Why You’re More Likely to Invest in Crypto Than Stocks: The Psychology of Crypto Investing
When it comes to investing, there are a lot of factors that go into the decision-making process. One of the most important is psychology: what drives people to invest in certain things? In this article, we will explore why people are drawn to these digital assets, and what drives them to hold or sell them. If you’re thinking about investing in crypto, it’s important to understand the psychological factors at play!
Momentum and social media
Momentum is the upwards and downwards trends in price movement observed in the crypto markets. Sharp rises or drops in prices can usually be traced to the spread of good or bad news on social media platforms such as Twitter or Facebook which can drive behaviours.
Celebrity comments, particularly on social platforms, can feed into hypes or fears around cryptocurrencies and the technologies they rest on. For example, Bitcoin’s price slide after Elon Musk posted a tweet suggesting he’s “fallen out of love with the world’s top cryptocurrency”, or Dogecoin’s price mooning after Musk and other celebrities appeared to back the crypto currency on twitter.
Research also suggests that people have a heightened tendency to become more risk-seeking in these kinds of investments when people discuss their investments in online spaces.
Herding behaviour and FOMO/FUD
When a celebrity or public figure expresses sentiment towards anything really, it can lead to herding behaviour. In crypto, FOMO and FUD are both forms of herding behaviour — when masses lean into, or give credit to, a particular or individual sentiment of a particular cryptocurrency.
You may have heard the term FOMO before, it is a ‘fear of missing out’ on something. It describes the situation in which a person experiences anxiety, feeling as though they may miss out on something great that is happening. FUD or ‘fear, uncertainty and doubt’, is a propaganda tactic to negatively influence public perception. In crypto, spreading FUD means to spread negative, dubious or false information, generally evoking fear and uncertainty around the topic.
Herding is a psychology that causes delayed overreaction in the sphere of momentum. When there is a strong uptrend of a crypto token, it is common for a surge in the price of that market as everyone jumps on the wagon. When this price spike is visible and so are the success stories of those investing, it results in more people investing which pushes the price higher and higher. Investors fear they will miss out on profit and so they buy in on the action too.
Similarly, and in reverse, when there is a negative sentiment towards a particular cryptocurrency, it causes doubt in the price of the asset and people are more likely to rush sell their shares. The sudden drop in the market price due to everyone selling can result in lowered confidence in the market.
Excitement and volatility
Volatility is not generally recognised as having positive association, but it is one of the very things that makes the crypto market so exciting! Smart investors, like Kevin O’Leary and Jim Cramer, have likened bitcoin to Vegas, in that it offers a similar thrill to gambling.
Checking the price of stocks regularly can be boring and monotonous but with crypto, it is far more exciting as there is always something happening on the market, according to Tom Meyvis, professor of marketing at New York University’s Leonard N. Stern School of Business. He explained “with something like bitcoin… you can check it 10 times a day and the price can vary wildly.”
Additionally, younger generations, who have grown alongside social media, are more likely drawn to high-risk-high-reward investments like cryptocurrencies due to social conditioning to want instant gratification and fast-paced cycles. This can be observed in almost every facet of a young person’s life, whether it’s fast-food, fast-fashion or even shorter song lengths. So, it’s not surprising Gen Z and millennials account for the vast majority of crypto buyers.
Identity and culture
Our culture and identity are psychologically fundamental for our mental growth and wellbeing. It’s also what allows us to connect with and understand each other as a species.
Finn Breton stated the “culture around bitcoin is part of the appeal” — and it’s true! For many people buying crypto is also buying into a scene that can become part of your identity. Crypto comes with its own jargon like ‘HODL’ and ‘MOON’ which creates a culture around the new digital assets. There is even a preferred car, the Lambo — Lamborghini — associated with crypto success!
The culture that surrounds crypto is unique and often linked with revolutionary and forward-thinking ideas which makes it that much more alluring.
Provides hope
Blockchain and the cryptocurrencies that rest on it are a novel technology that allow us to envision the future — and a better one at that! It is a technology that promises decentralization; in other words, more control over our data, finances and ultimately lives. It’s not simply a financial shift, it is a movement. People want to be part of a story, and part of change that can convey a value system to the outside world.
The technology also brings financial advantages such as faster transactions, lower transaction fees and less intermediaries to take a greedy cut of your funds. Considering the current economic climate, especially since COVID-19 and the rise of inflation and financial insecurity, crypto and blockchain can represent a refreshingly hopeful financial future for many people. The idea of a system that doesn’t rely on banks or government during a time that global sentiment towards government competency leans towards resentment, can be extremely attractive.
The disposition effect and prospect theory
We like to believe as humans that we can make rational choices. However, data from behavioural finance has suggested that we are likely overconfident in this belief, as we are liable to make decisions rooted in various biases.
The disposition effect explains the phenomenon in which investors will sell profitable investments early and hold poor investments for longer. It illustrates the initial underreaction of prices preluding the start of a price momentum.
The prospect theory highlights the psychology behind the disposition effect and states that “investors value gains and losses differently, placing more weight on perceived gains versus perceived losses. An investor presented with a choice, both equal, will choose the one presented in terms of potential gains”. Put simply, investors prefer to recognise their gains early but are reluctant to accept or acknowledge their losses. This is because we tend to be more open to experiencing the joy of a win than the pain of a loss.
In terms of crypto investments, it means you will find many people will HODL (Hold On for Dear Life) to their crypto when the price of an asset is going down, opposed to when the price is going up.
Confirmatory bias
Confirmatory bias is a concept that refers to the idea that people tend to believe an idea first, and then seek information or data that validates and supports that belief. How is does this relate to people buying, holding or selling crypto? Confirmatory bias accounts for why investors may sometimes view recent price movements as predictors of future price movements.
Although rooted in different reasons, the effect is akin to the ‘Hot hand fallacy’ where a person is likely to believe more strongly in the probability of something happening based on it having happened before and based on a small sample. Investors are more likely to buy tokens that have been recently profitable and sell tokens that have had recent price drops and can result in a self-fulfilling prophecy.
Conclusion
It’s important to be aware of your own behavioural biases when investing in crypto, or any asset for that matter. Doing so can help you make more informed investment choices and avoid costly mistakes. Have you noticed any behavioural biases influencing your investment decisions? Let us know in the comments below.
