What Is Narrative Trading in Crypto?
Trading Analysis

What Is Narrative Trading in Crypto?

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Created 8mo ago, last updated 8mo ago

A look at the role of narratives in crypto, how whales trade narratives and how to be early to one.

What Is Narrative Trading in Crypto?

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​​In the ever-evolving world of cryptocurrencies, narratives play a pivotal role in shaping the market landscape and influencing investor behavior.

While sentiment and technical analysis can provide valuable insights, it is the underlying narratives that drive changes in the cryptocurrency market, and fuel the growth of the best-performing projects and assets.

By captivating the imagination of developers, traders and the community, narratives can lead to long-term change in the market. As such, an understanding of how narratives are shaped, propagated and acted upon help savvy investors secure a strong position for themselves.

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What Are Cryptocurrency Market Narratives?

As a relatively nascent industry, the cryptocurrency market remains driven by so-called “narratives,” which are underlying reasons or catalysts behind how the market moves and reacts over time.

They are the underlying stories that highlight the value propositions, use cases and potential impact of specific cryptocurrencies. For instance, this year we saw the rise of layer-2 scaling solution Arbitrum, liquid staking derivatives (LSDs), China narrative, AI tokens and more. Narratives become a crucial lens through which investors evaluate opportunities and risks.

There could be multiple market narratives operating at once, and the broad response to these narratives by traders, institutions and regulators leads to changes in the supply and demand mechanics of the various different cryptocurrency assets.

Narratives can be negative or positive, with negative narratives often leading to price suppression and a general market sell-off, while positive narratives can lead to accumulation and growth.

Privacy coins are an example of a negative narrative, where the widespread belief of a looming regulatory crackdown alongside dwindling CEX support has crushed investment in these coins — despite their supposed benefits.
In contrast, the launch of ChatGPT and other AI tools saw many AI-related tokens appreciate in value — this is an example of a positive narrative.

Market narratives don’t just impact the day-to-day value and trading volume of related cryptocurrencies, but also their long-term prospects. This, because particularly positive or negative narratives can change developer interest and early-stage funding in the cryptocurrency space.

Narratives can be long-standing and pervasive, or remarkably short-term, fizzling out in just days or weeks. Besides the virality of the general theme, several external factors can impact how pervasive and long-lasting a narrative is — including regulatory pressure, technological development, media coverage and potential impact.

How Do Narratives Form?

Different narratives can form in the cryptocurrency market based on a variety of factors, including market sentiment, news and events, investor behavior, and the underlying technology of different cryptocurrencies.

One factor that can shape the narrative of a particular cryptocurrency is its perceived utility and potential for widespread adoption. For example, cryptocurrencies that are designed for specific use cases or have partnerships with established companies may be viewed more favorably by investors and analysts, leading to a positive narrative. This could be fueled by the backdrop of a bull market.
Conversely, negative narratives can form when the risk surrounding a particular cryptocurrency or digital asset class increases — such as due to regulatory crackdown, general poor performance, vulnerabilities, or obsolescence. This could be exacerbated by bear market conditions.

Narratives in the Previous Bull Market

Typically, each market cycle is dominated by a handful of narratives. The projects covered by these narratives tend to outperform the market average, and some can go on to define a new sector of the blockchain industry.

Some of the most prominent narratives of the previous cycle include:

Ethereum Killers

Ethereum alternatives and so-called “killers” were an enduring narrative in the previous bull run.
As the capabilities of the Ethereum blockchain were stretched to their limits and fees were sent soaring, a slew of alternative layer-1s (L1s), such as Solana, Terra (now TerraClassic), Avalanche, Fantom and more rose to prominence and began to establish ecosystems of their own.
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Many of these went on to develop thriving ecosystems formed of products that leverage the unique properties of the underlying L1. Proponents of the narrative believed that one or more of these L1s would eventually supplant Ethereum as the most popular smart contract platform and DeFi ecosystem — but this hasn’t yet held true.

X-to-Earn

In the previous bull market, hundreds of projects launched and promised to use blockchain technology to better reward users through revenue sharing and emission-based incentive models.

