The Impact of Crypto Catastrophes on Trader Psychology

By Angie Malltezi, Chief Strategy Officer of Shipyard Software

While the correlation between catastrophic crypto events and psychological trauma has not been thoroughly researched, there are extensive studies that empirically show how financial loss often results in lasting feelings of frustration, regret, and guilt that consequently impact investors’ emotional, social, and physiological health. Given the ongoing crypto market volatility and the severity of multiple recent, high profile crypto implosions, it’s not unreasonable to anticipate this effect happening to crypto investors. Especially given that for many people, participating in the broader crypto ecosystem represents a hopeful paradigm shift from merely investing to realizing some form of self-sufficiency.

Renowned trauma psychologist Peter Levine wrote that certain shocks to the organism, “Can alter a person’s biological, psychological, and social equilibrium to such a degree that the memory of one particular event comes to taint, and dominate, all other experiences.”

If we consider the surprise of recent global events such as the falling of crypto giants, impending recessions, and ongoing war, we may begin to recognize how our perceptions of the future and investing behavior may be skewed by our collective trauma. But what exactly is Trauma? A word that can be traced back to its Greek origin “wound,” trauma is a fitting expression to ascribe to the experiences of those impacted by sudden and dramatic financial loss. A study conducted to assess victim impact from the Madoff Ponzi Scheme found that the majority of respondents met the criteria for a presumptive PTSD diagnosis, experiencing a high-level of depression and anxiety. Victims affirmed a substantial loss of confidence in financial institutions. PTSD and related psychological trauma do not leave us unscathed. 

Extensive research on the neurobiological changes due to this stress have been shown when assessing the functioning of the brain's Hypothalamic-Pituitary-Adrenal Axis (HPA). The HPA is a term used to describe the interaction between the hypothalamus, pituitary gland, and adrenal glands, which plays an essential role in the body’s stress response.

Neuroimaging studies demonstrate that brains of PTSD patients show that several regions differ structurally and functionally from those of healthy individuals. In other words, our brains physically adapt in the face of emotional or psychological stress. This manifests in psychological amplification leading to an increase in loss-aversion and ambiguity aversion. This might show up in traders making short-term decisions on trades to try and exit the market or investing in lower-risk financial assets; moving away from venture capital and angel-investing, towards bonds, ETFs, and savings accounts. These brain adaptations exist as evolutionary protective measures to guide us away from making the same mistakes twice. 

Behavior economists have coined the term "competence hypothesis." The idea is closely related to whether an individual is ambiguity-averse or ambiguity-seeking, depending on how competent they feel in analyzing the situation at hand. According to the competence hypothesis, if an individual does not feel competent in analyzing a situation, they will be ambiguity-averse. Studies show that reduced confidence in one’s ability leads to reduced trading activity.

However, this might not necessarily be a bad thing. Researchers exploring how trader confidence impacts trading activity found that, “Confident investors rely more on intuitive judgments when forming beliefs about expected returns.” In particular, they rely more on reinforcement learning and extrapolate individual return experiences into the future. Thus, more strongly changing beliefs is associated with more turnover. Compared to less confident investors, overconfident investors underperform substantially. 

Financial devastation can lead to unfortunate social ramifications. We often isolate ourselves after traumatic experiences, embarrassed about financial loss. We view ourselves as less capable of making certain decisions, and begin to question our self-image. Financial victims perceive a sense of judgment from society about their losses, which can influence everything from an individual’s relationship with friends and family to their likelihood of taking depression-related medication. Indebtedness has been described as one of the strongest risk factors for mental health and the correlation between financial stress and depression is generally stronger among populations with low income or wealth.

As reported by the WSJ, SBF has claimed that wired customer funds contributed to over half of Alameda’s position on FTX, likely totaling over $5 billion. FTX is only one of several companies that contributed to crypto winter. Thus far, conservative estimates of funds lost by consumers can be tallied up to $550B, leaving investors, traders, and sidelined observers in a state of shock. One particularly cruel product of recent crypto catastrophes is that they tend to disproportionately impact vulnerable peoples, like those living in developing countries. Even though high-income households are overrepresented among US-based crypto investors, the fact that 18 out of 20 of the top crypto markets are classified as low to middle income countries cannot be overlooked. This is the group most likely to lack institutional support systems and infrastructure to aid in their recovery.

Each generation has defining financial moments that shape their internal decision-making frameworks going forward. In response to the 2008 market collapse and dwindling public trust in financial intermediaries, Satoshi Nakamoto published a paper articulating the need for an electronic payment system based on cryptographic proof instead of trust. While the cause of our current situation is more nuanced, it does leave us wondering what our industry's future will entail.

It’s hopeful to note that trauma is an essential part of the human experience as well as a driving force in our adaptation and push for innovation. To quote Gabor Mate, a man who spent a lifetime researching trauma and its impact on the individual and society, “Whether we realize it, it is our woundedness, or how we cope with it, that dictates much of our behavior, shapes our social habits, and informs our ways of thinking about the world. It can even determine whether we are capable of rational thought at all in matters of the greatest importance to our lives.”

Angie is a senior executive and the Chief Strategy Officer at Shipyard Software, a Web3 startup building a fleet of specialized DEXs to suit every crypto trader. Prior to Shipyard, Angie was a management consultant at Accenture Strategy, where she worked with C-suite executives of Fortune 500 companies from industries such as Financial Services, Consumer Packaged Goods, and Pharmaceuticals to identify new revenue streams and drive business growth. Angie has served as a startup advisor to early-stage companies in the deep tech space. She has a breadth of experience working with both public companies and early-stage startups. Angie holds a B.Sc degree in Neuroscience from the University of British Columbia.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.