Price Movements on Crypto Exchanges
How the market sustains irrational exuberance
While many have cited “going mainstream” to explain the meteoric rise in prices for cryptos, it is clearly the contrary that underpins this sustained irrational exuberance: (a) cryptocurrencies are pseudonymous or anonymous; (b) their issuance and exchanges aren’t regulated and, when regulated, can change jurisdictions; (c) their supplies are potentially unlimited through the introduction of new varieties; (d) people love to have something to believe in.
That they’re pseudonymous or anonymous are certainly an attractive characteristic. For price movements in particular, this makes it possible for market makers to remain virtually untraceable (because it’s easy to have multiple accounts and wallets). In extreme cases on exchanges without fees, wash trading can lead to complete price control. When fees are applicable, they can set up sizeable buy / sell walls — this practice is usually profitable, because even when small investors rush in to take out these walls the bulls / bears will be exhausted and a few active buy / sells afterwards will be able to push / pull the price back up / down — what remains is to sell / buy slowly in the next few hours or days at profit. Contrary to popular belief, these are perfectly normal practices and not to be confused with price manipulation (in the next paragraph). For cryptos that require significant investment to mine, particularly BTC & BCH, the biggest market makers are probably large miners, and they have vested interest in driving the price higher. For the ones that have significant pre-mine, it’d be the issuers. For everything else, the largest holders. There’s virtually no case where somebody’s interest is in driving the price down.
A more important factor in price movement is the lack of regulation or indeed the resistance to regulation. This allows for some classic tricks that have become illegal in some stock markets (but not necessarily so everywhere), more commonly spoofing and momentum ignition. Spoofing in particular is made easy by automated trading. While these may be illegal price manipulation tactics, it can be difficult to identify the true motives — maybe someone just wants to buy / sell at a good price — only their codes can tell. What’s more blatant are fake news and insider trading. These are absolutely illegal in most regulated markets and frequently prosecuted, but they happen almost everyday in crypto. They create FOMO / FUD to drive the price up / down. The most important part is that cheap margin, FOMO, and price manipulation together create a positive feedback loop. Price manipulation leads to FOMO fueled by cheap margin -> this leads to increased FOMO -> as the value of collateral increases more margin can be used -> more FOMO -> more margin. Some people believe the issuance of Tether, which is pegged to USD, may also be a factor. I don’t have enough understanding of it to say responsibly whether this is true.
However, this positive feedback loops alone can’t continue ad infinitum: at some point, people get afraid of the height and want to realize their profits; the loop gradually collapses. To keep the market on a continual up trend, another critical factor is the introduction of new coins1. When there’s always something exciting going on, realized profits will not leave the market; instead, they will get into the next big thing. Eventually, profit-seeking may circle back, as evidenced by Ripple at the end of 2017.
Last but not least, while prices see meteoric rises in crypto they rarely crash because people want to have something to believe in. This is quite nuanced, but the fact is people want to believe that they’re right. When the price rises, they tend to believe it’s because the tech is good and value is being recognized by the market. When price drops, it’s just short-term fear of the height. This leads small investors to “hodl” more than short-term profit-seeking would advise. Critically, however, because they hold the price doesn’t drop as deeply as self-interest-driven markets would prescribe. Together, small investors create “common value”. We may interpret this as the “cooperate – cooperate” strategy in prisoner’s dilemma.
Overall, under these conditions it’s quite easy to realize sizeable gains by being long. The systemic risk I believe is in Bitcoin: when Bitcoin is overextended, there’s currently no “next big thing” to jump into. Only when the period of downtrend is over should we go all in again. Fortunately, there are enough shills and special interests for Bitcoin that its downtrend won’t last very long (hopefully).