Dialogue with Bitwise Investment Manager: Not selling at a loss is a cognitive bias; waiting for liquidity to improve is the key to entering the market

Guests: Jeff Park, Alpha Strategy Investment Manager at Bitwise; David Kalk, CIO of Reflexive Capital

Hosts: Jason Yanowitz, Founder of Blockworks; Santiago R Santos, Investor;

Compiled by: Deep Tide TechFlow

Key Takeaways

In this episode, David Kalk from Reflexive Capital and Jeff Park from Bitwise discuss the critical role of psychology in crypto trading. They believe that controlling one's emotions and biases is key to standing out in the highly volatile and reflexive crypto market. They reveal the limitations of traditional venture capital approaches, the potential of liquidity strategies, and why psychological resilience may be the most valuable asset in today's cryptocurrency landscape. They share their views on managing trading psychology, adapting to market regimes, and the future of institutional crypto investment.

Introduction of David and Jeff

• David Kalk is the Founder and Chief Investment Officer of Reflexive Capital, while Jeff Park is the Head of Alpha Strategy and Portfolio Manager at Bitwise. Both guests have unique backgrounds, particularly David's extensive experience in macroeconomics.

• David began his career in 2008 in Goldman Sachs' interest rate derivatives division, 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 establish Commonwealth Asset Management and identified cryptocurrency as a macro asset in the process. David also mentioned that he set up some customized products to enter the crypto market in 2021 and decided to focus on crypto business after observing changes in Federal Reserve policies, ultimately founding Reflexive Capital.

Inefficient Market with Low Liquidity in Cryptocurrency

Liquidity and Efficiency in Crypto Markets

• David points out that the cryptocurrency market is a high liquidity but inefficient market. Typically, liquid markets are more efficient, but the crypto market is a notable exception. Despite some liquidity, its efficiency is low, primarily due to the composition of market participants, lacking professional trading experience, and being dominated by retail and novice investors.

• David believes there is a clear under-adjustment of portfolios in the market, especially during significant volatility in crypto cycles, where many investors fail to adjust their strategies in a timely manner. He compares the current crypto market to the macro markets of the 1990s, noting that correctly capturing significant market rotations could yield substantial profits.

Investor Psychology and Trading Strategies

• David further analyzes the psychological factors of investors in the crypto market, asserting that trading and risk management skills are crucial in this market. He notes that successful traders can adapt flexibly to market changes, contrasting this with the long-term thinking of venture capitalists. Venture capitalists often react slowly to market price changes, potentially missing optimal trading opportunities.

• Jeff adds that as the Head of Alpha Strategy at Bitwise, his team is dedicated to finding unique crypto investment returns through a multi-strategy, multi-manager framework. He emphasizes that the inherent volatility of the crypto market is one of its characteristics, and this volatility provides opportunities for professional investors.

Market Structure and Future Outlook

• David discusses the structural changes in the crypto market, suggesting that historical experiences may lead to misleading conclusions. With the influx of venture capital, the initial token prices in the market are affected, leading liquidity investors to face higher entry costs. He believes that many investors currently lack sufficient capital to make effective investments when facing market volatility.

• Yano mentions that many funds are fully allocated during market bull runs, making it difficult to respond effectively during market downturns.

• David believes investors need to reassess their portfolios to cope with different market cycles and suggests adopting flexible strategies to seize new investment opportunities.

• Jeff also points out that investors, when selecting managers, are often influenced by traditional venture capital thinking, overlooking the unique value capture mechanisms of the crypto market. He believes that the crypto market relies not only on financial capital but also on social and human capital contributions, providing investors with new perspectives and opportunities.

Focus Points for Liquidity Providers

High Return Expectations from Investors

• Santi mentions that when pitching to liquidity providers (LPs), investors often expect extremely high returns, such as 30x returns. They are not concerned with specific investment strategies or governance participation but hope to achieve returns consistent with historical performance. This mindset poses challenges for many managers when pitching to LPs, as they need to prove their strategies can deliver these expected returns.

Relationship Between Returns and Volatility

• David further points out that liquidity providers are more concerned with returns within a range of volatility rather than maximizing returns. The current capital allocation process is often limited to those managers who align with investor thinking, resulting in a lack of effective return models in the market. Many investors wish to keep most of their funds in cash and invest only a small amount in crypto, but such strategies need to be packaged appropriately; otherwise, they may be deemed unviable.

