- Bitcoin pushes powerful behavioural buttons
- This could be key to its success
- But it could also make investors overlook risks
- Loads of new idea generating data
If you find yourself increasingly excited about crypto currency Bitcoin – whether rooted in lust or loathing – then you may well be suffering from one of the most dangerous ailments known to investors: you’re human!
The rather amazing digital asset, and its remarkable performance over recent months, pushes at least three important behavioural buttons – and it pushes them hard!
Firstly, it preys on what psychologists called our availability bias. This describes how people unintentionally put more weight on what most readily comes to mind. This is influenced by things like press coverage and chats with peers, as well as how attention-grabbing an event is.
Secondly, there is what’s known as recency bias, itself related to availability bias. This describes the human mind’s habit of giving increased importance to events that have occurred recently. We’re hardwired to do this whether or not it is warranted, which often results in investors mistakenly extrapolating short-term performance into the future.
Finally, we have what brain wonks call skewness. This is the observation that people tend to over allocate to lottery-style bets; big payoffs with very low probability. The idea of a life-changing stroke of luck is just too much fun to resist. This is why bookmakers tend to make so much money from longshots as well as why people play the lottery.
Time and again these behaviours have, in general, been demonstrated to produce bad investment decisions. However, for an asset such as Bitcoin, where its value is supported by belief rather than anything truly tangible, pushing these psychological buttons may actually be key to making it mainstream. Even after its 2017/18 crash, its power to produce FOMO (fear of missing out) is outstanding.
Significantly, the backers of bitcoin during the recent price surge can no longer simply be characterised as oddball “HODLERs”.
Experienced private investors and institutions are now warming to the digital currency. Many cite its virtues as a hedge – although, it can’t harm the case that the price has once again gone “exponential” prior to softening over the last week.
In the UK, wealth preservation specialist Ruffer has been at the forefront of sensible brigade that are dipping a toe in. This week the asset manager declared that markets were “at the foothills of a long trend of institutional adoption and financialisation of bitcoin”. Surly that’s a prospect giddying enough to make all non-holders feel the ache of FOMO!
As institutions move in, another behavioural bias could be triggered: herding. This is what Bitcoin bulls are dreaming of. Not only does the herding of institutions into Bitcoin have the potential to create big price gains, it could also create legitimacy. Legitimacy would not only be bestowed by the credibility of having institutional owners, but also by the likelihood that institutional ownership would encourage more regulation. Regulation means recognition.
This is a lovely narrative, but it is far from a given. There are many factors set against Bitcoin’s mainstream adoption including; its volatility; its limited 'free float'; the environmental impact of the data processing needed to 'mine' coins and verify the blockchain; and perhaps most significantly, the willingness of governments to sanction an asset with so many anti-statist and nefarious associations.
But in all the excitement, these challenges that Bitcoin faces are so easily underplayed or even forgotten. The broad investment lesson here, which can be applied to any growth stock that pushes one's behavioural buttons: just don’t get too carried away!
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