by Eloisa Marchesoni
With this article, I would like to add a behavioral dimension to the current and seemingly never-ending discussion on Bitcoin, raising awareness on the behavioral impact on financial markets.
In fact, it is almost impossible for some not to be fascinated by the Bitcoin phenomenon, which could be considered among the most significant behavioral event to occur since the emergence of behavioral science and its application to financial markets (which the world is only now beginning to comprehend). Among other things, we are witnessing herding, fear of regret, speculation, envy, and anti-establishment sentiment on a grand scale.
Adopters are placing faith and trust in Bitcoin, as much as it represents a radically new concept. Viewed through a behavioral lens, Bitcoin comes into focus not only as an entirely new concept with unique characteristics, but as an item that has a different identity and appeal to different people. We know that people use cognitive shortcuts to simplify their purchase or investment decisions, often reducing the decision to perhaps only one or two key criteria or rationales. We can take these key purchase rationales and define arbitrary market segments around them. While this represents an oversimplification of the market, it can be very useful for establishing a high-level view of the key psychographic variables at work.
Importantly, there are new behavioral factors inherent to this phenomenon that transcend finance and economics, and which bear serious consideration. Bitcoin was conceived for clearly stated goals that seek to remedy global problems such as inflated fiat currencies, mistrust of some financial institutions, high payment transaction fees, and the impracticalities of using gold as an international store of value. These are unique rationales that add an important social component – a statement that we have been witnessing more and more often through populist events around the planet and in elections in several countries. Many appear to demonstrate mistrust and frustration regarding the actions and policies of some governments and large financial institutions. Thus, for some people, purchasing Bitcoin may feel like donating to a political cause, with the only difference that, in this case, their money is not just helping the message to be spread among the masses, but to actually fund the program.
Bitcoin has also been regarded as a possible replacement for gold as a long-term store of value. In fact, Bitcoin is experiencing a speculative rush, much like the California gold rush of 1848. This introduces a behavioral group interested almost solely in making fast money. A few years ago, Bitcoin was just seen as an interesting experiment that few took seriously, except for the usefulness of the underlying blockchain technology. Around June 2017, when the price broke out of a long slow multi-year trend to go parabolic, Bitcoin seemed to have reached a tipping point, which was probably caused, or at least enhanced, by the addition of this speculation group, animated by an unrestrained herd instinct. It is also this group who is likely adding the most to price volatility, though this will stop as the Bitcoin exchanges become more efficient and the professional market makers enter the fray.
Despite Bitcoin’s meteoric rise, it has also fallen 75 to 80 percent on five separate occasions. This serves as a reminder: whenever you’re feeling too excited about an investment, it’s always worth taking a step back to consider the potential downsides. Individual investors are seduced by what are oftentimes rare success stories. As with public equities, we should keep a level head and think about risk.
I, myself, even if I am an expert in the field, choose not to run my own money because I know I’m subject to all the same inconsistencies and emotional drivers as the anyone else. I have read from a recent study that people who receive financial advice see a 3 percent higher performance in their portfolios, compared to those who don’t, and about half of that premium comes from behavioral coaching from an asset manager. Seeking financial and investment advice from a professional can be useful before making significant decisions.
Finally, you can always find new cryptocurrencies which you may think could be able to replicate the incredible performance of Bitcoin, although it is now more complicated than ever. This is due to the fact that, nowadays, there are thousands of cryptocurrencies to choose from and, for new digital coins, the so-called “fundamentals”, parameters which would normally allow to define their potential market price. That said, there still are some rules of behavioral finance and technical analysis that can be of precious help for those who want to invest in the newest cryptocurrencies, but extreme caution must always be a prerequisite. Investing on assets that leverage on ruthless advertising promotion rather than on fundamentals is a risky game, sometimes leading to big losses.