How to trade crypto: DeFi Meets CeFi: Markets and Phases in Decentralised and Centralised Finance

  • Each phase of a crypto market circle lasts approximately 4 years.

Markets move in the same direction

We have all heard of market bubbles and similar expressions used in traditional centralised finance (CeFi). Along with the emergence of decentralised platforms, financial markets became more approachable given that blockchain technology is open and permissionless, along with significant growth prospects.

As the name suggests, decentralised finance (DeFi) is made of financial services and products, supported by the technology of smart contracts. Even though there are no intermediaries, it soon became evident that the same rules apply. We probably even know someone that has been caught in a bubble, bear or bull stage. 

For example, bear and bull markets are terms that stem from traditional finance, but they have been more associated with the crypto industry. If you are interested in finding out why, check out our 'What do the terms Bull & Bear Market mean?'.

Crypto markets have been making headlines for a time now being frequently called out for volatility and instability. What if we told you that a little bit of CeFi knowledge could make you understand DeFi more?  A bunch of terms coined during the era of the traditional financial system are used within DeFi systems.

If you need to refresh your memory on how DeFi works, we suggest reading this article: ‘How to use crypto: Getting started with DeFi’. 

Markets, centralised or decentralised, move in the same direction or better to say – move in the same cycles. Before explaining the cycles, let’s go through some traditional expressions or occurrences that shape all markets. 

What is a market bubble?

If you ever watched children blowing soap bubbles, you understand how frail they are. A sudden movement caused by a bit of wind, or a tender touch is enough to make them pop. Similar to the saying ‘you never know you are in a bubble until it bursts’, fragile soapy bubbles pop unexpectedly. 

When talking about market bubbles, the underlying principle is similar. Usually linked to the stock market, bubbles describe a situation when prices for a stock or any other type of asset rise exponentially over a period of time, excessing their intrinsic value. 

There are many potential reasons behind the emergence of a market bubble. While Keynesian economics usually points to speculation and trading based on herd mentality, other schools blame basic economic principles of supply and demand. On the other hand, fans of the efficient market theory think that bubbles don’t exist because prices always reflect their intrinsic value. 

At some point, prices hit a wall, and the bubble bursts. This is relatable to many industries, from stocks and real estate to cryptocurrencies. Market bubbles can be developed through years and there are many factors behind their emergence and development. However, one thing stays the same – they burst quickly and cause a global domino effect.

Crypto bubbles explained

The value of investments and assets is measured using factors such as demand, growth potential, performance, earnings, and others. It is normal for a price to go a bit higher. When we speak of bubbles, we talk about rapid increases that exceed the asset’s intrinsic value. 

A crypto bubble is formed under particular circumstances. The early stages of bubble formation are characterised by the excitement that leads to a rapid price increase. When investors notice the rise in value, they invest in the asset, making the price go even higher. With more crypto users investing, the price surpasses its intrinsic value, and the bubble is formed. 

Sometimes bubbles are mixed with too much hype. Hype doesn’t necessarily lead to a bubble formation. Technologies are emerging at the speed of light, and the consumers' focus shifts frequently. The crypto market has been accused multiple times, mainly due to a belief that the only purpose of cryptocurrencies is speculation.  

This was caused by people thinking it doesn’t reflect the real economy considering that it is still difficult to pay for real-world products and services using cryptocurrencies. Now that, thanks to DeFi, applications and use cases are on the rise, utility features of the crypto ecosystem are growing. 

Investments in the traditional financial system are valued usually based on business performance, yet cryptocurrencies are primarily valued based on factors such as competition and demand. 

For example, Bitcoin is used as an example of bubbles’ occurrences throughout the years. Back in 2017, Bitcoin’s price reached over $13,000 before it popped.  

Inflation vs deflation. What’s the difference?

When you hear about inflation, you know it is bad news. In economics, inflation refers to a quantitative measure of how fast the price of goods on the market is increasing. It is associated with a high demand for goods and services that creates a drop in supply.  

Markets are shaped by the law of supply and demand. To find more about basic finance and how it relates to crypto, why not read this article: ‘When CeFi Meets DeFi: Basic Finance Terms’. 

