Insights from a Market Maker: The Evolution of Market Psychology in Cryptocurrency Trading
TLDR: We examine the role of market psychology in crypto trading and how it influences decision-making for market makers. We discuss how understanding and incorporating market psychology can be a key factor for success for market makers and their clients.
At Artis, as a client-focused market maker, our approach to cryptocurrency trading goes beyond just numbers and technical analysis. We recognise the substantial impact of market psychology on the trading behaviours of retail participants and/or that of professional participants in the space aka Market Makers and how this can affect our clients. We want to discuss how market psychology shapes the cryptocurrency landscape and how this understanding is a decisive factor in delivering successful outcomes.
The Psychology of Liquidity
When it comes to modern financial markets, market psychology is driven by professional participants assessing the real value of an asset and their future expectation of its value. For example, let’s use the Black Box analogy. If we have a ‘Black Box’ and we put $10 in it, the real-world value will be $10.
A proficient or professional market participant will trade the ‘Black Box’ and will ‘quote liquidity’ at around $10. This is the ‘fair value’ of the box because it has $10 in it, and as a result, it will trade for $10. This simple analogy illustrates how financial traders make a market for an asset.
In Crypto, there are less professional traders in the space. As a result, what we find if we put $10 in a crypto ‘Black Box’, it will NOT trade at $10. Firstly, because there are people either ‘betting’ or ‘trusting’ that there is actually more in the crypto box than $10, and it’s just a surprise, or they will value this at a higher value than $10.
On the other side, there are participants who disagree with the $10 actually being in the box and are trusting or betting it is actually worth less than $10. This discrepancy is the most interesting evolution of Crypto market psychology; asset values are driven by people’s ‘beliefs’ around asset values and their opinions, rather than by traditional fundamentals around asset values, such as allocations or future expectations of returns.
Most real-world assets closely resemble where they should be valued based on market sentiment or measurable data-led results. But when we look at assets where it is more retail or ‘people-driven’ such as Tesla, Bitcoin, Ordinals, or Memecoins, the value is based on people’s ‘belief’ around future returns, the Fear of Missing out (FOMO) or any number of other uneducated guesses by retail participants.
As market makers, we leverage market psychology to provide liquidity in a way that capitalises on emotional trading patterns. By understanding these patterns, we can set spreads and choose positions that reflect the current psychological state of the market. We believe this gives us a strategic edge over our competitors.
Retail-Volume-Driven
How does this influence our decision-making as Market Makers? In Cryptocurrency markets, we need to be prepared for unreasonable events and higher levels of volatility when it comes to asset values. Retail traders, in particular, are prone to following the crowd, a tendency which leads to significant market movements such as prices going up 100% in a single day. By analysing data from social media, news, KOLs and other platforms, we can track market sentiment, allowing us to react to market shifts more effectively.
As market makers, identifying and anticipating these herd behaviour trends can inform our market positioning and liquidity provision strategies. With this level of inconsistency and the fact we can’t use any kind of performance to predict or map what will happen on a daily basis, means that we need to be much more prepared for black swan events or huge price movements.
As a result, we are much more retail-focused, watching what well-capitalised retail participants as well as professionals are doing in the market. We focus more on monitoring volume in crypto markets because there is no guarantee, especially with the smaller altcoins, that there is any specific event driving the price movements other than retail-driven sentiment.
At Artis, we use algorithmic trading strategies to monitor volumes, developing technology that anticipates actual human behaviours to see if the participant engages with or alters their orders. If the human responds or reacts to us changing the order book, then we can change what we are trading based on real-time market volumes.
Generally speaking, many core differences between the real world of financial trading and cryptocurrency markets come down to the decreased level of professional participants in crypto and the smaller volumes being traded. We are focused on developing technology that focuses on dealing with non-professional retail participants and smaller capitalised altcoins as a result to deliver value for our clients.
A deep understanding of behavioural finance principles helps us identify the cognitive biases and emotional responses that influence retail behaviours in the crypto space. This knowledge is critical in designing technology that can harness these biases for optimal trading outcomes.
Market psychology is a fundamental aspect of cryptocurrency trading, influencing the decisions of both market makers and retail participants. For market makers, integrating these psychological elements into our trading strategies is crucial for navigating crypto markets effectively. By combining our data-driven approach with insights into human behaviour and market sentiment, we stay one step ahead of the ever-evolving and emotionally charged world of cryptocurrency trading and deliver successful outcomes.
Reach out to ck@faculty.group if you want to learn more.
About Artis
At Artis, we are a client-focused market maker that works closely with our clients to provide tailored, synchronised solutions that meet their specific requirements every step of the way. Our USP is our ability to customise services around the needs of our clients, regardless of market conditions or business life cycle. We help our clients navigate the complexities of market making, treasury management and CEX support in order to achieve their critical milestones, increase the number of token holders, build their user base and extend their financial runway. We believe in building long-term relationships that grow with our clients to deliver financial success for everyone.
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