Do you want to buy cryptos?

In recent years, the cryptocurrency fever has been increasing. Many articles have focused -naturally- on the financial aspect, giving advice on when is the best time to acquire or sell cryptocurrencies in order to make a profit. However, in the present article, the author analyzes the purchase of cryptocurrencies from the behavioral approachl[1] describing which are the cognitive biases that influence the purchase. The article will be organized in two installments. In this first, the biases that determine the acquisition of cryptocurrencies as bitcoins and / or ethers will be exposed for the first time, while in the second the biases present will be exposed once the acquisition is made.

Erik Finman is a young American who, when he was only 12 years old, made a decision that would change his life forever. In the 2011 year, Erik received from his grandmother 1,000 American dollars to invest in their education. However, instead of investing in books, he opted to buy bitcoins, which by then his value did not exceed 50 US dollars for each bitcoin.

What happened with Erik Finman seems obvious. He became one of the many millionaires who decided to buy bitcoins in their first years of appearance. Today, despite having lost faith in Bitcoin[2], benefits from that youthful outburst that led him to bet all the money that his grandmother gave him for a technological innovation that, at that time, was mostly used in black markets operated in the Deep web[3].

After reading these initial paragraphs, surely it has come to mind "what luck that guy's " and the second thing that will come will be "Now is a good opportunity to invest in cryptocurrencies?" For those who have read or heard these stories of crypto-millionaires "overnight," surely they have been moderately aware of the price of bitcoins and popular popular cryptocurrencies, for example, the ethers of the Etherum protocol.

The answer to this question does not have anyone. The only true-basic rule-for all those who invest in cryptocurrencies, not trading, but simply storing cryptocurrencies until they expect their price to rise (the famous "hodlers"[4]) is "cheap buying and selling expensive".

The technology behind Bitcoin and Etherum (and other crypto-projects) is innovative and disruptive, not for nothing big companies are behind these projects to take advantage of this technology in their internal processes and offer products and services[5]. However, most people see these digital currencies only as a means to make a lot of money.

It is not the first time that people suffer from this speculative "fever". Already in the seventeenth century the "Tulipomania" was lived in the Netherlands. What was it about? The Dutch were amazed by the tulip bulbs that had been brought from Turkey, then Ottoman Empire, especially because it turned out that the Dutch lands were suitable for the flowering of this plant, which was in different colors.

This new exotic product was coveted by the high Dutch class of that time, which in a short time became a symbol of wealth. The growing demand for tulips caused the price of this plant to skyrocket, turning many into millionaires by selling their tulip bulbs at an excessively expensive price.

Why did the Dutch become interested in tulips? A mixture of economic bonanza and an interest without equal by the exotic thing could have been the factors that unchained this financial bubble; However, if we dig a little deeper we can appreciate that we are facing cognitive biases.

The Dutch saw in the sale of tulip bulbs a quick way to earn a lot of money, as many people see in cryptocurrencies as a quick way to get rich[6]. The interesting thing about this is that many of these (unsophisticated) investors pretend to make money without even having any basic knowledge of investment strategies or investment portfolio management, but simply follow what most people do, Under the premise "If it worked for him why would not it work for me?"

This is a cognitive bias known as Herding o herd behavior, which refers to acting based on the action of the other; that is, I decide to invest because another has invested before me, then, I imitate it. This cognitive bias is very common in financial markets and even more so among unsophisticated investors who usually make investment decisions based only on the recommendations of another; for example, by signals (signals)[7].

A fundamental reason for Herding in the cryptocurrency market is due to the lack of reliable information. It is very common that people who wish to acquire a certain cryptocurrency -possibly, in the best case- have visited a few websites and seen some forums (eg Reddit or Bitcoin forum) to decide whether or not to buy cryptocurrencies.

From that moment, a series of cognitive biases enter the scene. Once you have visited some pages on topics such as "Should I buy cryptocurrencies now?", "How much is the estimated value of bitcoin by the end of the year?", you will find that there are gurus who will advise that "Now is the appropriate time to buy bitcoins, since the price has gone down and, according to my technical analysis (or simply because I did well before), I KNOW we will soon enter an upward trend (bull market)."

The gurus in the cryptocurrency market are over, they are from those known in the world tech as it is John McAfee (yes, the same antivirus), who predicts that a bitcoin will be worth 1 million US dollars in 2020, as the aforementioned crypto-millionaires[8].