Clarity of Investment Strategies

• Santi emphasizes that managers need to clearly distinguish whether their investment strategies come from hedge funds or venture capital, especially when pitching to LPs. If a strategy is perceived as "liquid risk investment," investors may feel confused and choose to opt-out. Therefore, managers need to clearly communicate the nature and objectives of their investment strategies.

Psychological Factors and Risk Management

• David points out that psychological factors play a significant role in trading. Successful trading relies not only on market knowledge but also on a deep understanding of risk management. He mentions that many managers from traditional finance may lack the necessary trading skills, which poses challenges in the crypto market. Effective risk management can become an advantage, while trading itself is a psychological game that requires flexibility.

Structural Issues with Investment Tools

• Jeff mentions that the structure of investment tools is crucial for attracting investors. Open-ended structures differ from closed-end funds in their incentive mechanisms, with the latter potentially having advantages in risk management. However, existing structural issues in the current market, such as annual fee burdens, can lead to investor disappointment after experiencing significant volatility. Therefore, managers need to consider how to design investment tools to better meet investor needs.

Comparison Between Liquid Markets and Private Markets

New Trading Mindset and Financialization

• Jeff mentions that with the development of the crypto market, a new trading mindset and trend of financialization are emerging. For example, the introduction of Bitcoin ETFs may lead to more derivative trading, such as options. The integration of traditional financial trading tools with the crypto market will gradually increase, providing more pathways for risk management trading solutions. He believes that choosing the right investment tool structure to align with liquidity providers (LPs) is a key issue that may not have received enough attention in the past but is expected to improve in the future.

Lack of Trading Skills and Data Points

• David emphasizes that successful trading requires special skills. He notes that while some individuals may have extensive experience in traditional finance (such as oil trading), this does not guarantee their success in crypto trading. He points out that the lack of appropriate data points makes it difficult to assess traders' abilities. Moreover, trading is not just a combination of techniques and strategies; it also involves emotional management and understanding cognitive biases. He expresses skepticism about those who can effectively manage their emotions and develop trading plans.

Emotional Management and Trading Plans

• David further explores the importance of emotional management in trading. He believes that only a few traders possess sufficient discipline and emotional self-awareness to effectively utilize their cognitive biases in formulating trading plans.

The Importance of Psychological Advantage

Psychological Factors in Trading

• Santi mentions that in discussions with other traders, the most commonly discussed questions are "What am I not seeing right now? What are my biases?" This self-reflective mindset is crucial in trading, especially when facing complex markets. Managing emotions and cognitive biases is considered key to successful trading, and this psychological advantage is particularly pronounced in the crypto market.

Cognitive Biases and Market Behavior

• David emphasizes that psychological advantage is the most significant edge in the crypto market. He notes that many traders are easily influenced by cognitive biases during market fluctuations. For instance, investors may choose not to sell assets due to past losses, leading them to continue holding losing assets during market downturns. Such behavior reflects emotional responses to losses, often resulting in irrational decisions.

Reflection and Market Response

• David further explores the market's response mechanism, emphasizing the reflexivity of the market. The feedback loop between price changes and fundamentals can influence investor decisions. For example, when Bitcoin prices rise, market sentiment becomes optimistic, leading more investors to enter the market, further driving up prices. This phenomenon is particularly evident in bull markets, while in bear markets, it may lead to reverse emotions and decisions.

Capital Protection and Risk Management

• Santi points out that many managers, when facing uncertainty, often hesitate to tell liquidity providers (LPs) that they are holding cash or major assets. They fear this might affect their relationship with LPs, but in reality, managers sometimes need to adopt conservative strategies during market uncertainty to protect capital. Effective risk management and psychological advantage can help managers remain calm during market volatility and make more rational decisions.

Coping with Market Environment

Changes in Investment Environment

• Santi raises the question of how to adjust psychological models to achieve outperformance in the investment environment over the past three to six months. Jeff responds that the multi-strategy investment approach over the past six months has demonstrated its importance, especially under current market conditions.

