Investor Sentiment Behind Crypto Gains and Losses—Is Next Bitcoin Crash Already Written?

Key Takeaways

• CryptoSent is a novel sentiment index that assesses the overall mood of the cryptocurrency market.
• Cryptocurrencies with high sensitivity to sentiment tend to have lower returns in the short term.
• Sentiment has played a significant role in shaping major price movements in the digital assets market.

Cryptocurrency markets, known for their volatility and rapid price fluctuations, are often influenced by factors beyond traditional economic indicators. One such factor is sentiment , which encompasses the collective mood and perception of investors towards cryptocurrencies.

A recent study examined sentiment’s significance as a systematic risk factor in the cryptocurrency market and explored how it can impact expected returns.

What Is CryptoSent Index

CryptoSent is a sentiment index that assesses the overall mood of the cryptocurrency market. Created by researchers John Kose, Li Jingrui, and Liu Ruming, it integrates a wide array of components, such as market indices, trading activity, social media discussions, and blockchain indicators.

By combining these elements, CryptoSent aims to offer a comprehensive perspective on investor sentiment and market dynamics.

The components of CryptoSent include metrics like the cryptocurrency market index, market volatility, trading volume, social media sentiment based on cryptocurrency-related tweets, and trends from Google searches.

Blockchain activity, such as the number of active wallets, initial coin offerings (ICOs), and blockchain transactions, is also incorporated.

Data for these components was gathered from sources like CoinMarketCap, X, blockchain explorers, and Google, covering the period from January 2014 to March 2023, with some components available earlier.

Crypto sentiment over the years

The analysis revealed strong correlations among its components, showing that they are closely linked. The index also showed significant fluctuations over time, reflecting major events and shocks in the cryptocurrency market. Moreover, CryptoSent holds potential as a predictive tool for anticipating future market trends and investor behavior.

How Sentiment Works in the Crypto World

Historic Impact of Sentiment in Crypto

Sentiment has had a profound impact on the cryptocurrency market, with sentiment shifts often driving major price movements. Unlike traditional markets, the crypto space is particularly susceptible to sentiment due to its speculative nature, lack of regulatory oversight, and the significant role of retail investors.

Throughout cryptocurrency’s short but volatile history, there have been several key instances where sentiment played a decisive role in shaping market trends and influencing price movements.

The Bitcoin (BTC) bull run of late 2017 is an example. During this period, positive sentiment surrounding Bitcoin and cryptocurrencies reached unprecedented levels. As media coverage of Bitcoin soared, retail interest surged, and social media was abuzz with discussions of blockchain’s potential.

This frenzy of optimism and fear of missing out (FOMO) led to a massive influx of new investors. That drove Bitcoin’s price from around $1,000 in early 2017 to nearly $20,000 by December of the same year.

Crypto sentiment during significant events

The sentiment-driven rally was largely fueled by excitement and hype rather than fundamental developments, leading to a rapid price rise across the cryptocurrency market. However, when sentiment shifted, the bubble burst, leading to a steep correction in 2018, with Bitcoin losing more than 80% of its value by the end of the year.

Another example is the crash in March 2020, known as the “COVID-19 crash.” The cryptocurrency market saw a sharp decline in sentiment as fears of economic instability and liquidity concerns gripped investors.

Bitcoin dropped nearly 50% within a day, from around $9,000 to under $5,000. The negative sentiment spread rapidly across social media and news outlets, amplifying the sell-off.

However, as governments responded with stimulus measures and investor confidence in risk assets recovered, sentiment in the crypto market improved dramatically, helping Bitcoin and other cryptocurrencies rebound sharply in the months following the crash.

Doge and Terra Cases

The Dogecoin rally in early 2021 is another key illustration of sentiment’s role. Initially started as a joke, Dogecoin saw explosive growth largely due to positive social media sentiment, particularly on platforms like Reddit and Twitter.

High-profile celebrity endorsements, including Elon Musk, and the viral nature of Dogecoin’s community-driven marketing, propelled the cryptocurrency to new heights. At one point, Dogecoin rose over 12,000% within a few months, reaching a market capitalization of over $80 billion.

Despite the lack of strong technical fundamentals behind Dogecoin, the rally demonstrated the power of collective sentiment in driving prices in the crypto market.

More recently, the collapse of Terra’s algorithmic stablecoin , UST, in May 2022, illustrates the rapid shift from positive to negative sentiment. Terra had become a promising project, attracting large investments and building confidence in its ecosystem.

However, when UST lost its dollar peg, panic spread across the market, and negative sentiment overwhelmed the crypto space. Investors rapidly fled, causing the price of Terra’s LUNA token to plummet from around $85 to near zero within days.

The collapse not only wiped out billions of dollars in market value. But it also severely damaged investor sentiment. In fact, it contributed to the broader crypto market downturn throughout the rest of 2022.