In this essay, we will explore the application of market reflexivity, a theory put forth by George Soros to the crypto market.
The legendary hedge fund manager George Soros put forward the idea that thinking participants in a situation (here the market) participate with an incomplete and often distorted set of information about reality. This is the principle of fallibility.
The projection of this principle to the market creates far-from-equilibrium market situations, which create inconsistent short-term movements far from the postulate of the market economy theory of a complete and balanced market. This is the principle of reflexivity.
This principle of reflexibility is accentuated by the very nature of the thinking participants here, human beings. The structure of our brain and our emotions make it difficult for us to process information in an objective way. Each participant projects the information with mistakes and in a distorted way, which takes us further away from the equilibrium situation. The subjectivity of each participant can therefore influence the objectivity of reality, creating a feedback loop that accentuates the situation of reflexivity.
This is the essence of aggressive market movements during speculative bubble phenomena such as the subprime crisis or the internet bubble. Fear and greed of each participant and the subjectivity of their information processing pushes them to modify reality in such a way that the new state of reality reinforces the subjectivity of their thinking. This principle, once integrated, creates an edge against market volatility. We can even see all market situations as situations of dynamic disequilibrium and affirm that we are never in a situation of equilibrium.
Now that we have put Soros’ work in context, we can ask ourselves how to use this theory as an edge in the crypto market.
The crypto market is by definition the perfect breeding ground for the theory of reflexive markets. It is a fairly immature unregulated market with high volatility and low market cap. The subjectivity of the movements is catalyzed by the nature of the thinking participants who are for the most part new entrants to the financial markets driven by the short-term gain. We can also note the role of social networks which tend to amplify the impact of news and increase the subjectivity of participants and the strength of the feedback loop which leads to extreme volatility in short-term movements.
This is quite contradictory given the quality of the market data that everyone has at their disposal, with on-chains data allowing to rely on much more relevant data than traditional markets.
On-chains data allow to process in real time and in a precise way the data on blockchains such as the number of users on the network, the behavior of whales, all the movements on the exchanges… We can therefore define the reality of the market at a given moment and thus define the size of the disequilibrium of the reflexivity situation. This allows us to develop an edge by measuring the distance between the market reality and the disequilibrium situation.
This can be illustrated in a more concrete way with some indicators that illustrate this theory, such as the Rhodl Ratio developed by Philip Swift, which measures the ratio between the movement of one-week-old wallets (Subjective Thinking Players) and the movement of one-two-year-old wallets on the bitcoin network. We can thus project the level of positive and negative reflexivity of the market and thus define buying and selling zones.
In a world driven by uncertainty and the subjectivity of its participants, I find Soros’ theory of general reflexivity more than relevant. It is a reading prism for any situation where human subjectivity can change the reality of the situation.
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