The Psychology of Crypto

6 rules for investing in crypto — that allow you to sleep at night

Crypto investing can be a scary game. Volatility is high, the market is largely unregulated, and there’s a ton of noise. As we continue to power through a raging bear market and unstable macro conditions, people are starting to doubt the opportunity that crypto offers. Is this perhaps the end of crypto as an asset? *SPOILER ALERT* The answer is most likely no.

But if that’s the case, how can you as a retail investor make any sense of the market when there’s so much uncertainty? How should you approach crypto investing?

Photo by Maxim Hopman on Unsplash

Investing in any asset class is more a game of mental strength and endurance than it is financial savvy or analytical ability. It’s mind over matter, and having perseverance through the hard times is far more valuable than finesse in maneuvering the market.

If you want to find success in your crypto investments while still being able to sleep at night, there are a few rules you should keep in mind. As always, this isn’t financial advice. Info and entertainment purposes only. I’ll be sharing my approach to the market and how I think about things.

6 rules for successful crypto investing

Before you dive in, please be aware that this isn’t a guide for making the best financial analysis of a token or forecasting price movements of the ‘next big thing’. There’s no technical investing advice shared here, only mental models and principles. These are a mixture of age-old investing principles and some of my personal frameworks that you can follow that will help you get exposure to crypto as an asset class without spiking your anxiety levels or losing sleep.

The principles for crypto investing that we’ll look at in this article are:

  1. Conviction
  2. Time
  3. Emergency fund — to sleep at night
  4. Stick to blue chip tokens
  5. Ether cost averaging
  6. The 5% rule

To the astute reader, you’ll notice that these rules are eerily similar to basic investment advice you could find anywhere on the internet. You’d be correct. We’ll be exploring these through the lens of crypto with a goal of bringing you a more comfortable way to approach crypto investing. Let’s dive in!

1. Conviction

I got into crypto for one very simple reason. I thought I could make quick money. It’s why a lot of people join the space at first. Whether that’s a sound reason is up for debate. However, it will never sustain you through the ups and downs of this volatile market. You need to have conviction in the technology and its future in order to sail these seas without capsizing. So how do you build conviction?

When anyone asks me if they should invest in cryptocurrency, I always tell them the same thing. Go to Coinbase and buy $20 worth of Ethereum or Bitcoin, transfer it to a non-custodial wallet, and use your token somewhere in DeFi. Learn what it’s like to take a loan in a split second using Aave. Experience the empowering feeling of sending tokens to a wallet on the other side of the world in seconds without your bank’s approval. Go buy an NFT you like. Make a token swap on a decentralized exchange like UniSwap. All of these things will give you exposure to the ecosystem and teach you more about what it’s like to live in a permissionless and decentralized world. These actions tend to spark a deeper interest that forces you to read up on how things work, which increases your exposure to the ecosystem.

Exploring crypto assets on Coinbase.

After some exploration, you’ll start to get a sense of your level of interest and if it’s something you want to continue to use and explore. Building conviction, however, will take time and will force you to continue exploring. But without conviction, the violent price movements and unpredictable markets will undoubtedly rattle your cages and make it uncomfortable to stick to your positions and hold out for the long-term. Once I developed absolute conviction in the technology, price swings became irrelevant. I’m in it for the long-haul, and I’m convinced that this technology will fundamentally shift life on this planet.

2. Time

Just like any investment, you need to be very clear on your time horizon. The shorter your intended time horizon for holding an asset, the higher the risk. Why? Because nobody knows how the market will move. I don’t care if it’s crypto, real estate, stocks, or bonds. Nobody knows for sure. If your time horizon is short and you know you’ll need to liquidate your assets within the year, you increase the risk that your original investment is lower in value than when you started.

If you have the privilege of a long time horizon for your crypto positions, you are in good shape. I think of it in decade intervals. Since I’ve established strong conviction in this technology and asset class, I’m comfortable with sitting through bull markets and bear markets without reacting. I know there are many years left until I’m going to reconsider my positions. Time is your unfair advantage in any investment. But due to the allure of fast money in crypto, people tend to forget this principle quicker than most.

3. Keep an emergency fund

Want to take some risky positions and still be able to sleep at night? Keep a healthy emergency fund in fiat currency. Even if you have full conviction in the space, the fact of the matter is, dollars, pounds, euros etc. are still the best instrument for buying energy, food, water, medicine, and clothing. It’s vital that you keep an emergency fund large enough to sustain your lifestyle in the event of unfortunate circumstances such as losing your job.

The size of your emergency fund will vary depending on your life circumstances. A general rule of thumb is to have a minimum of 6 months of expenses and living costs covered in an emergency fund. That way, you have plenty of time to find a new job, downsize your monthly expenses, and sell off some assets if you absolutely must.

This is age-old advice, but it can’t be understated how important this is. The moment I got my emergency fund in good shape, I started sleeping much better at night. It doesn’t matter if ETH, BTC, or SOL has tanked by the time I wake up. I’ve got conviction in the technology, I’ve got a long time horizon, and 6 months of expenses covered in the event of losing my primary income. High risk investing in comfort.

