Bitcoin Trends and Expectations: The Art of Behavioral Finance
Opinion Analysis by Siriine ElKhalili, Contributor
February 15th, 2021
Bitcoin has experienced immense pricing movements over the years, with it being a highly volatile and risky instrument, it was either scaling up on large percentage points or significantly crashing in short periods of time.
Several theories have emerged regarding the causation of the bitcoin peak in 2017, in which the currency jumped from less than $1,000 in January to greater than $19,000 in December. According to the MIT Technology Review, that price spike was due to a single holder with a large account called a “whale” who may have committed market manipulation. “This pattern is only present in periods following the printing of Tether, driven by the single large account holder, and not observed by other exchanges”.
On the 15th of November in 2018, a Bitcoin Civil War was unleashed in which there was a conflict between the developers. Amaury Séchet, Bitcoin Cash (BCH) developer, was pushing for an upgrade to modify the blockchain ordering transactions. This led to a rift that was tense enough to split bitcoin cash into 2 versions: Bitcoin Adjustable Blocksize Cap (ABC) and Bitcoin Satoshi’s Vision (SV). Both versions fought to take over ownership of the BCH symbol. Without delving into the details, the conflict resulted in a “harsh war” leading to a halt of several exchanges. Bitcoin hit the floor, going below $4,000 by the end of 2018.
When the coronavirus transformed markets and economies worldwide, its impact on the well-known cryptocurrency did not go unnoticed. Analysts concluded that the pandemic motivated investors to consider the long-term outlook of bitcoin and other cryptocurrencies, which led to their large increase in value. COVID-19 was a catalyst to the digital transformation of various companies, which caused high expectations to rise in a digital currency.
Elon Musk, Tesla Chief Executive, recently backed bitcoin by stating that “bitcoin is a good thing” and that he was “late for the party” in the comments of a broadcast on Clubhouse. After Musk added #bitcoin on his Twitter bio, the value of the currency surged over $38,000 from an initial $30,000 per bitcoin.
The Bitcoin price history since November 2012 - Source: www.etero.com
The Bitcoin phenomenon could be one of the most substantial behavioral events since the birth of behavioral sciences and their application in financial markets. Therefore, it is suggested that the prices of cryptocurrencies are driven by herding behavior.
Behavioral Finance aims to explain why investors act the way they do through introducing cognitive biases that impact their behavior. Cryptocurrency investors have minimal prior knowledge as well as scarce resources for information processing. Consequently, they depend on the sources of others to evaluate these currencies, which can cause unanticipated results.
A “new economy” will remain a fascination for profit-seeking individuals that perceive bitcoin as a foolproof investment. Hence, when price increases a bulk of investors are attracted to “jumping into bandwagon” to easily generate profit without even acknowledging how bitcoin and cryptocurrencies work, but rather immensely aware of the opportunity cost of not pitching in. This enthusiasm is also promoted by media outlets, so a rise in pricing leads to further bid-ups, making cryptocurrency valuation a self-fulfilling prophecy. In this situation, bitcoin experiences the criteria of a bubble, but then again it is rather not possible to foresee when it will ensue.
Economist John Maynard Keynes (1936) described the stock market as a beauty contest where judges would pick what they perceived other judges would choose as most beautiful, “each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligence to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.” The metaphor can be applied to the cryptocurrency market in regard to determination of price and on choice of investment. The perception of the compliance degree within the community is not a simple task due to experienced users exploiting ignorant or curious users in various situations.
Herbert Simons, a well-known economist, introduced the bounded rationality concept in 1982, where humans tend to take “shortcuts” that could cause suboptimal results. There are various behavioral biases called heuristics, which can be modified by market participants as well as various signals and noise. Relevant examples of heuristics include overconfidence and optimism, social judgement, and salience. It is proven that irrational investors create a deviation from fundamentals, therefore the lack of a value parameter in bitcoin issues a unique puzzle.
Investors commonly stray from the “rational asset pricing benchmark” and opt for the “consensus in market stress situations”. Thus, to invest in bitcoin do not play the odds, play the man.
Sources:
https://www.etoro.com/markets/btc/stats
https://www.technologyreview.com/2019/11/04/132066/one-bitcoin-whale-may-have-fueled-the-currencys-price-spike-in-2017/#:~:text=A%20single%20Bitcoin%20holder%E2%80%94called,more%20than%20%2419%2C000%20in%20December.
https://www.fintechfutures.com/2018/11/bitcoin-cash-hard-fork-creates-civil-war/