Broadly described as “X-to-Earn,” these projects leveraged a variety of token-based reward mechanisms to drive growth, retain users and incentivize stakeholders.

The play-to-earn (P2E) model was by far the most popular, with platforms like Axie Infinity, Illuvium, and My Neighbor Alice giving players the opportunity to earn potentially lucrative rewards for their in-game performance.
This was followed by the move-to-earn (M2E) model, which was used by a wide array of DApps to reward users with digital assets for staying active. Binance-backed STEPN became the best-known M2E platform, followed by smaller platforms like Sweat Economy, MoveZ, and Genopets.
These platforms sometimes offered generous rewards to early adopters, but often fizzled out over time due to mercenary behavior and excess token inflation.

Metaverse

In the previous cycle, a huge amount of hype developed around the metaverse — an interconnected landscape of virtual worlds and platforms that players could cohabit, explore, co-create, and in some cases, monetize.

The blockchain metaverse narrative began in December 2020, with the launch of Decentraland — the first player-owned and developed, blockchain-enabled metaverse. A further wave of growth was then catalyzed following the launch of The Sandbox in November 2021.
Both Decentraland and the Sandbox grew to achieve a multi-billion dollar market capitalization, and helped spawn dozens of other metaverse platforms, like Highstreet, XANA, and Yuga Labs’ ApeCoin.

In October 2021, Facebook rebranded to Meta as part of a push to become a leader in the development of the metaverse. Just a month later, Microsoft acquired AltspaceVR in a bid to gain a foothold in the booming metaverse market.

However, many metaverse platforms remain limited in their usability and capabilities, resulting in low user engagement — a challenge that remains today.

Recent Narratives

Though the industry is still reeling from a bear market, a handful of narratives has led to spots of outperformance in the market since the start of 2023.

These narratives currently include:

Artificial Intelligence

Thanks to the massive success of OpenAI’s ChatGPT and related large language models (LLMs), interest surrounding the capabilities of artificial intelligence has skyrocketed in recent months.

This had a major spillover effect, leading to renewed interest in existing AI-enabled blockchain projects like Render Token (RNDR), SingularityNet (AGIX) and Fetch.ai (FET) — all of which recorded triple-digit percentage growth since the start of 2023.

It also fueled the dramatic expansion of the blockchain/AI sector, with dozens of projects now exploring the intersection of the two technologies. Some of the most recent include ChainGPT, LayerAI, and BitTensor.

Memes

Most recently, the cryptocurrency market saw a clear wave of hype surrounding meme coins, driven by the largely unexpected success of Pepe.

In under a month, Pepe evolved from an obscure meme coin to a top 40 cryptocurrency with an all-time high (ATH) market cap of $1.6 billion — and listings on several prominent exchange platforms. The market cap currently stands around $500M.

Driven by a sizable community, general hysteria and irrational exuberance, Pepe became the fastest-growing meme coin of all time and catalyzed renewed interest in community coins and tokens with little-to-no utility.

In the last three months, hundreds of meme coins have launched, most of which were crafted in absurdity and quickly fell into obscurity. A tiny fraction, however, managed to generate momentum.

Liquid Staking Derivatives (LSDs)

Liquid staking derivatives (LSDs) began to explode in popularity in early 2021, as people began to explore ways to maximize the capital efficiency of their staked ETH on the beacon chain, which could not be withdrawn then.

Liquid Staking platforms provide users with LSD tokens by staking their ETH tokens with the associated protocol. These tokens represent their share of the supply staked with the protocol and can be in DeFi — such as lending, trading and yield farming.

Between January 2022 and May 2023, the total value locked (TVL) in liquid staking protocols grew fourteen-fold, increasing from $1 billion to over $14 billion. This came on the back of the Merge and Shapella upgrade. Meanwhile, the tokens associated with early movers like Lido (LDO) and Rocketpool (RPL) recently achieved their all-time highest market capitalization.
Next-generation LSD platforms, including diversified proof-of-stake L1 Tenet, and restaking platform EigenLayer, are now in development — potentially helping to fuel the LSD narrative further.

