Market Meditations | August 25, 2021
Why 99% of investors fail
? Today, we would like to draw your attention to the base rate fallacy.
⚠️ One of the main reasons why the majority of investors are unsuccessful.
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Here’s 5 things you should know about the crypto markets today:
? A Fair Exchange?
Recent news suggests that crypto exchange tokens are continuing to surge upwards as Bitcoin and Ethereum rally from their late-July lows. But what are exchange tokens and why are they so popular? Beyond pure speculation, here are some of the other use cases.
Exchange tokens are issued by centralised or decentralised exchanges and can have many different use cases.
They started off as being used to provide discounts on trading fees for holders in centralised exchanges, along with some governance features such as voting rights.
As liquidity has grown, big exchanges like Binance and FTX have started using them in base trading pairs, and they can also be used in some cases as payment methods or to secure loans.
Last year, decentralised exchanges started to provide holders with a transaction fee revenue (think UniSwap, SushiSwap, PancakeSwap), and staking has been widely adopted by many tokens, especially those with a direct parent blockchain.
To drive adoption further, exchanges associated with new product launches (sometimes known as IEOs) have mandated the use of native tokens for participation and early access.
Finally, the world of yield farming has expanded to exchange tokens, and many of them can now be provided as liquidity to DEXs or capital to lenders to earn additional passive income.
It’s clear that exchanges are in a powerful position to stack revenue through multiple use cases. But keep in mind that although they may surge in an up-trend, they are just as susceptible to a market-wide crash.
To keep an eye on price movements, check out The Block, which tracks some of the biggest centralized exchange tokens, and for more information on passive income our exhaustive guide is essential reading.
Our Market Meditations are longer format educational segments. Each letter features a Market Meditation which will deep dive and analyse a relevant crypto event, theme or tool.
? How Likely is Success?
From decentralized finance to NFTs and the metaverse, crypto continues to drive innovation. It is therefore easy to believe every new project will succeed and grow exponentially. However, this line of thought disregards a crucial bit of information: how many new tech projects have failed in the past? We consider the individual merits of crypto projects but do not consider the merits of the overall asset class and in doing so fall victim to the base rate fallacy – our frequent failure to account for the base or original probability of a specific event occurring1.
Consider the current NFT trend. We may look at an individual project and think “these NFTs look great, they have a compelling narrative so this project will succeed”. However we do not account for the fact that most NFTs are not profitable. Additionally we do not account for the fact that most NFT traders are not profitable. By failing to consider these base rates, we think our chances of success are significantly higher than in reality and increase the probability of making a poor investment decision.
So how can we avoid falling for this fallacy? Our favourite is to follow Charlie Munger’s two steps process2.
1️⃣ Actively seek to understand all factors that govern the interests involved. Our failure to consider base rates occurs because our brains skip over such factors automatically. Seeking to understand all relevant components of a matter broadens our scope to include base probabilities.
2️⃣ Understand what biases may be leading you astray. Sometimes our mind hides base rates from us through cognitive errors such as survivorship bias. Seek to continually improve your self awareness and you will learn to identify where your thinking process can be improved.
The base rate fallacy can lead to us to dramatically overestimate the likelihood of any given event and can therefore lead to making poor investment decisions. Deliberately seek all factors that are relevant in understanding any given matter, continually improve your self awareness and you will be able to understand the true chance of success.
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? It’s a DeFi ParTi
Bloomberg recently partnered with Galaxy Digital to launch a DeFi index fund or a portfolio of protocols in the DeFi segment of the market. Investing in an index fund allows you to reap the rewards (and downfalls) of multiple projects at once. This index will allocate no more than 40% and no less than 1% to any protocol.
According to a press announcement, the Bloomberg Galaxy Digital DeFi index will track assets at the following proportions: UNI 40%, AAVE 18%, MKR 12.7%, COMP 10%, YFI 5.4%, SNX 5%, SUSHI 4.3%, ZXR 0x 2.8%, UMA 1.8%
Protocols will be considered for addition or removal monthly. If you would like to invest in the index fund, you will have to become a Bloomberg customer as it is only offered on the Bloomberg terminal under DEFI.
Judging by recent headlines like Citi awaiting regulatory approval to trade Bitcoin futures, Nasdaq backing Valkyrie’s Bitcoin futures ETF and Bloomberg’s DeFi index fund it seems institutions are finally FOMOing into crypto.
You can hardly get more mainstream than Bloomberg validating DEFI, unless of course someone like VISA was to buy a Crypto Punk and validate the NFT market 😉
Not financial or tax advice. The content in this newsletter is for informational purposes only. Nothing in this email is intended to serve as financial advice. We are not financial advisors. Every investment and trading move involves risk. Do your own research when making a decision. See our important security disclaimers here.
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Kahneman D. and Tversky, A. (1973). On the Psychology of Prediction. Psychology Review. 80(4), 237-251. doi: 10.1037/h0034747