Behavioural Science Behind Cryptocurrency Investing
Cryptocurrencies like Bitcoin and Ethereum have experienced tremendous popularity over the past decade, enticing speculative investors with the potential for significant profits. However, the extreme volatility inherent in crypto prices also poses substantial risks that investors need to carefully consider. As cryptocurrencies become increasingly mainstream, understanding smart strategies for secure investing becomes paramount.
A recent article published by the U.S. Securities and Exchange Commission (SEC) argues that secure crypto investing is indeed possible despite common challenges like volatility (SEC.Gov, 2024). The SEC is an independent federal government regulatory agency responsible for protecting investors, maintaining fair and orderly functioning of the securities markets, and facilitating capital formation. The SEC’s approval of Bitcoin exchange-traded funds (ETFs) represents a significant milestone, effectively bridging traditional and decentralised finance realms and enhancing legitimacy. ETFs provide easier, regulated exposure to cryptocurrencies without the concerns surrounding private key security. This development is expected to increase accessibility and stability, thereby potentially calming prices. Nevertheless, active collaboration between crypto leaders, regulators, and experts remains crucial for ensuring the long-term success of cryptocurrencies.
Regulators acknowledge the risks associated with cryptocurrencies while striving to strike a balance between fostering innovation and protecting investors. The recent approval of several Bitcoin ETFs by the SEC reflects a recognition of court rulings mandating equal market access. Chair Gary Gensler emphasised the protections offered by ETFs, including disclosure requirements and exchange monitoring. However, he reiterated the speculative nature of Bitcoin and its potential for facilitating illicit financing, distinguishing it from ETFs holding assets with broader utility. While the SEC aims to maintain a neutral stance, Gensler cautioned investors to remain vigilant regarding crypto’s volatility and unlawful uses. This balanced approach signals regulators’ gradual integration of cryptocurrencies into the mainstream financial landscape while emphasising the importance of prudent investor precautions (SEC.Gov, 2024).
While ETFs offer tangible benefits, it’s important to acknowledge the inherent risks associated with cryptocurrencies. Research suggests that Bitcoin traders often exhibit greater financial risk appetite and tendencies akin to gambling compared to stock investors (Johnson et al., 2022). Moreover, crypto traders are prone to chasing losses and making emotionally-driven decisions (Almeida and Gonçalves, 2022). When faced with losses or adverse market conditions, crypto traders often display a psychological phenomenon known as loss aversion, wherein they become more risk-seeking in an attempt to recoup their losses quickly. This behaviour stems from the emotional distress associated with losses, leading traders to engage in impulsive and irrational actions in the hopes of reversing their fortunes (Nakavachara et al., 2022). Setting predefined risk limits on positions and diversifying portfolios can help mitigate emotional actions and balance out crypto’s swings (Brière et al., 2015). However, aligning with rational investing practices, another study found that traders holding Bitcoin long-term display less bias. This underscores the importance of implementing smart strategies tailored to the unique volatility of the cryptocurrency market.
Experts also recommend evaluating one’s risk appetite and investing only disposable income into cryptocurrencies given the high level of uncertainty. Opting for trusted, regulated trading platforms offers protection for new investors. Acquiring a basic understanding of cryptocurrency technology equips investors with the knowledge to avoid blind speculation. It’s advisable to assess whether cryptocurrencies align with one’s financial goals. For young investors with a higher risk appetite, a small exposure to cryptocurrencies could offer long-term growth potential. However, chasing short-term profits in unstable assets often leads to undesirable outcomes.
Understanding investor psychology is crucial when evaluating the potential and pitfalls of cryptocurrencies. Research indicates that perceptions of financial risk tolerance (FRT) and financial risk behaviour (FRB) don’t always align with actual decision-making. Despite male crypto investors often reporting a greater willingness to take risks, studies suggest minimal gender disparities in investment scenarios involving losses. This incongruity underscores a potential gap between perceived and genuine risk tolerance levels. Implementing prudent risk management strategies becomes essential to counteract excessive optimism or loss aversion among investors (Kannadhasan, 2015). It is imperative for investors to candidly assess their risk appetite and adopt measured approaches. However, it’s important to acknowledge that no strategy can completely mitigate the inherent uncertainty associated with cryptocurrencies. While risk perceptions significantly influence market participation, psychological factors alone cannot entirely mitigate volatility. Ultimately, effectively managing the risks associated with cryptocurrencies demands knowledge, discipline, and an acceptance of the remaining uncertainties.
In conclusion, cryptocurrency investing demands rigorous risk management but can serve a portfolio role for savvy investors with the right mindset. Measured allocation, secure platforms, understanding fundamentals, and avoiding emotional decisions are key best practices. While cryptocurrencies are likely to remain volatile, employing smart strategies can help navigate uncertainty. As the market continues to evolve, active collaboration between crypto leaders, regulators, and experts will be crucial to ensuring that the next chapter of cryptocurrencies benefits society. Investing wisely requires recognizing both the promise and peril of cryptocurrencies.
References
Almeida, J., & Gonçalves, T. C. (2023). A systematic literature review of investor behaviour in the cryptocurrency markets. Journal of Behavioral and Experimental Finance, 37, 100785. https://doi.org/10.1016/j.jbef.2022.100785
Brière, M., Oosterlinck, K., & Szafarz, A. (2015). Virtual currency, tangible return: Portfolio diversification with bitcoin. Journal of Asset Management, 16(6), 365–373. https://doi.org/10.1057/jam.2015.5
Johnson, B., Co, S., Sun, T., Lim, C. C., Stjepanović, D., Leung, J., Saunders, J. B., & Chan, G. C. (2022). Cryptocurrency trading and its associations with gambling and mental health: A scoping review. Addictive Behaviours, 107504.
Kannadhasan, M. (2015). Retail investors’ financial risk tolerance and their risk-taking behaviour: The role of demographics as differentiating and classifying factors. IIMB Management Review, 27(3), 175–184. https://doi.org/10.1016/j.iimb.2015.06.004
Nakavachara, V., Ratanabanchuen, R., Saengchote, K., Amonthumniyom, T., Parinyavuttichai, P., & Vinaibodee, P. (2022). Risk-Taking Behaviour During Downturn: Evidence of Loss-Chasing and Realisation Effect in the Cryptocurrency Market. https://doi.org/10.2139/ssrn.4294488
SEC.gov | Statement on the Approval of Spot Bitcoin Exchange-Traded Products. (n.d.). from https://www.sec.gov/news/statement/gensler-statement-spot-bitcoin-011023
