risks.
Dynamics Between Old and New Coins
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Santi discusses the performance of established tokens, noting that some have healthy circulating supplies while others perform poorly post-unlock. He observes that the market now recognizes unlock impacts, and many investors favor projects that have already unlocked and have solid fundamentals.
Reflection and Forward Outlook
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David notes that although many legacy tokens performed well in past cycles, future investor interest may shift away from them. He believes new opportunities will emerge from innovative projects—not merely from relying on previous favorites.
Managing Emotions in Markets
Emotion and Market Response
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Santi raises the question of how to quantify growth in markets. Jeff explains their research methodology, focusing on two key metrics: the ratio of Total Value Locked (TVL) to market cap, and weekly user growth and engagement. These indicators help identify assets at risk of devaluation.
Reflexivity and Emotional Regulation
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David emphasizes that market reflexivity means certain factors—like new wallet creation and user growth—can significantly influence market sentiment and asset prices. When these move together—up or down—investors must adapt quickly. Emotion plays a critical role in trading decisions, especially during volatility.
Recognizing Market Shifts
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Santi believes the key to understanding market changes lies in acknowledging that you aren't smarter than the market. Many investors become overconfident when facing change, leading to poor decisions. In contrast, accepting market complexity and uncertainty helps investors respond more effectively.
Impact of Emotion on Decision-Making
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During shifts in market sentiment, investors often struggle with whether to maintain positions. David argues that emotional control is central to trading success. He suggests having a predefined plan to respond to changing market moods, rather than relying on intuition. Emotional fluctuations can lead to poor choices, making recognition and management of these feelings essential.
Practicing Emotional Management
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Santi shares his experience this cycle, underscoring the importance of scaling into positions gradually. Though he sometimes missed ideal entry points, building positions incrementally allowed him to achieve better returns during rebounds. This approach helped alleviate emotional stress from failing to buy at the bottom.
Is Cryptocurrency Worth Investing In?
The Role of Liquidity
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Santi emphasizes that liquidity is crucial in crypto markets because it can vanish or reappear rapidly. In the current environment, overtrading may lead to losses, so he prefers waiting for liquidity to recover before acting.
Investment Strategy and Psychological Factors
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David believes many investors don’t actually want liquidity, as it implies frequent trading. Facing volatility, many feel paralyzed and prefer avoiding decisions altogether. By comparison, traditional financial markets may allow greater risk tolerance, since investors can afford to wait longer for outcomes.
Adapting to Market Changes
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Santi advises investors to embrace volatility rather than flee from it. During downturns, view them as buying opportunities and maintain available cash to act. He stresses the need for a clear plan that can be adjusted based on market developments.
Long-Term Investment Perspective
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Jeff notes that despite fierce competition, crypto still offers unique opportunities. He believes liquidity and volatility are essential considerations. With proper strategy, investors can find profitable niches. He also notes that strong returns are often tied to liquidity risk, making the identification of suitable opportunities crucial in crypto investing.
Emotional Management and Decision-Making
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Santi highlights emotional regulation as one of the biggest challenges in crypto investing. Understanding and controlling one’s emotions is key to success. After major losses, many investors become overly cautious. Developing strong psychological resilience and sound investment habits is therefore essential.
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