Bear markets are where the money is made, so sticking around and staying engaged is crucial for success in crypto.
Second-order thinking and expected value are two instrumental mental models to use when preparing for the next leg up.
Bear markets could last years, and crypto asset prices could go lower than everyone’s expectations, so staying patient is essential for surviving the crypto winter.
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It’s been a brutal year for crypto investors. After an extended market rally saw the global cryptocurrency market capitalization top $3 trillion in late 2021, Bitcoin and other digital assets have been battered by macroeconomic turmoil, suffering a decline that’s sent many of last year’s new crypto adopters running for the exit. Today the space is worth just under $1 trillion, with Bitcoin and Ethereum both trading over 70% down from their all-time highs.
But while this year has tested even the most ardent crypto believers, early adopters have become used to extreme volatility in both directions. Crypto has historically boomed roughly every four years as new entrants discover the technology and hype builds, but it’s always suffered from severe crashes after the market euphoria hits a peak. These downturns have become known as “crypto winter” phases, characterized by significant declines in market activity and interest, project washouts, and extreme selloffs. Although few crypto fans welcome bear markets, they can provide an excellent opportunity to recuperate and take stock ahead of the next market cycle. In this feature, we share our top five tips for surviving the ongoing crypto winter. Those who follow them should be well-positioned to thrive once crypto finds momentum.
Stick Around Through Crypto Winter
While crypto winter can be challenging, it’s important to remember that bear markets are actually where many people build true wealth. This is especially true in crypto for two reasons.
One, projects that lack fundamentals, product-market fit, or are outright scams, get washed out during bear markets. At the same time, the space turns its focus from price action, marketing, and hype to product and business development. Some of the leading crypto projects today, such as Solana, Cosmos, and Uniswap, were built and launched during bear markets. Ethereum, the world’s second-largest cryptocurrency, launched in the middle of the Bitcoin bear market in 2015 and traded below $10 until the 2017 bull cycle. Ethereum peaked at $1,430 at the tail end of that cycle in January 2018, yielding staggering returns for early investors.
This leads to the second reason why sticking around is key for surviving the crypto winter and thriving during the next cycle. Many legitimate cryptocurrencies get mistakenly labeled as Ponzi schemes when they are “greater fool” assets. In finance, the greater fool theory suggests that investors can sometimes make money on “overvalued” assets by selling them to someone (the “fool”) for a higher price later. Exacerbated by herd mentality, this psychological phenomenon leads to economic bubbles followed by massive corrections. And while all markets are subject to this, crypto assets are especially prone, further highlighting the importance of being early.
And being early in crypto means staying engaged, learning, and analyzing the market when the industry is in a bear cycle. Some of the most successful investors in the 2017 bull run were those who endured the 2014 through 2016 bear market. Similarly, many of those who made a killing in 2021 stuck through the grueling 2018 through 2019 downturn. Above all else, sticking around is the most decisive factor for success when the market turns around.
Rethink Your Thesis
Losing money is never fun, but it can be a great teacher. Crypto winter is an excellent opportunity for investors to re-evaluate their investment thesis, reflect on any mistakes they made over the last cycle, and prepare for the next leg up.
An asset or an entire asset class plunging 70% from its all-time highs could mean different things. For example, a significant drawdown in an investor’s portfolio could mean that the market has invalidated their investment thesis, meaning they need to rethink their approach and reconstruct their portfolio to reflect the new reality better. If this is the case, selling at a loss and making different investments could be warranted.
However, a significant drawdown doesn’t necessarily mean that an investor’s investment thesis has been invalidated. Instead, it could be an excellent opportunity to double down. For example, if a token’s fundamentals improve, investors who liked it at $1,000 should like it even more at $200. A drop in an asset’s price doesn’t necessarily imply it has become a weaker investment. There are numerous reasons an asset could temporarily decline despite strengthening fundamentals, many of which are exogenous or unrelated. An investor’s job is to identify precisely these market inefficiencies, buy temporarily undervalued assets, and then sell them at a higher price when the markets have caught up.
