Cryptocurrencies have recently dominated the news, whether it is Bitcoin, Litecoin, Monero or Ethereum. With astronomical value increases, our attention has been captured and our thoughts amplified of whether we are missing out on the seemingly limitless profits from the surge in prices experienced in crypto markets.
Such hot topics circulate all over our social media and not to mention the high likelihood of a friend or someone we know boasting about their crazy profits realized through their investment decisions with respect to cryptocurrencies.
Cutting Through the Noise
But how do you get away from all this noise and make a well-reasoned investment decision that is best suited to you? This article will explore the psychological factors that are involved in our “rational” or irrational decisions surrounding investment into cryptocurrencies. Behavioral economist Stephanie Bank from Evree recently shared her insights about unintended biases that we unconsciously may be victims of in our everyday lives and, most interesting, in our investment decisions.
The reports of a multitude of success stories covered in the media about those that have now become millionaires due to their fortunate investment decisions in bitcoin and other cryptocurrencies over recent years have been substantial. While such success stories are amazing, it is important to note there are fewer stories that cover the losses that have been experienced by many bitcoin adopters simply due to the complexity of unlocking their wallets or remembering their seeds, trading the markets, damage to their computers, hacks and so on.
What is Confirmation Bias?
Such positive stories surrounding bitcoin do not falsify the theory of success which leads to misconceptions, known as confirmation bias, signaling amateurs to invest in any cryptocurrency with the belief that their expected return may be similar to that of bitcoin. This dangerous way of thinking that we may be channeled into, due to the various success stories, is to believe that we have almost no chance of failing.
“Confirmation bias: The confirmation bias refers to the phenomenon of seeking selective information to support one’s own opinions or to interpret the facts in a way that suits our own worldview. Investors seek confirmation for their assumptions. They avoid critical opinions and reports, reading only those articles that put their point of view in a positive light.”
It is in our nature to leverage support and search out evidence for the beliefs we hold reaffirms our actions, and the occurrence of such behavior means, as a result, our decisions are biased without looking at alternative possibilities. A fascinating experiment conducted in 2009 at Ohio State University briefly asked their participants about their interest in politics and opinions on particular issues, before they browsed online forums with articles supporting opposing views on the issues. The findings showed participants spent 36 percent more time reading articles that supported their views.
It is no wonder that cryptocurrency investors gravitate toward information about astronomical returns on investment to validate their decisions. While simultaneously ignoring information about dramatic price fluctuations, potential criminal elements, and vulnerability to theft including the reasons many retailers and financial institutions are averse to adopting to cryptocurrencies.
No matter the situation just remember you always have a choice
Stephanie Bank, as a behavioral economist, simply explains that it is your personal decision whether you decide to invest into cryptocurrencies and provides the background knowledge into the mental processes that influences our behaviors surrounding financial technologies such as cryptocurrencies.
Additionally, the public perception of bitcoin has seen a dramatic shift from being viewed as an untraceable currency used by criminals on the Dark Net to becoming a solution to a multitude of economic and social problems and creating business opportunities. How can we forget to mention, bitcoin has been in the spotlight for creating millionaires in a matter of months; there no getting away from all this noise even if you are not very technical or financial by nature.
Bank highlights the cryptocurrency’s prevalence is chiefly linked to human psychology and less in relation to intelligence, risk tolerance or experience. Since psychology explains why we as humans behave in the way that we do given a particular situation or the way in which we process certain information.
Are you Following the Herd?
Bank predicts that due to our behavior being so profoundly influenced by psychology, our dinner party conversations are likely to consist of the following predictable pattern:
“All the smart players are getting into cryptocurrency… One of the primary reasons everyone is investing in cryptocurrency is because, well, everyone is investing in cryptocurrency!”
Such mass psychological dynamics in the patterns of collective human behavior is a result of non-rational impulses sensed by market participants in complex and uncertain situations such as the world of cryptocurrency is a part of. Psychologists refer to this phenomenon as “herding”; since individuals adopt the behaviors and beliefs of those around them in the absence of individual decision-making or thoughtfulness.
Here, we should be mindful of cryptocurrency or blockchain ‘influencers’ and look past what they say and focus on their intentions, their own confirmation biases before taking their musings seriously. Take what they say with a grain of salt, challenge their assumptions and world view internally before taking it as a definitive truth.
We all have particpated in herding at some point or another, it is usually something we do almost as if we are on autopilot. Since all around us everybody seems to be talking about cryptocurrency investments, it is bound to make us feel like this is the norm, and it is something that we should be doing (if not already).
Research shows Fear, Regret are Related to Herding
Extensive research conducted over the years by behavioral economists at the most prestigious institutions, including UCLA and Princeton, have recognized herding as a fundamental cause of the biggest financial bubbles experienced in history. During late 2017, Biriyani Associates provided an analysis confirming cryptocurrency is predicted to be one of the largest financial bubbles in human history. Adding to that, the price to earnings ratio of bitcoin amounted to four times that of dot-com stocks at their 1990s height toward the end of 2017, as documented by Bloomberg.
It is important to consider that herding does not simply occur because of an innate desire to be included into a group; but primarily driven by fear and regret, two very powerful human emotions that influence our behavior. Researchers from Stanford University, Peter DeMarzo, Ron Kaniel and Ilan Kremer in 2007 identified from their study when an asset is overpriced and predicted to burst; individuals commonly herd into risky investments due to fear of diverging from the crowd and being in a situation of watching the price to continue to rise. An insightful result recovered by the researchers is that our greatest fear in investing isn’t the risk of loss, but instead the risk that we will be worse off in comparison to everyone else. Therefore, we are more worried about being relatively poor than actually having little to no money.
It is in our nature to identify patterns and produce predictions about future events. This, in turn, frequently results in an incorrect perception of structure in random sequences and expect that the patterns will continue. This is something we may do daily, for example, if your favorite Chelsea football player scores in the last few games you have watched, you start very quickly expecting that behavior to continue.
A study conducted by Duke University revealed that people perceive patterns after a sequence repeats as little as two times and thus influencing their expectations of upcoming events. If the price of bitcoin has risen for several days/weeks in a row, we digest this information as a trend and simply assume the price rises will persist into the future and vice versa for when prices fall over several days/weeks.
The Worst Enemy of the Investor is Most Likely Themselves
The cyclical investment process, including information procurement; stock picking; and making, holding, and selling investments, followed by making a new selection, is full of pitfalls. These can come at a high price to investors. As the famous investor Benjamin Graham liked to say, “The worst enemy of the investor is most likely himself.” Purchasing investments is a rapid-fire process, and the value of these investments can decline just as rapidly.
To seriously consider investment in cryptocurrencies, the individual should be aware of their own psychology, how it can fool them, and learn how to ignore emotional impulses.