Do you dare to buy cryptocurrencies? – Part 2

Do you dare to buy cryptocurrencies? – Part 2


Written by: Adolfo Morán

Senior Lawyer en EY, Executive Director at Lawgic Tec and Blogger at The Crypto Legal

In this second installment, the author analyzes the cognitive biases that a cryptocurrency investor presents after acquiring his first cryptocurrencies.

Part One: https://www.changetheblock.com/do-you-dare-to-buy-cryptocurrencies-part-1/?lang=en

 

On May 22, 2010, Laszlo Hanyecz, a Bitcoin programmer and miner, published a post on BitcoiForum offering 10,000 bitcoins for two large pizzas. Several were interested in such an offer, but it was Jeremy Sturdivant, under the pseudonym Jercos, who bought two large pizzas at Papa John’s and sent them to Laszlo in exchange for the bitcoins offered. Jeremy did his life’s business.

At the time, those 10,000 bitcoins amounted to approximately 30 US dollars; however, today (February 3, 2019) is US$34,889.5 billion. In 2013, when 10,000 bitcoins amounted to nearly $6 million, The New York Times  interviewed Laszlo, who stated “at the time bitcoins had no value, so the idea of traded them for pizzas seemed incredibly great to me. No one knew they were going to be worth so  much.”

Like Laszlo, many of the  hodlers[2]  are currently unsure of what their cryptocurrencies may be worth in the future. 2018 was a year marked by the devaluation of all major cryptocurrencies[3],generating large losses to cryptocurrency investors.

Faced with this situation of uncertainty, the best option could be to wait until the value of cryptocurrencies increases again, recover the money invested and, as far as possible, make a profit; In the meantime, you could take advantage to buy more cryptocurrencies now that your prices are low.

On the contrary, other investors, tired of having seen the value of their digital assets fall days after day, will believe that the best option is to sell their cryptocurrencies immediately to recover some of the money invested. In this disjunction that hodlers have been going  through lately, due to the bear market of the cryptocurrency market, several cognitive biases are present.

Two cognitive biases are faced so you can make a decision about buying more (and waiting) or selling? The first of these is the bias known as Inaction Inertia Effect or Inaction Bias. This bias is one that appears when we feel that the opportunity to buy or invest has passed, that prices will not rise again and that it will be unlikely to generate profits. We constantly appreciate this bias in purchasing decisions in the  retailsector, where product prices can rise or fall overnight.

For example, if we are going to buy clothing from one of the big stores by department, we will surely expect to find some offer that encourages us to buy; so, if we noticed that last week the shirts we wanted were 20% off and now they’re regularly priced, we certainly don’t buy and wait for an upcoming offer or opt for other cheaper shirts.

In the case of cryptocurrencies, we might say, like Erik Finman, that Bitcoin or cryptocurrencies in general “are dead in the long run”; therefore, “the  opportunity to make us millionaires with cryptocurrencies, has already passed.” If this is what a hodler or cryptocurrency  investor thinks, it is best that you no longer invest in more cryptocurrencies and, if you think it is convenient, sell your cryptocurrencies immediately in order to recover at least some of the money invested.

However, usually this bias is countered by our ambition to become millionaires and live a life of luxuries. The bias known as FOMO  or Fear of Missing Out is one that counteracts the conservative effects of inaction bias.

The FOMO bias comes when an apparent good investment opportunity appears before us, which means that we want to invest immediately before we “miss the train”. For example, when a friend who doesmarketing networks [4] comes up to us and tells us “I’m telling you about this new business because you’re my friend and I want you to seize the opportunity (…), this is the best time to get into the net, since there aren’t many people yet, you’d be one of the first.”

This bias is very common in people who want to invest for the first time in cryptocurrencies, as in those who already have these digital assets in their possession. Especially now that we are in a bearish market for quite some time, there is greater acceptance of cryptocurrencies and by the history of bitcoins, it is likely that in a matter of days the bitcoins we keep will appreciate quickly. [5]

While FOMO bias counteracts the Inaction Inertia Effect,  it usually does so with the help of other biases that are also present: (i)  Confirmation bias and  (ii)  Sunk Cost Fallacy. These two biases are of great importance when deciding what to do with the cryptocurrencies we hold.

As we noted in the first installment, when referring to the Authority bias   and the Overconfidence effect, an unsophisticated investor will decide to invest in cryptocurrencies using only the information he finds on the Internet. In that sense, possibly the first thing an investor does before making a decision on the future of their cryptocurrencies will be to re-review the websites and comments of the gurus they consulted when they first decided to buy cryptocurrencies.

Even though it is an unconscious act, it will surely give greater value to information that indicates that bitcoins or any other cryptocurrencies you have are a good investment[6] above that which indicates otherwise[7]. Then, we will be  observing the Confirmation bias  or confirmation bias in action, the investor will confirm that he has actually made a good investment.