Employ Second-Order Thinking
Every crypto bull cycle is triggered by multiple catalysts and enveloped by different narratives. The 2017 bull run was characterized by Initial Coin Offerings on Ethereum and the “blockchain, not Bitcoin” narrative, where startups raised millions selling mostly useless tokens on empty promises about tokenizing and decentralizing anything. The last bull run kicked off with Bitcoin’s halving in 2020, which coincided with the unprecedented post-pandemic money printing that shone the spotlight on its value proposition as an apex inflation hedge asset. The cycle continued with the boom of food-themed decentralized applications on Ethereum during a period that became known as “DeFi summer,” before a mainstream boom in NFTs gave rise to “NFT summer” a year later. The 2021 cycle ended with the rapid rise and fall of alternative Layer 1 networks Terra, Solana, and Avalanche.
Those who successfully predicted the dominant narratives made a killing, while latecomers who were unable to spot where the puck was going had less luck. Predicting the next cycle’s dominant narratives requires second-order thinking or deep reflection that considers the long-term consequences of many relevant causally-linked events. In this regard, the game of investing is identical to Keynes’ infamous beauty contest, where investors have to guess what other investors will think rather than what they themselves think.
Given that cryptocurrencies are subject to the greater fools phenomenon, successful investing isn’t necessarily about trying to find projects or assets that will outperform the market, but rather anticipating the anticipations of others. Where first-order thinkers may currently be trying to figure out whether the upcoming Layer 1 network Aptos will outperform Solana, second-order thinkers are trying to figure out which blockchain most unsophisticated investors will think is best when the next cycle starts.
Think in Terms of Expected Value
Another useful mental model to employ when trying to survive bear markets and crypto investing is to practice making only positive expected value investments. In this context, the expected value (EV) is the sum of all possible values for a random variable, each value multiplied by its probability of occurrence.
Let’s assume an investor is considering purchasing $1,000 worth of token X. The token in question is a highly volatile small-cap cryptocurrency that has a 95% chance of going to zero and a 5% chance of soaring to $25,000. The formula to calculate the expected value of this investment would be:
EV = (-$1,000 x 0.95) + ($25,000 x 0.05) = $300
This means that the expected value of the bet is positive and that if the investor continued to invest $1,000 on investments with the same chances indefinitely, they would, on average, profit $300 per investment. In simpler terms, if they made 100 investments ($100,000), lost all of the money in 95 of them (-$95,000), but profited 2,400% on five of them (5 x $25,000 = $125,000), they would end up with a $30,000 profit ($125,000 – $95,000).
However, while considering expected value makes it easier to judge whether a specific investment is worth it, only a small change in the assumed variables can often turn a positive EV trade into a negative one. This means that properly judging the probabilities of certain events occurring is essential for investment success. Beyond that, considering that there are thousands of cryptocurrencies on the market and investors have a finite amount of money, it’s also imperative to compare the expected values of different investment opportunities and only invest in a diversified set of those with the highest expected value.
For example, suppose an investor is weighing whether to invest $1,000 in Bitcoin or Ethereum at their current market prices and they think they have the same 50% chance of either going to zero or reaching their previous all-time highs. In that case, they can calculate the expected value for both investments to see which is sounder. In this case, Ethereum has a slightly higher expected value because it would have to appreciate more than Bitcoin to reach its previous all-time high price.
Patience is essential during crypto winter. The winter period can last longer than expected, which can be mentally challenging even for the most steadfast believers. The current bear market comes during the worst macroeconomic backdrops since the Great Financial Crisis. It’s perfectly possible that cryptocurrencies could keep plunging or trade sideways for two to three years. For sidelined investors, exercising patience may be relatively easy, but for those with a significant portion of their net worth held in crypto, it can be very challenging.
Moreover, bear markets are much less forgiving than bull markets, meaning that not making any investments can sometimes be the best move to make. This is especially true given that most cryptocurrencies on the market are over 99% down from their all-time highs. Bear markets are where many investors build life-changing portfolios, but patience, research, and foresight are necessary to make the right moves and pick the cryptocurrencies that will outperform the market during the next leg up.
As this year proves, the crypto market is not for the faint of heart. While upside volatility can help cryptocurrencies soar to staggering highs during bull runs, they can plummet just as fiercely during prolonged downturns. But those who adopt a long-term mindset and learn to embrace downturns have historically been some of the biggest winners in the space to date. Assuming crypto doesn’t die, following the tips listed in this feature should help investors prepare themselves for the next rally. We are stuck in crypto winter, but the fundamentals haven’t changed. Anyone who thinks of the big picture will have a much easier time surviving crypto winter.
Disclosure: At the time of writing, the author of this feature owned ETH and several other cryptocurrencies.
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