How To Identify Narratives Early

When it comes to trading narratives, being early is paramount. Today, there are several platforms that allow users to easily spot and track high-performing wallets, such as those associated with VC funds, individual whales and well-known traders — these are generally known as “smart money trackers” or some derivation.

These platforms can reveal traders that move early on narratives and manage to capitalize on them. They can also be used to gauge when a narrative might be running out of steam — signaling an early opportunity to exit related positions.

Click here for a more detailed look at how you might get started spotting emerging crypto unicorns.

Another important factor is to seek to identify the underlying narratives that drive how the market evolves and partially determine the assets that perform well.

Those familiar with general macroeconomic theory may have heard, "A rising tide lifts all boats.” Applied to the blockchain space, this means a strong narrative lifts all (or most) of the projects that fit within it.

Because of this, investors can use the prevailing narrative to narrow down potentially undervalued projects or even spot the next crypto unicorn.

Narratives can form in different ways and some are clearer than others. Because of this, it’s important to have a broad understanding of the cryptocurrency market, the technology sector, and current macroeconomic events to help you more easily identify emerging themes that others might miss.

Nonetheless, there are some simple tips you can use to give you a better chance of spotting narratives early. These include:

1. Identify problem solvers: Projects that solve long-standing or prominent problems in the blockchain space or related industries can fuel new waves of innovation. They can also go on to become a first mover in a broader narrative.
2. Stay up-to-date on news: By staying up-to-date with the latest news, you can grow your awareness of the space to help you tease out the broader picture.
3. Follow the money: Smart money such as VCs, prominent traders and institutions often identify narratives earlier than most. By tracking recent VC investments and project funding rounds, you can see where the smart money believes growth is likely.
4. Attend conferences: In some cases, new technologies, projects and opportunities are revealed first at crypto events, such as conferences, expos and developer events.
5. Grow your network: Many successful traders take advantage of the massive information asymmetry that exists in the blockchain space. By building a high-quality network, you increase your chances of hearing something relevant through the grapevine.
6. Leverage on-chain data: For the more data-oriented, on-chain data and analytics can provide a treasure trove of information that can be assimilated to identify emerging themes. This can include data from block explorers, price trackers and sentiment analysis platforms.

How Do Whales Trade Narratives?

The ability to spot a current or emerging narrative is only part of the challenge traders are faced with. What to do when a narrative has been identified is arguably even more tricky.

Generally, successful narrative traders will use some variation of the strategy outlined below to maximize their profitability and manage their risks.

Step 1: Predicting Narratives

The first step involves predicting emerging narratives.

Some VCs and institutional investors are noted for capturing narratives early. Such as the venture arm of Animoca Brands, which was one of the first VCs to capitalize on the Play-to-Earn narrative, or Binance Labs, which invested in many of today’s most prominent layer-1 projects in their early funding rounds.

This requires staying informed about technological advancements, societal trends and changes in investor sentiment.

Step 2: Research and Analysis

Once a potential narrative is identified, it's crucial to perform comprehensive research and analysis.

This might involve identifying high-potential projects related to the narrative and understanding their key features to assess whether they stand a chance at achieving growth.

Step 3: Managing Risk

Once promising projects have been identified, it’s then important to evaluate their short and long-term potential, their risk factors, and how they fit into the overall trading portfolio.

Risk management strategies such as diversification, stop losses, and careful position sizing should be employed to minimize risk.

Step 4: Entering Positions and Maximizing Yields

After assessing potential and risk, traders should strategically enter positions to maximize yields. This could involve laddering buys to get a good average entry price or timing purchases to coincide with market trends.

The savviest investors will typically look to maximize their yields where possible, using a combination of the numerous DeFi and CeFi platforms to earn a further return on their assets — such as through staking or liquidity provision.

Step 5: Defining and Applying the Exit Strategy

A well-defined exit strategy is critical. This might involve setting price targets, using trailing stop losses, or planning to hold until certain project milestones are reached.

As narratives evolve, traders should be ready to adjust their exit strategy, always ensuring it aligns with the overall risk tolerance and investment goals. Most traders will use a combination of automatic alerts and manual reviews to keep their positions in check.

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