Cryptocurrency markets are volatile, have large deviations from traditional economics and exhibit price movements that have very little resemblance to the underlying economic value of an asset or currency. Cryptocurrencies typically rise hundreds of percent in price within weeks only to cut their value by the same amount or more in the following weeks' trading. In times when the price of an asset or currency exceeds the limits of what can be logically supported by normal economic activity (often referred to as a crypto bubble), the market is frequently driven up by collective belief, speculation and unfounded optimism.
There are many reasons why markets like crypto currency experience greater volatility during bubbles than they do in more normal times, but the most important reason is what we call reflexivity in the financial markets. In the traditional view promoted by most classical economists, the price of an asset should reflect an accurate measure of the economic value of that asset at all times, however, the concept of reflexivity argues that the value of a financial instrument is generally influenced by human perception and is shaped by human behaviour and by the relationships between humans. Since crypto markets are evolving, the degree of correlation between people's belief and the price of cryptocurrency also creates a very significant force that results in more volatility in the crypto market.
This article defines how the phenomenon of market reflexivity creates more volatility in a bubble market and discusses how psychological, structural and narrative elements create cycles of boom and bust that reinforce themselves.
Defining Market Reflexivity in Depth
Market reflexivity refers to a situation where the behavior of market participants interrelates with market price.
In reflexive systems:
Investors create perceptions about an asset's value or future potential
Those beliefs then dictate the nature of various buying and selling decisions.
Price movements induced by these decisions, in turn, reshape beliefs.
This is a self-reinforcing, not one-way, causal process. With rising prices, confidence increases, while declining prices erode confidence. And oftentimes, these belief changes precede changes in actual real-world fundamentals.
Reflexivity in crypto markets is amplified because:
Future expectations dominate present utility
There is instant dissemination of information
Price action is highly observed by market participants to show some sign of legitimacy.
Price, consequently, is the input and output of belief.
Why Crypto Markets Are Particularly Reflexive
The cryptocurrency markets are more structurally disposed to reflexivity compared with most traditional asset classes.
1. Uncertain Fundamental Valuation
Unlike equities or bonds, many crypto assets do not possess any measurable cash flows. This renders valuations necessarily subjective and belief-driven.
2. Narrative-Based Adoption
Crypto adoption often relies on promises of what is to come, rather than what is, in the form of technological breakthroughs, regulatory acceptance, or mass usage.
3. Dominance by Retail Investors
Retail participants are more emotive to price action and therefore tend to enhance reflexivity.
4. Environment of Continuous Trading
With no market close, emotional momentum builds uninterrupted and volatility intensifies.
5. Influencers and Social Media
The stories spread in a viral manner, reinforcing belief cycles that impact demand and price directly.
Put these together and they create an environment where perception is the largest market driver.
The Emergence of a Crypto Bubble via Reflexivity
A cryptocurrency bubble will form when, because of an escalating price, it starts to fuel evermore optimistic expectations that are not adequately grounded.
Reflexivity’s role in crypto bubble:
Early price gains attract attention
Attention fosters belief in future value
Attract new capital
New capital fuels subsequent price rises
Price Appreciation supports the belief
Eventually, the process of valuing these assets becomes recursive because these very same assets appear valuable solely because of increasing prices.
Through this self-reinforcing process, the crypto bubble can grow rapidly while masking potential threats.
Detailed Breakdown: How Reflexivity Amplifies Volatility
Step 1: Initial Price Movement Creates Perceived Validation
Early price increases are often interpreted as confirmation that a project or asset is legitimate, innovative, or undervalued.
Step 2: Belief Accelerates Participation
As confidence grows, participation increases. New investors often enter without deep understanding, relying on price momentum as justification.
Step 3: Demand Outpaces Market Depth
Rapid inflows strain liquidity, causing prices to move sharply even with modest buying or selling pressure.
Step 4: Volatility Becomes Structural
Large price swings normalize, reinforcing speculative behavior and short-term trading.
Step 5: Sensitivity to Information Increases
Markets react disproportionately to news, rumors, or social sentiment, regardless of actual impact.
Step 6: Reflexivity Reverses Direction
When prices stall or fall, belief weakens, triggering panic selling that accelerates volatility on the downside.
This explains why crypto bubbles rarely unwind slowly.
Psychological Forces Driving Reflexive Volatility
Human psychology plays a central role in reflexive crypto markets.
Key emotional drivers include:
FOMO (Fear of Missing Out): Encourages late entry at elevated prices
Overconfidence: Leads to underestimation of downside risk
Social Proof: Validation from communities reinforces belief
Loss Aversion: Causes panic selling during downturns
Herd Behavior: Replaces independent analysis with imitation
These emotional reactions intensify feedback loops, making volatility more extreme during both expansion and collapse phases of a crypto bubble.
The Power of Narratives in Reflexive Crypto Markets
Narratives act as fuel for reflexivity.
During rising markets:
Media coverage becomes increasingly optimistic
Simplified success stories dominate discourse
Future potential is overstated
Risks are minimized or ignored
As narratives strengthen belief, belief drives prices higher. When sentiment shifts, narratives quickly turn negative, accelerating market downturns with equal force.
Pros and Cons of Market Reflexivity in Crypto
Advantages
Rapid capital formation for innovation
Increased visibility for emerging technologies
Accelerated network effects
Liquidity expansion during growth phases
Disadvantages
Valuation distortion
Excessive speculation
Heightened systemic risk
Severe market corrections
Reduced long-term investor confidence
Reflexivity is neither entirely positive nor negative—but its unmanaged effects amplify volatility in a crypto bubble.