It is very certain that, given the lack of knowledge and hyping at the moment, the interested buyer decides to invest based on what one of these gurus says; we will then face the bias of obedience to authority (authority bias). This bias is quite simple and we observe it in many areas (religion, work, school, etc.). In this case, the interested investor will buy cryptocurrencies just because a guru (the authority) indicated in their social networks that it is the right time to buy, for example, bitcoins.

Once we have read a sufficient amount of web pages about cryptocurrencies, as well as having researched about the bios and tweets recent of different gurus, surely we will decide to buy a few cryptocurrencies with the determination to become in a few months in crypto-millionaires. We will be convinced that NOW IS THE TIME.

Then surely we will enter one of the exchanges of known cryptocurrencies, such as Coinmama.com, and we will buy our first cryptocurrencies with our credit card[9]. We will verify, after a few minutes, that the purchased amount is now registered in our cryptocurrency wallet; then, we only have to wait and wait until the value of our cryptocurrencies increases at stratospheric prices.

Two cognitive biases are present once we decide to buy, as we are sure that now is the perfect time to do so. The first is the superconfidence effect bias (overconfidence effect) and the second is the optimistic bias (optimism bias).

As identified by Kahneman and Riepe (1998), these two cognitive biases are common in investment decisions. In this case, after reading several pages that we describe as "high quality" we will feel quite confident to buy the first cryptocurrencies; It is not necessary to consult with specialists, but it is enough with my analysis of all the information gathered to make the right decision.

Finally, the last bias present in the cryptocurrency purchase operation is optimism, a very important component to decide to buy; this is, "Others will have lost money because of bad decisions, I have made a good decision and I can only wait until (one day) my cryptocurrencies are valued enough to sell and make me a millionaire." While optimism lasts, there will be no problems.

We have identified four cognitive biases present in those unsophisticated investors (which are the majority) of cryptocurrencies: herding, authority bias, overconfidence effect y optimism bias. I am aware that we can face other additional biases, however, these are some of the most important ones.

Now that we know that our cryptocurrency investment decisions are based on biases, it remains to be defined if there are also biases present in the sale of cryptocurrencies; that is, the biases related to the dilemma of continuing to keep my cryptocurrencies waiting for them to appreciate in time or sell them now that I have won a little or I have not lost much. This will be the subject of development of the second installment. Do not miss it.

*Originally published in www.enfoquederecho.com, in the PsychoLAWgy column.


PAGE NOTES:

[1] This article takes as a starting point the biases described by Patrick Oberstadt in a brief but quite enlightening article. However, what is written here will develop other biases present in the investment decisions in the cryptocurrency market of those mentioned by said author. You can see here the article mentioned: https://medium.com/crobox/6-psychological-biases-youll-experience-when-it-comes-to-trading-cryptocurrency-8c7490086774

[2] Despite having been a staunch supporter of Bitcoin for the last few years, in a recent interview, clearly affected by the bad year in the prices of cryptocurrencies, he said that "Bitcoin is dead in the long term". For more information see: https://es.cointelegraph.com/news/teen-bitcoin-millionaire-erik-finman-proclaims-bitcoin-is-dead-long-term

[3] The best known case was the drug and weapons marketplace that operated on the Deep web whose name was Silk Road. Its founder Ross Ulbricht, known as Dread Pirate Roberts, was arrested by the FBI and is currently in jail. The purchase in this marketplace was done with bitcoins. For more information see: https://www.forbes.com/sites/andygreenberg/2013/08/14/meet-the-dread-pirate-roberts-the-man-behind-booming-black-market-drug-website-silk-road/#1c2e4d788b73

[4] It is said that hodlers to those investors who buy cryptocurrencies and keep them waiting for them to appreciate and then sell them and generate profits. This word, together with Hodl, arose because of a "typing error" of a user in the Bitcoin Forum forum; that is, hodl would be the word hold of the English language.

[5] For example, in the case of Etherum there is the Enterprise Etherum Alliance, which is made up of more than 380 members, among which are Microsoft, Banco BBVA and T-Mobile. For more information see: https://entethalliance.org/members/

[6] This is due to the volatility of digital currencies, with bitcoins being the paradigmatic case. For example, in early February of 2017 a bitcoin cost around 1,000 US dollars, if a person bought 10 bitcoins at that price, for the 17 of December of the same year their bitcoins would be worth in total 200,000 approximately US $ 1,000.