Inflation presents a threat because it requires a bigger consumer purchasing power. When inflation runs wild, hyperinflations may occur. In simple terms, when the increase in monthly prices goes over 50% for a certain period, then we are facing hyperinflation. Don’t worry though because these are rare. 

Unlike inflation, deflation happens when the supply exceeds the demand; in cases when too many goods are available or if there isn’t enough money circulating to buy the goods. The price drops accordingly.  

It is important to distinguish deflation from the term disinflation which represents a decline in the positive rate of inflation from time to time. 

Even though inflation is usually associated with something bad, deflation can lead to severe consequences such as recession or economic depression. In CeFi, central banks generally work on stopping deflation from its very start. 

Cryptocurrency: inflationary and deflationary

Cryptocurrency inflation and deflation refer to the notion of how the general purchasing power of a specific cryptocurrency changes over time. While inflationary cryptocurrencies have declining power over time due to increases in supply, deflationary crypto assets increase in intrinsic value because the total supply remains unchanged or decreases. 

When you say for a cryptocurrency that it is inflationary, it means that the number of coins in circulation rises over time. Some inflationary cryptocurrencies have fixed supplies, and others have unlimited supplies. For example, Dogecoin has an unlimited supply that happened after one of its founders abolished the cap of 100 billion DOGE coins.  

On the other hand, we have Bitcoin as a good example of a deflationary crypto asset. From the moment of its emergence, there was a hard cap of 21 million BTC available for mining. Therefore, as the supply decreases, the intrinsic value increases, making its purchasing power rise as well. 

To return to the bubble’s topic – just because Bitcoin is a deflationary financial instrument, it doesn’t mean that its market value will not drop. Just in terms of investing, deflationary cryptocurrencies have been viewed as decent options. 

What is market equilibrium in crypto terms?

Equilibrium simply means that the supply matches the demand and vice versa. Whenever there is an imbalance between supply and demand, the market is in a disequilibrium stage and market forces drive prices to achieve equilibrium again. 

In reality, markets are never completely in equilibrium. Whenever there is a substantial degree of market stability, volatility is eliminated, and the market moves toward an equilibrium.  

Crypto markets are young markets. Basically, they are further from the notion of equilibrium when compared to some long-standing markets. As a market known for its volatility, it is not yet stable enough to achieve total balance. 

What is Volatility?

As you can, DeFi and CeFi share many similarities, at least when it comes to explaining concepts within the financial system. Financial applications and digital assets of the DeFi ecosystem are considered riskier, which brings us to a term often associated with the crypto industry - volatility.

Basically, it is a statistical measure of the dispersion of returns for a given asset. Dispersion is usually used to measure the degree of uncertainty and risk associated with a particular asset. 

In the stock market, when it rises and falls more than 1% over a determined period of time, it is known as a volatile market. The more volatile an asset is, the riskier it is considered to be used as an investment.  

As a novel asset class, crypto assets are considered to be volatile, along with the potential for severe upward and downward movements over time. Therefore, when we say that the crypto market is highly volatile, it means that it encompasses high risks. 

Moving in cycles: centralised finance

A market cycle can be defined as an economic trend observed within divergent businesses. It is also known as the stock market cycle where it is observed how a particular class of assets performs with more efficiency than others. Usually, it is because certain market conditions have a better growth prospect, along with taking into account the business model assets run on. 

It is almost impossible to accurately state which market cycle is currently going on since the beginning and the end are usually not able to be concisely defined. New cycles can be formed due to a new technological innovation entering the market or when a change in regulations disrupts existing trends. 

However, cycles can be determined in retrospect. The beginning and the end of one cycle generally come down to the period between the highest and lowest price of a common benchmark. 

Expert investors in the industry tend to identify upcoming shifts to determine the direction of a market cycle ahead of time to make profitable trades. In most cases, this is known as speculation. 

Phases of a market cycle (CeFi)

A market cycle has 4 phases. All markets go through the same phases that are cyclical– they rise, peak, dip, and bottom out. When one phase is over, the next one instantly begins. 

a. Accumulation phase

After the market was at the bottom, early adopters and bold investors began to trade. The overall market sentiment is still a bit bearish, but most investors think that the bad days are over. 