Advantages of Multi-Strategy Investment

• Jeff emphasizes that adopting a multi-manager investment strategy can better cope with market volatility. He notes that as the market changes, different trading strategies (such as macro trading, trend strategies, and high-frequency trading) perform well at different times. For example, with the launch of Bitcoin ETFs, both macro trading and computer-driven trend strategies can capture market opportunities. Additionally, innovations in the DeFi space (such as Pendle and Athena) have also become focal points for investors.

Understanding Market Liquidity

• David mentions that understanding changes in market liquidity is key to successful investing. He points out that there are significant differences in capital flows between the first and second quarters, which are particularly evident in liquidity indicators for Bitcoin ETFs and stablecoins. Furthermore, he emphasizes that the market may experience technical selling pressure in certain situations, and investors need to carefully assess risks.

Dynamics of Old Coins and New Coins

• Santi discusses the performance of old coins, noting that some old coins have healthy circulating supplies, while others perform poorly during unlocking processes. He believes the market has become aware of the impact of unlocking, and many investors are more inclined to choose assets that have already been unlocked and have fundamental support.

Reflection and Future Outlook

• David mentions that although many old coins performed well in past cycles, the future market may not attract investors in the same way as before. He believes that new investment opportunities will arise from new projects and innovations rather than solely relying on previously popular assets.

How to Manage Emotions in the Market

Emotions and Market Response

• Santi raises the important question of how to quantify growth in the market. Jeff explains their research methodology, focusing primarily on two indicators: the ratio of total locked value (TLV) to market capitalization, and weekly user growth and engagement. These indicators can help investors identify which assets may face depreciation risks.

Reflexivity and Emotional Management

• David emphasizes that the reflexivity of the market means that certain factors (such as new wallet creation and user growth) can significantly impact market sentiment and asset prices. When these factors change simultaneously in either direction, investors need to adjust their strategies promptly. He mentions that emotions play a crucial role in trading decisions, especially during market volatility.

Recognizing Market Changes

• Santi believes that the key to understanding market changes lies in acknowledging that one is not smarter than the market. He notes that many investors tend to develop overconfidence when facing market changes, which can lead to decision-making errors. In contrast, recognizing the complexity and uncertainty of the market can help investors better cope with challenges.

The Impact of Emotions on Decision-Making

• When market sentiment changes, investors often face confusion about whether to continue holding positions. David believes that emotional management is key to successful trading. He mentions that investors need to develop plans to cope with changes in market sentiment rather than simply relying on intuition. Emotional fluctuations can lead investors to make incorrect decisions, so recognizing and managing these emotions is crucial.

Practical Emotional Management

• Santi shares his experience during this cycle, emphasizing the importance of gradually increasing positions. He mentions that although he sometimes missed the best entry points, by gradually adding to his positions, he was able to achieve better returns during market rebounds. This strategy helped him overcome the emotional pressure of not entering at the lowest point.

Is Cryptocurrency Worth Investing In?

The Importance of Liquidity

• Santi emphasizes that liquidity is crucial in the cryptocurrency market, as liquidity can quickly disappear and also recover rapidly. He mentions that in the current market environment, overtrading may lead to losses, so he prefers to wait for liquidity to rebound.

Investment Strategies and Psychological Factors

• David believes that many investors do not actually desire liquidity, as it means they need to trade frequently. He notes that many investors feel lost when facing market volatility and tend to avoid making decisions. In contrast, traditional financial markets may have a higher risk tolerance, as investors can typically wait longer for results.

Adapting to Market Changes

• Santi suggests that investors should learn to embrace volatility rather than avoid it. He advises that when facing market downturns, investors should view them as buying opportunities and maintain cash flow to seize these opportunities. At the same time, he emphasizes that investors need to have a clear plan and adjust based on market information.

Long-Term Investment Perspective

• Jeff mentions that although the crypto market is highly competitive, it still offers unique opportunities. He believes that liquidity and volatility are factors that must be considered when investing in cryptocurrencies. With appropriate strategies, investors can find profitable opportunities in the market. He also notes that good investment returns are often related to liquidity risks, making it very important to seek suitable investment opportunities in the crypto space.

Emotional Management and Decision-Making

• Santi points out that one of the challenges investors face in the crypto market is emotional management. He believes that understanding one's emotions and learning to control them is key to successful investing. Many investors may become overly cautious after experiencing significant losses, so building good psychological resilience and investment habits is essential.