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Crypto currency and herding behaviour

Crypto currencies refuse to play by the rules. People rely on experts for all sorts of advice,
but when it comes to cryptocurrencies, they seek advice from peers and the internet.
So, what causes this behaviour and what are the implications? Hint: it’s rooted in
behavioural psychology.

By Udette Kirsch, behavioural economist and strategic marketing specialist
ecent studies suggest that crypto currency investors rely less on expert advice and increasingly
Rfollow peer investor communities for guidance.
The daily value of South African crypto trading recently exceeded $141 million for the first time,
indicating that many South Africans consider the risks of this complex, unregulated market to be
acceptable for the returns which it may deliver.
Digital advocates have hailed crypto currencies as the “new gang on the block, who refuse to play
along with the traditional rules of engagement”.
For the first time, investors feel “freed” from the constraints of financial regulations and can find
their own “facts”.
Given that many people find block chain technology difficult to understand and struggle to
explain the excessive volatility in the crypto markets, it is interesting that they rely mainly on online
sources, such as social media and social news aggregation websites, to shape their crypto currency
investment strategies.
The abundance of information from like-minded investors has heralded an era of information-
enabled investors. For the first time, the early adopters of block chain technology and crypto currency
understood the underlying opportunities and trends better than their knowledgeable financial advisors.
Its value, in essence, is determined by its unique characteristics and similar opinions. Udette Kirsch
One of the foundations of behavioural economics is the principle that under conditions of
uncertainty, complexity and time pressure, people tend to revert to cognitive shortcuts or mental about $4 billion worth of coins.
biases. Although one could argue that the
This, and the growth in popularity of crypto currencies, plus an abundance of available digital revolution has brought a new
information, is driven by something called the network effect. This implies that the more people who level of empowerment to consumers, it
participate, the higher the crypto value becomes. seems that it has also intensified people’s
The second factor that plays a role in shaping the price of crypto currency is called social judgement biases.
judgement. This theory states that you accept or reject a statement on your cognitive map. Having There are no real reference points to
already been primed to the opportunity of crypto currency by the network effect, “whales” – early determine the value of crypto currencies,
adopters in the crypto world – who have amassed vast crypto investments, have the power to and therefore the pricing mechanisms are
artificially create exaggerated price swings or speculative bubbles. ‘Crypto celebrities’ make a driven mainly by collective evaluation of the
proclamation, and vast numbers of followers follow suit. buyers and sellers.
This sort of volatility concerns institutional financial minds and scares some investors off but People tend to jump on the
equally attracts large volumes of new trade after some off-the-cuff announcements on social bandwagon and mimic the behaviour of
media platforms. others, often on the basis of anecdotal
evidence of success stories on social media,
Fertile soil and the herd that follows it without fully appreciating that the human
The market for crypto currencies seems to provide fertile soil for investor biases to steer decision- tendency is to herd under conditions of
making. An obvious example would be the bandwagon effect whereby investors buy cryptos primarily optimism or positive news, creating market
because others are doing it, regardless of their convictions, which they often override or ignore. bubbles and crashes.
A study by Calderon (2018) confirms that crypto investors display herding behaviour when There is, admittedly, a range of examples
navigating crypto market ambiguity. Investors tend to hold on to their cryptos, even in highly negative in the traditional financial markets where
conditions, partly explaining the weak link between information and market outcomes. This is typical herding behaviour also drives the decisions
herd behaviour. of many investors. The difference though,
as many South Africans now can attest, is
The downside of herds the inherent risk of an unregulated, complex
The flipside of the potential gains to be made from crypto coins is the tendency for herd behaviour market where “coin-diggers” – those
to create opportunities for exploitation. South African crypto investors had to stomach two of the wishing to make a quick buck – can, and do,
largest crypto scams in the world this year. In January, Mirror Trading International disappeared with capitalise on the flaws in human decision-
about 23,000 digital coins, valued at $1.2 billion and in April, Africrypt allegedly absconded with making behaviour.

EngineerIT | November 2021 | 44