The last present bias we will discuss is the Sunk Cost Effect  or the sunken cost bias. Let’s imagine that we are one of those unlucky investors who decided to invest in bitcoins after December 2017, and may have bought them at a price of approximately US$10,000 perbitcoin. Today, a bitcoin is approximately 3,500 US dollars; that is, that  hodler  has lost about 65% of its investment.

However, despite losing such an initial investment, you will surely resist selling your bitcoins, due to the effect of the sunken cost bias. This bias refers to one persisting in doing some activity, even though it does not generate profits or satisfactions, for the sole reason that he believes that he has already invested a lot of time or money in that activity.

That way, someone who has invested 10,000 U.S. dollars in bitcoins will hardly want to accept that they have lost 65% of their investment or $6,500. Therefore, you will securely store your bitcoins in your wallet  and wait until you feel that the ideal time has come to sell your bitcoins at a better price.

Having read this second installment, it is surely clear to the reader that in any investment decision, especially in the cryptocurrency market, we are subject to cognitive biases that condition our decisions. The cryptocurrency market is definitely interesting, with around 10 years of existence it has evolved into an accessible, dynamic market within reach of anyone.

Finally, we are aware that we are facing more cognitive biases than the eight identified throughout the two deliveries; [9]  However, I hope that the biases explained have been able to clarify the mental processes to which any hodler or cryptocurrency investor is immersed. Investing in any market, even more so in one as volatile as cryptocurrency, requires detailed technical analysis and not letting ourselves be carried away by our biases alone. We won’t all have the same luck as Erik Finman or Jeremy Sturdivant.

*Originally published  www.enfoquederecho.com, in thePsychoLAWgy column.

PAGE NOTES:

[1] The translation is ours. You can read the interview here:  https://bits.blogs.nytimes.com/2013/12/22/disruptions-betting-on-bitcoin/

[2] The definition of  hodler  is found in the first installment of this article:  https://www.enfoquederecho.com/2019/01/27/te-animas-a-comprar-criptomonedas/

[3] For example, the value of bitcoins was reduced from 13 thousand to US$3,800 throughout the year (approximate values).

[4] I have nothing against marketing networks, I honestly believe that there are people who make a good amount of money in these business schemes. However, it must also be admitted that a lot of effort and dedication is required, which is why many do not do very well and end up retiring within a few months.

[5] We all know that the cryptocurrency market is extremely volatile, you can lose or win in just a few days. For example, between early and mid-December 2017, bitcoin increased in value by 100%, from 10 thousand to 20 thousand US dollars (approximate values).

[6] For example, John McAfee, cryptocurrency guru and cybersecurity expert, signals that a bitcoin will be worth US$1 million by 2020.

[7] For example, that Erik Finman, a young crypto-millionaire, signals  that “Bitcoin is dead in the long run” or that PayPal co-founder Bill Harris thinks Bitcoin is the biggest scam in history.

[8] Just to clarify, one can buy less than one bitcoin, these smaller values are often referred to as satoshis, with 1 BTC being 100,000,000 satoshis.

[9] For example, we can also consider the biasof the bettor’s fallacy (Gambler’s Fallacyor Monte Carlo Fallacy) and the bias of lossaversion( Loss Aversion).

Bibliography:

Publications:

ARKES, Hal R.; Yi-Han KUNG; Laura HUTZEL. (2002).  Regret, Valuation and Inaction Inertia. In: Organizational Behavior and Human Decision Processes, Vol 87, No. 2, pp. 371-385.

NICKERSON, Raymond S. (1998). Confirmation Bias: A Ubiquitous Phenomenon in Many Guises. In: Review of General Psychology, Vol 2, No. 2, pp. 175-220

PRZYBYLSKI, Andrew K.; Kou MURAYAMA; Cody R. DEHAAN; Valerie GLADWELL. (2013). Motivational, Emotional and Behavioral Correlates of Fear of Missing Out. In: Computers on Human Behavior, No. 29, pp. 1841-1848

Blog post:

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

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

Press articles:

BILTON, Nick. (2013).  Disruptions: Betting on a Coin With No Realm. In: The New York Times. Extracted from:  https://bits.blogs.nytimes.com/2013/12/22/disruptions-betting-on-bitcoin/  Visited on February 2, 2019

THE FINANCIER. (2018). Bitcoin is a fraud ‘never seen before in the world’: co-founder of PayPal. Retrieved from:  https://www.elfinanciero.com.mx/tech/el-bitcoin-es-la-mayor-estafa-en-la-historia-cofundador-de-paypal  Visited on February 2, 2019.

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

PUIGVERT, Mariano. (2016). Learn about the history of Bitcoin Pizza Day and… Good Profit! In: Cryptonews. Extracted from:  https://www.criptonoticias.com/sucesos/conozca-historia-bitcoin-pizza-day-buen-provecho/  Visited on February 2, 2019