4. Stick to blue chip tokens

If you’ve never invested in cryptocurrency before, it can be hard to know what token to buy. There’s a lot of noise in this market and people will give you lots of different kinds of advice. We see lots of YouTubers and bloggers who are incentivized to recommend the ‘next big opportunity’ because they’ve been paid to do so. The problem here is, most advice is delivered with absolute conviction using very valid arguments. Just remember that everyone who gives you investment advice has their own agenda.

Photo by Traxer on Unsplash

If you’re not sure what you’re doing, just stick with the ‘blue chip’ tokens and ignore the noise. In my opinion, blue chip tokens include the following:

  • Bitcoin (BTC)
  • Ethereum (ETH)
  • Binance (BNB)
  • Ripple (XRP)
  • Solana (SOL)

These all fall on different aspects of the risk curve but are among the most established tokens on the market, and it would be sensible to start with a selection of those. How did I arrive at these? I simply went to CoinMarketCap and picked some of the most valuable coins by market cap (adjusting for some background knowledge and personal bias on the token projects). If you’re still uncertain, just stick with Bitcoin and Ethereum. But remember, everyone has an agenda. I hold ETH and SOL, and I’m incentivized to increase buying pressure on these assets. Gotta keep it transparent people!

5. Ether Cost Averaging

Even with the above principles in mind, it can be hard to know when to enter the market. Has it bottomed out? Is it peaking? Will it continue to go up? Will the market crash in a week? Should I wait for news from the FED?

Let me give you the secret answer to all of these questions that will put you well ahead of the competition.

You’ll never know, and it doesn’t matter.

Nobody can time the market. If they do, it’s almost certainly luck. There are countless examples in financial history of top-tier hedge fund managers trying to time the US stock market with their active portfolios. Let me save you some time in researching these case studies. They can’t do it.

The better option by far is to follow something known as dollar cost averaging (or, in this case, ether cost averaging 😉 ). Simply decide on an interval you want to invest in (mine is monthly), an amount you’re comfortable with, and the assets you want to invest in. Then stick with it. Through thick and thin. If you can, setup an automated buy so you don’t even have to do it yourself. Check back in on your positions in a few years. It’s as easy as that.

This approach will give you the statistically best chance at the lowest unit cost and increase your returns over time. If you want to read more about dollar cost averaging and how it works, there are plenty of great articles out there explaining the math behind it. Here’s a good one from Forbes.

6. The 5% Rule

In the next few years, the web3 and crypto space is primed for explosive growth. Some have estimated that the space will increase in value by as much as 100x. Of course this growth won’t be concentrated on the particular tokens you’ve taken a position in, but it will certainly influence their price over time. However, the astute investor knows, with increased upside comes increased risk. The more potential upside we face, the bigger the risk of losing it all. So how can you invest comfortably, knowing there’s such a big risk of losing your money?

If you don’t have 100% conviction but you want to get in on the action in a meaningful way, I suggest you leverage the 5% rule. It’s really simple. You take 5% of your investment portfolio and put it in crypto assets of your choice. But how will 5% be meaningful, I hear you ask?

Remember how I said the market has been estimated by some to increase 100x? Well, let’s suppose it’s not quite that much, but it’s still going to be a massive 20x growth in the next 10 years. With your 5%, the math works out such that it DOUBLES your total investment portfolio at 20x growth. On the flipside, if the entire web3 market fails and plunges to 0, you’ve only lost 5% of your portfolio, which is generally considered the cost of playing the game of investing and your remaining 95% will probably prop up those losses anyway. It’s a nice way to get exposure to crypto without betting the farm.

Photo by Morgan Housel on Unsplash

Volatility is the cost of entry

On a final note, I want to talk about volatility. We’re all humans, and humans are emotional beings. We’ve worked hard for our money, and volatility can be nerve wrecking. Everyone finds it difficult, no matter how sound their strategy is. Bear markets fuel uncertainty, and everyone asks themselves, at one point or another, “have I made the right bet?”.

In Morgan Housel’s book, The Psychology of Money, which inspired the title for this article, he writes about volatility as a cost of entry. The way he describes it is that people tend to think of volatility (or at least downward volatility) as a fine. It’s a penalty for an investor doing the wrong thing. This is totally the wrong way to look at it. Instead, Housel claims that you should view downward volatility as the cost of playing the game. It’s the ‘rent’ you pay for taking up space in the markets. If you can’t afford the cost of rent, you’ll have to move to a less expensive ‘neighborhood’ such as treasury bonds.

With that, remember that crypto is a very expensive neighborhood and paying rent will always hurt a bit. It’s the cost of playing the game, and if you have conviction, it’s well worth the cost.

I’m always looking to learn new financial frameworks, and I’d love to hear some of your foundational principles for investing in crypto. Leave a comment and share your approach!

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The Psychology of Crypto was originally published in The Capital on Medium, where people are continuing the conversation by highlighting and responding to this story.

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