Phil Glazer

@philglazer

Resistance to Cryptocurrency as Explained by Behavioral Economics

January 15th 2018

Of all the attention that cryptocurrencies have received, the most fascinating phenomenon I have witnessed in the past year has been the strong, almost visceral, negative reaction that some people have towards the technology. If nothing else, cryptocurrencies have provided food for thought on a number of topics, including what constitutes a “currency” and various psychological quirks like FOMO (fear of missing out) and loss aversion. In this piece, I will examine the response to cryptocurrency from different groups, like governments, banks, and investors, using the lens of behavioral economics, which is the study of psychology as it relates to the economic decision-making processes of individuals and institutions. This piece does not advocate for or against the adoption of cryptocurrencies or comment on recent price fluctuations.

The Biases

Humans have a well documented set of gaps in thinking that are broadly referred to as “cognitive biases,” which are a consequence of our inability to handle too much information, a need to respond quickly to our environment, and the limitations of a finite memory. Understanding these biases can sometimes help explain behavior that cannot entirely be justified rationally.

Authority bias: the tendency to attribute greater accuracy to the opinion of an authority figure (unrelated to its content) and be more influenced by that opinion.

Status quo bias: a preference for the current state of affairs. The current baseline (or status quo) is taken as a reference point, and any change from that baseline is perceived as a loss.

Loss aversion: people’s tendency to prefer avoiding losses to acquiring equivalent gains: it’s better to not lose $5 than to find $5.

Egocentric bias: the tendency to rely too heavily on one’s own perspective and/or have a higher opinion of oneself than reality.

Response From Banks

Some of the loudest critics of cryptocurrency have come from the executive ranks of the banking system, and it is understandable why: if cryptocurrencies can achieve a fraction of what has been promised then portions of the current banking system are at risk of being replaced. Cryptocurrencies would allow many transactions (payments, lending, etc.) to take place outside of the traditional banking system, representing a loss of revenue from fees for incumbents. Loss aversion comes into play as those in the banking system picture the pain of loss in being displaced and gain little in comparison from imagining the benefits that come from lower-cost banking and lending being offered at scale (even though this would be great for consumers). Additionally, authority bias is at play (or, in this case, its corollary) because a technology that some suggest to be world changing has essentially been built by an online community of software developers, some of which operate anonymously. The fact that such a meaningful innovation came from mostly outside of the network of established institutions (the bank’s engineers, university research labs, etc.) makes it more difficult to accept and evaluate by its merit.

Response From Governments

Governments are cautious about cryptocurrency because it may enable bad-actors through granting near anonymous movement of money and even potentially offers an alternative (and threat) to government issued fiat currency. Status quo bias is strongly present here, especially from the perspective of a regulator. Simply put, cryptocurrencies are a massive headache for governments and regulators because they introduce something completely new to them that is highly technical in nature. Inevitably, whenever new technology pops up, people gradually find ways to use it to do things that were never possible before and in ways that cannot always be anticipated, which means regulators must play catch up and run around putting out fires. Additionally, cryptocurrencies going mainstream in 2017 has led to numerous concerns for consumer financial protection — the projects are still highly technical in nature and volatile price swings are the market norm which means that consumers may put funds into a project without fully appreciating the risk involved. Like banks, governments also exhibit a form of authority bias (in this case, its corollary) and have a particularly hard time engaging with the quality of technology being presented because of its source.

Response from Investors

In general, many investors aren’t sure what to make of cryptocurrency. Is it a “currency”? Is it an “asset class”? Is it something else entirely? One thing that is certain for many investors (or at least the more vocal investors) is that egocentric bias is at work. Whether an investor believes that cryptocurrencies are massively undervalued relative to what influence they might have in a few years or that cryptocurrencies are unfathomably overvalued, they hold strong convictions about what is truly going on and aren’t shy about expressing these opinions. Historically, humans have been terrible at predicting the impact of new technology and cryptocurrencies may emerge as a winner or a loser, but one thing that is true is that people overestimate the certainty with which they predict how the future will play out. Realistically, the most honest opinion may be that it is too hard to know now what the impact of cryptocurrencies will be. Given how many intelligent people are working on the technology, perhaps it is best not to dismiss it at first blush and to continue rooting for technologies that offer the promise of improving our lives (which cryptocurrencies do, rampant price speculation aside).

Conclusion

Only time will tell what impact cryptocurrencies will have. If they are for real, this is just the beginning and further innovation and development can be expected to take place in the coming years. In the meantime, it may be valuable to evaluate the reactions of different groups with respect to the positions they hold and the cognitive biases that color human thinking.

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