Recently Bitcoin’s whitepaper celebrated its 11th Birthday. 11 years down the line there are no solid arguments or basis to sustain what drives the cryptocurrency markets. The market is vastly driven by sentiments and why not, people haven’t seen such massively erratic volatility ever in their lives. Most of us are pulled into the cryptocurrency markets because a friend or a colleague suggested us to invest with the promise of enormous returns. In the midst of the greed of earning quick money, market stayed untouched by technicals and overdriven by sentiments because a vast majority of traders don’t have much of an idea on what they have invested in. We have all seen traders are easily overwhelmed by 20–30% green and red sticks but for usual traders, they are seeing it every week. Other than the overdriven volatility, investors are very likely prone to take poor investment decisions because of the widespread misinformation and their cognitive biases running a marathon on this data.
As Buster Benson points out in his cognitive bias cheat sheet, cognitive biases are most likely to affect your decisions when at least one of four problems exist:
- there is too much information to appropriately weigh and consider,
- the context around the issue is very confusing,
- the decision must be made quickly, and/or
- we have a limited experience with the issue/topic.
In the world of cryptocurrency, unfortunately, nearly all four of these problems are present.
- Mainstream media coverage on cryptocurrencies, particularly Bitcoin, and initial coin offerings (ICOs) has increased significantly over the past year. Small part of this section has been found to influence or manipulate the prices in the crypto markets
- The rate of ICOs have increased significantly in the past year alone across many industries. That, along with the lack of regulatory guidance, has created a bit of havoc in cryptocurrency investment. The landscape has kept the investors utterly confused and due to the failure of ICOs, investors have lost a vast sum of their investments.
- Startups conducting an ICO often structure their rounds in a way that takes advantage of the fear of missing out (FOMO) among investors, which adds urgency to investment decisions. The decisions have to be made quickly as there have been ICOs which have closed their funding rounds within 30 minutes.
- Meanwhile, ICOs are still a new fundraising method — no older than five years old, the fundraising companies as well as their team are still inexperienced with this mechanism.
The Availability Heuristic
According to the Wikipedia. ‘The availability heuristic is a mental shortcut that relies on immediate examples that come to a given person’s mind when evaluating a specific topic, concept, method or decision.’ It refers to a flawed thought process in which the more easily you remember or imagine a scenario, the higher the likelihood you assign that scenario of occurring. Unfortunately, many new cryptocurrency investors can easily recall and imagine a cryptocurrency rising in value due to the significant news coverage of Bitcoin.
Anchoring or focalism is a cognitive bias where an individual depends too heavily on an initial piece of information offered (considered to be the “anchor”) when making decisions. Anchoring occurs when, during decision making, an individual depends on an initial piece of information to make subsequent judgments. Every new (and even old) cryptocurrency trader has been a victim of anchoring bias. For the ICO investors, looking at ICO ratings on company’s websites or rating websites like ICObench and the distortion of perspective has already started. If you see an upcoming ICO with a rating of 10, it will be harder to convince you that the ICO is actually a risky investment than it would be to convince someone who never saw that rating at all. Continuous threads of a news driven by social media algorithms on trader’s smart devices collectively form an unconscious market sentiment which drives the market for a few days. Also due to high volatility, people anchor themselves to the first amount they see, and if the price goes up, they resign themselves to the sidelines because they believe they missed their chance. They find it difficult to adjust their expectations of current value despite projections of future value.
Confirmation bias is a type of cognitive bias that involves favoring information that confirms your previously existing beliefs or biases. Confirmation biases impact how we gather information, but they also influence how we interpret and recall information. Fear of loss, high volatility, negative bias, and pre-settled doubts on cryptos still drive the direction of trades of new traders. On the contrary, partnerships with an established business, comments by named personalities which could potentially see the price spike Adding to this, traders get attached to a particular cryptocurrency and imagine them as their lifelong partners. And trading is not the place where you make attachments.
The boom in initial coin offerings is a textbook example of how our emotions drive us to be overly optimistic and to become fixated on the spectacular gains made by others. Companies and designers can also appeal to our emotions and our conceptions of ourselves by appearing to adopt moral positions. This is a recipe for creating what’s called “optimism bias” because people become fixated on the spectacular gains made by others, playing into a lust for wealth. Comparing our meager incomes to these huge profits also means, deep down, we become terribly afraid of losing our chance at riches, stimulating feelings of stress and what’s known as “loss aversion”. A similar bias emerges with the optimism called as the HALO Effect. The halo effect refers to our propensity to give a significant and disproportionate amount of attention to the positive attributes of something, and overlook many negative attributes. The halo effect is often associated with our perception of other people, but it can apply to business-related considerations too. A noble and admirable cause may not result in a valuable cryptocurrency, despite what your brain tells you. There are many other factors to consider.
Definition: traders tend to be more social than individual so they rely on news and actions of other market players. We buy when others buy and sell when others sell, especially focusing on crypto influencers. The problem is that attention bias may surpass the importance of more objective stuff like chart patterns. Social judgment is intrinsic to the cryptocurrency market since the valuation of any currency is contingent on the extension of the group that finds it valuable. As with cryptocurrencies, most of the information technologies exhibit network effects or network externalities, which is also particularly strong in communication platforms.
Hence, it is advisable to traders to protect themselves from the flawed decision-making when trading.
DO YOUR HOMEWORK!!!!!!!!!
The cryptocurrency space is becoming increasingly complicated, so you must do your due diligence on every cryptocurrency you are considering. You should know what the underlying value or function of the token is. You should know about the industry, the startup, the utility of the tokens, the tokenomics, the use cases, the trends and movements of the tokens before investing. You should know the startup’s leadership team, and assess if their experience, knowledge, and skill set is likely to lead them to success.
Nov 2, 2019