Behavioral economics explores the intersection of psychology and economic decision-making. It highlights cognitive biases, emotional influences, and social dynamics that shape individuals' actions. Insights from this field have been widely applied to traditional finance. Unknown to many, behavioral economics can also shed light on the cryptocurrency market.
The market's decentralized nature makes it suitable to view through a behavioral lens, given that highly emotional—sometimes irrational—decisions usually drive crypto's rapid price swings and speculative investments. Institutions, governance, and regulatory frameworks curb irrationality in traditional finance—something the crypto market is still developing. The latter operates without centralized oversight, leaving it vulnerable to behavioral biases.
Without regulatory guardrails, social media, collective sentiment, and psychological triggers like fear and greed sway the crypto market. Nokkvi Dan Ellidason, the Chief Financial Officer of GAIMIN, a technology company that utilizes blockchain technology, believes that applying behavioral economic theories in this chaotic, largely unregulated environment, where emotions and groupthink sometimes overtake rational analysis, is beneficial in empowering investors to make more informed, strategic choices.
Ellidason's academic and professional background equips him with a unique perspective on cryptocurrency's complexities. He holds a bachelor's degree in Applied Mathematics and a minor in Statistics from Háskóli Íslands, as well as a master's in Statistics and Data Science from Yale University. The mathematician, relatively new to the crypto world, approaches the space with excitement and caution, motivated by his keen interest in the technology behind digital assets.
The data expert highlights that, alongside mathematical analytics, there are key psychological forces that drive the behavior of crypto investors and shape the behavioral cryptonomics landscape, with distrust of traditional financial institutions and systems being the first. The creation of Bitcoin, the first and most widely recognized cryptocurrency, demonstrated that there can be a financial system outside the control of centralized institutions.
In fact, the first Bitcoin block (Genesis Block) referenced a somewhat cryptic headline that insinuated the failings of banks due to the bailouts at the time. This instance created an "us vs. them" mentality that nurtured a sense of community among crypto enthusiasts. Economic crises helped deepen this synergy.
The scarcity of cryptocurrencies is another psychological driver. Most cryptos have a fixed supply, which creates a sense of urgency. For instance, Bitcoin has a cap of 21 million coins. This scarcity feeds into the fear of missing out (FOMO). Investors fear they might miss out on securing a finite asset, and this usually leads them to buy impulsively, even with inflated prices.
Lastly, blockchain technology promises massive potential. Its future appeal lies in possible applications in fields besides finance, such as healthcare, supply chains, and governance. The possibility of widespread adoption entices investors to invest in future tech transformation. Ellidason cautions that this can lead to speculative investment behavior, such as the dot.com bubble in 2000.
Besides these psychological drivers, the CFO explores behavioral economic theories to understand better the behavior of crypto investors. Ellidason points to herd behavior, which is evident in crypto markets. Investors rely on platforms like Reddit, Telegram, and X to guide their decisions and are quickly swayed by crypto influencers or key opinion leaders (KOLs). Scarcity and FOMO only intensify herd behavior, leading to volatile market swings.
Overconfidence bias is also prevalent in the crypto market. Many investors believe they have an edge in predicting price movements. This can be a problem if overconfident traders take excessive risks, disregarding market warnings and trends. The lack of regulatory oversight emboldens this behavior.
The third theory is anchoring. Investors usually fixate on certain price points and use them as reference points regardless of whether market conditions change or not. They tend to hold through price dips or cling to past highs, making them miss opportunities. All these partly explain phenomena occurring in the crypto space, from rapid price surges to speculative trading. Still, it's worth noting that the absence of established regulations in crypto has exacerbated bad actors playing on the irrational behavior seen in markets.
"Historically, the market has been easily manipulated where bad actors have taken advantage of channels like social media where FOMO and distrust thrive, adding to the problem," Ellidason states. "Basically, this 'us vs. them' environment is ideal for manipulation."
Given this landscape, the CFO recommends that investors remain vigilant of manipulation tactics. He advises: "Treat certain crypto investments, especially investments in meme coins, like betting in a casino. The objective is not to be left holding worthless assets. Be mindful of projects that polarize groups or play psychological appeals. If you recognize these biases you can avoid deciding impulsively in the face of hype."
Ellidason also suggests approaching the crypto-invest market for what it is—a risky asset—and advises looking to utilize diversification when it comes to building a portfolio, like more traditional streams such as stocks, bonds, and commodities. Diversifying a portfolio across different assets helps investors avoid the pitfalls of overconfidence and anchoring. Investors must also analyze the underlying technology, utility, team, and development progress of the companies and projects they venture into.
The decentralized, speculative world of crypto offers unique opportunities and risks, making it a suitable field for applying behavioral economics. Nokkvi Dan Ellidason shares his insights on the significance of understanding how psychological drivers, biases, and the lack of governance impact the space, empowering them to make more informed, rational decisions in an unpredictable market.
