Cryptocurrency markets are notoriously volatile with frequent boom and bust cycles. Bitcoin alone has witnessed rallies of over 1000% and crashes of over 80% over the past decade. Such extreme volatility in crypto markets has significant roots in crowd psychology biases.

In this article, we dig into how human psychology shapes the turbulence of crypto markets.

What Drives Crypto Market Volatility?

There are some inherent factors to cryptocurrency markets that exacerbate volatility:

• New asset class – Unlike stocks or commodities, crypto does not have decades of trading history with established valuations.
• Speculation – Significant speculation around future potential rather than current fundamentals results in pricing disconnects.
• Information asymmetry – Large knowledge gaps between novice and expert traders leads to manias and panics.
• Low liquidity – Thin trading volumes across crypto markets magnify price swings.
• Whales – A few large holders known as whales often trigger big price moves with massive buy/sells.

However, while these are contributing factors, the outsized swings in crypto markets have deeper roots in human psychology.

Crypto Market Cycles

Cryptocurrency markets go through boom and bust cycles frequently as greed and fear reach extremes:

• During a bull market, greed sends prices parabolic as traders fear missing out on gains.
• At market tops, euphoria results in hype-based investing divorced from fundamentals.
• The sell-off is often sharp as fear replaces greed – this deepens into capitulation at bottoms.
• Despair dominates at market lows with widespread loss of confidence in the asset’s future.
• The cycle then repeats with skepticism turning back into optimism, restarting the hype cycle.

These emotions result in highly asymmetric bubbles and crashes across short periods in crypto markets compared to other assets.

Herding Behavior

Crypto traders exhibit strong herding behavior – acting in concert by mimicking decisions of others while ignoring fundamentals:

• Buying intensifies as prices rise as traders fear missing the rally. This creates positive feedback loops.
• Selling gathers steam in a crash because others are panicking and selling.
• In crypto markets, going against the herd is difficult due to high uncertainty and volatility.
• This results in amplified volatility clusters as traders stick to a direction even if misaligned with fundamentals.

As social creatures, humans have an innate tendency to trust the crowd which exacerbates booms and busts in crypto markets.

Loss Aversion

People prefer avoiding losses much more than acquiring gains. This results in irrational decisions:

• Traders hold on to losing positions too long hoping to break even, instead of cutting losses. This worsens sell-offs.
• Investors also prematurely sell profitable positions to lock in gains out of fear of losing what they already gained.
• This limits upside but also increases downside volatility.
• Many traders also lack clear profit taking and stop loss discipline which worsens the effects of loss aversion.

This tendency to hold on to losing trades and sell winners too early results in greater volatility spikes, especially on the downside in crypto markets.

Overconfidence

Traders are usually overconfident in their ability to make accurate predictions and time the markets:

• When things are going well, people attribute gains to their own skill and downplay luck. This manifests as arrogance.
• Crypto traders also have inflated sense of knowledge relying on irrelevant data or influencers to make decisions.
• They dismiss risks and overestimate expected returns leading to making riskier decisions.
• When the tide turns, overconfidence is rapidly replaced by panic and a sense of helplessness.

This pendulum swing creates an unstable psychological foundation that amplifies volatility.

Confirmation Bias

People selectively look for information that aligns with their existing views and ignore contradicting facts:

• Crypto traders latch on to any news or metrics that confirm bullish outlooks and downplay anything bearish.
• During downturns, they do the opposite – seeking out only negative sentiment while ignoring positives.
• This confirmation bias results in skewed market narratives becoming dominant and crowded trades.
• With no balanced perspective, markets move from extremes of optimism to pessimism which feeds volatility.

Seeking out only biased sources validates existing outlooks and prevents reflecting reality.

Conclusion

In conclusion, the foundation of excessive crypto market volatility lies more in unstable mass psychology than intrinsic fundamentals alone. Phenomena like herding, loss aversion, overconfidence, and confirmation bias result in exaggerated cycles of greed and fear.

For crypto markets to stabilize, the asset class needs to mature through broader participation, transparent valuation models, and behavioral evolution of traders. Until human emotions no longer override fundamentals consistently, Coin Jungle acknowledges that crypto will likely continue experiencing high volatility compared to other assets.

But over the long-term, behavioral learning and evolution can gradually anchor crypto markets closer to reality.