The accumulation phase is associated with flattened prices and market trends that are switching from negative to neutral. 

b. Mark-up phase

After being stable for some time, the market is moving higher. Now more people acknowledge that the market direction and sentiment have changed. In a fear of being left out in terms of financial gains, more investors are jumping on the bandwagon. 

More investments influence the market volume that begins to increase. However, the economic theory of the greater fool jumps in as well, taking into account that valuations are climbing beyond norms. At the end of this phase, the market sentiment moves from neutral to bullish.

c. Distribution phase

In the third phase of the market cycle, sellers are dominating. The bullish market sentiment is switching to a mixed one and prices generally remain locked in a particular trading range. 

The distribution phase can be a quick one – once it is over, the market changes direction again. It is associated with a mixture of investors’ fear and greed as the good times may be over soon.  

The transition to the last phase can happen fast if triggered by a negative economic or political event.  

d. Mark-down phase

The last phase is the one everyone feared. It is a bad stage for investors that still hold positions as investments have fallen below what they paid for them.  

Since this is the fourth phase, it also represents a sign that the accumulation phase is coming next in which other investors will buy the depreciated investments.  

Moving in circles: decentralised finance

Market circles are natural occurrences that take part in every market. The crypto market is no exception. Keeping track of ups and down can help many users on the crypto market to participate in a more informed manner.

As any other market, the crypto market is affected by general things such as supply and demand, business performance data, geopolitical sentiment and technical indicators. However, there are some unique features that affect the crypto environment. For example, we are talking about Bitcoin halving, correlation and social media influencers. Just remember what happened after Elon Musk's tweets.

Phases of a market cycle (DeFi)

Let's examine how crypto markets correspond to each phase.

a. Accumulation phase

Similar to CeFi, the market volume and interest are lower than average and the situation is calming down after the previous phase ended. Prices are flattening, but the market sentiment is still dominated by uncertainty. 

Taking into account the market circle, either CeFi or DeFi, is partially linked to the psychology of market participants, their actions and sentiment go hand in hand with the economic situation. In this phase most market actors are scared to enter the market, while early adopters and bold investors are stepping in.  

b. Mark-Up phase

The crypto market is now moving higher in price with new participants entering. Demands for assets are starting to outweigh the supply, adding up to price appreciation. Usually, all-time highs happen during this cycle on the crypto market.

A positive market sentiment dominates the market. Any dips in this phase are considered as a signal to trade, rather than a sign to be cautious. Keep in mind that not all assets perform well in this phase; similar to CeFi, some assets respond better to current economic conditions than others. 

It is important to be informed enough when this phase comes up. If you are interested in finding out more about crypto trading, we suggest reading this article: ‘How to earn crypto’.

c. Distribution phase

Now that the bull has been running for some time, more sellers are stepping in, creating an equilibrium of buyers and sellers in the crypto market. 

The market sentiment is coloured by confidence, greed, and a small fraction of uncertainty. The greed index serves as a common indicator used by analysts to measure change. 

Knowing that the bearish period is near, some traders may begin liquidating their position to prepare for the final stage.  

d. Mark-Down phase

The bear market is here; at the beginning, the supply exceeds the demand and the market sentiment is full of anxiety. Fear amounts to an increased selling pressure that causes a high volume price decline and overall downtrend chart. 

This phase is still a favourable one for speculation since short sellers can gain from the market downtrend if they play their cards right. Other participants are becoming very cautious to avoid losses. When this phase ends, we are back to the first phase. 

How does DeFi differ from CeFi in terms of market phases?

While DeFi and CeFi share common principles, it is logical that DeFi would show off unique traits. The supercycle concept is unique to the crypto environment and cannot be found within CeFi. 

As a bullish run, it would amount to crypto increasing in volume over an extended period, gaining mass adoption similar to the emergence of the Internet.

Basically, it refers to a potential expansion of prices on the entire crypto market when blockchain technology nears massive adoption. The supercycle notion is still more theoretical than practical, along with not being well defined by clear parameters.

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