[7] Signal service is very common in the forex and cryptocurrency markets. This service consists of a trader experienced (or on some occasions a muzzle) sends signals for the investor to place the purchase or sale order on the platforms or exchanges of cryptocurrencies, such as Bitfinex. The problem with this service is that it promotes poorly informed investment decisions and only based on the technical analysis of another, which in many cases can fail. For more information about the signal service: https://www.babypips.com/learn/forex/signal-services

[8] I have to make a disclaimer. I do not intend to point out that there are not traders or serious gurus, who are really promoting the use of cryptocurrencies or performing analysis of this market in a professional manner (eg Andreas Antonopoulos); However, with the help of social networks, today there are many pseudo gurus or traders that do not contribute to the development of this market, but that often influence people to distrust technology.

[9] Many people usually buy cryptocurrencies with credit cards. Watch: https://www.bloomberg.com/news/articles/2018-01-11/bitcoin-buyers-turn-to-credit-cards-as-fomo-breeds-risk-taking


BIBLIOGRAPHY:

Publications:

BALCILAR, Mehmet; Riza DEMIRER and Shawkat Hammoudeh. (2012) Investor Herds and Regime-Switching: Evidence from Gulf Arab Stock Markets. Taken from: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2147709 Visited the January 10 of 2019.

CIALDINI, Robert B. Influence: The Psychology of Persuasion. Harper Collins e-books. 2006.

KAHNEMAN, Daniel and Mark W. RIEPE. (1998) Aspects of Investor Psychology: Beliefs, preferences and biases investment advisors should know. In: Journal of Portfolio Management, Vol 24, No. 4 pp. 52-65.

POYSER CALDERON, Obryan. (2018) Herding behavior in cryptocurrency markets. Taken from: https://arxiv.org/pdf/1806.11348.pdf Visited the January 10 of 2019.

SALEH, Mohamad. (2018) Cryptonomics: Investment behavior in the cryptocurrency market. Taken from: https://www.academia.edu/37876981/Work_in_Progress-_Cryptonomics_Investment_behaviour_in_the_cryptocurrency_market

Post of blogs:

HOCHMA, Tomer. The Ultimate List of Cognitive Biases: Why Humans Make Irrational Decisions. Taken from: https://humanhow.com/en/list-of-cognitive-biases-with-examples/Visited the January 19 of 2019.

BABYPIPS. Forex Signals. Taken from: https://www.babypips.com/learn/forex/signal-services Visited the January 19 of 2019.

LEINZ, Kailey. (2018) People Desperate to Buy Bitcoin Are Paying with Credit Cards.Taken from: https://www.bloomberg.com/news/articles/2018-01-11/bitcoin-buyers-turn-to-credit-cards-as-fomo-breeds-risk-taking

OBERSTADT, Patrick. (2017) 6 Psychological Biases you'll experience when it comes to trading Cryptocurrency. Taken from https://medium.com/crobox/6-psychological-biases-youll-experience-when-it-comes-to-trading-cryptocurrency-8c7490086774 Visited the January 10 of 2019.

REZAIEZADEH, Siamac. (2017) The Authority Bias - Cognitive Bias Review Part VII. Taken from: https://smallbusinessforum.co/the-authority-bias-cognitive-bias-review-part-vii-5266ef075800 Visited the January 20 of 2019.

Press articles:

GREENE, Tristan. (2018) Erik Finman is a Bitcoin millionaire: Now what? Taken from: https://thenextweb.com/hardfork/2018/08/14/erik-finman-is-a-bitcoin-millionaire-now-what/ Visited the January 08 of 2019.

GREENBERG, Andy. (2013) Meet The Dread Pirate Roberts, The Man Behind Blooming Black Drug Drug Website Silk Road. Taken from https://www.forbes.com/sites/andygreenberg/2013/08/14/meet-the-dread-pirate-roberts-the-man-behind-booming-black-market-drug-website-silk-road/#da463318b735 Visited the January 11 of 2019.

HULLIET, Marie. (2018) Erik Finman, Bitcoin teen millionaire proclaims that Bitcoin is "dead" in the long term. Taken from https://es.cointelegraph.com/news/teen-bitcoin-millionaire-erik-finman-proclaims-bitcoin-is-dead-long-term. Visited the January 10 of 2019.

WALL, Jeremy. (2018) McAfee Stands By $ 1 Million Bitcoin Price Prediction By 2020. Taken from: https://www.investinblockchain.com/mcafee-bitcoin-price-prediction/ Visited the January 20 of 2019.

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Adolfo Morán
Adolfo is Founder and Executive Director of Lawgic Tec, a nonprofit association dedicated to research on issues of law and new technologies. General Editor of The Crypto Legal web platform and Legal Consultant in the Financial Regulation and FinTech area of ​​EY Law. He specializes in Blockchain, Smart contracts and Fintech. Email: contacto@lawgictec.org

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