The Behavioral Heuristics of Crypto Investors

Behavioral biases can skew investors’ choices towards making less optimal and rational decisions. Some choices are overconfidence, the disposition effect, and representativeness bias. These are some of the  jargon in behavioral finance but I will simplify them further.

Let’s talk about  them one by one:

Representativeness bias

It describes making misjudgments based on how historical price has done of crypto. The overwhelming optimistic sentiments of most cryptocurrency investors is that the winners will always remain winners and losers will always lose due to the indicated volatility. This belief comes from the one-directional and upwards trend line. It is often found that an individual draws inferences from the new information without checking whether that is true or false. One also does not include sample sizes or see whether the data presented to them has a relevant sample. This behavior is consistent with the confirmation bias and increases the tendency of the investors to overreact or underreact as per the info. Representativeness can also be described as” forming patterns on a stormy rain”.

Overconfidence bias:

At some point in our life, we all feel overconfident about a task and fail in carrying it out. In the crypto market, sometimes individuals perceive their  investment skills are better, however this euphoric feeling often turns them out to be a losers.They tend to make riskier investments, especially after achieving some success. An increase in overconfidence can also be attributed to the rise in the trade volume of their assets

Overconfidence mainly occurs due to two key/basic things as follows:

1: Self-attribution: It is the tendency to credit oneself for success and bad luck for failure.

In the crypto market, males are especially more overconfident and that is one of the primary/fundamental reasons why women  typically deliver much better returns.

2. Hindsight bias:This is the next reason for overconfidence. It is the natural phenomenon or tendency of believing that a given event could have been accurately predicted than they effectively were. It is just that they misremember the information. Sometimes this causes overoptimism and leads to losses.

The Disposition effect 

It describes the tendency to hold on to a losing asset for too long. There is hope inside the investors that they can resell their holdings on an upswing. This makes them miss out on various opportunities that come at lower prices at that point. This disposition effect is not only limited to inexperienced traders but also highly experienced ones .

One can also see the effect when an investor sells its winning asset sooner than the losers. Once an investor realizes this asset is going to be profitable, they sell it as soon as possible. This effect can be seen on both sides as well. Sometimes investors tend to hold on to their investment in light of the uncertainty whether it is profitable or not.
There is a saying among cryptocurrency traders:” Hold On To Dear Life,” which means holding one asset even on the downtrend.

Trading Crypto Bots And Investors

Cryptocurrency can be divided into mainly four categories
1) Wallets
2) Payment service providers
3) Mining
4) Exchange

One can also add digital management services to it. These are some of the  main things which define crypto and its behavior. 

Let’s look at how the trading bots and the exchanges impact the behavior of an investor.

A crypto exchange is open 24*7 if not on maintenance. It  provides its users with facilities  irrespective of their geographical location. The behavior around the exchange sometimes changes with global events. For example, banks in Chile shut down due to their association with the crypto exchange. Similarly, other countries followed the suit.. One can find that these events influence the thinking of investors in a particular region.

Trading bots can also influence the behavior of investors. If you observe the data, there is a 30% chance in the buy-intervention group. Additionally, the study found over a 7% average rise in the total purchase after a bot purchase. (The sample of the study is not quite large compared to today’s user base and volume).

The other factors that may have been in effect are the peer influence and increased early adoption of the new cryptocurrency in the hope that it may rise to a new high.

The Media Effect And How To Determine The Sentiment

Some studies consider the use of media and news sentiment and overnight returns as proxy measures of investor sentiment to be inadequate. 

Sentiment (j,t)= sum( past return (j,t-n))/N

J = CRYPTO currency, n= number of days, N=THE formation period ( The time taken for the sentiment to build up)

This formula was used in the early days to determine the sentiment created by the news and how does the cryptocurrency return drops or spike

One can also use 

𝐵𝑇𝐶 = 𝑇/ 𝑘 × R

Where BTC is one bitcoin, T is an average amount of transactions, k is a “coefficient”, which captures the miners’ reward per one block and R is the average revenue per transaction. This simple decomposition defines the rational and less rational components of Bitcoins valuation. The T/k ratio (average number of transactions per block) represents the rational component. It reflects Bitcoin fundamentals – the supply and demand relationship within the Bitcoin virtual economy.

Where BTC is one bitcoin, T is an average amount of transactions, k is a “coefficient”, which captures the miners’ reward per one block and R is the average revenue per transaction. This simple decomposition defines the rational and less rational components of Bitcoins valuation. The T/k ratio (average number of transactions per block) represents the rational component. It reflects Bitcoin fundamentals – the supply and demand relationship within the Bitcoin virtual economy.

Note: One can find more about the sentiment analysis by Jarsalov Bukanovia in his research paper on sentiment and Bitcoin Volatility

These are some of the methods to calculate the Sentiment of the cryptocurrency. There are some more complex methods through which you can get greater accuracy of the sentiment in crypto.

Conclusion

The development of blockchain technology and cryptocurrency has made people invest in them. The behavior of an investor is determined by various factors including the price change and past performance and the peer influence. The sentiment towards particular crypto has also been researched by various analysts and has seen a vast development.

If one should invest in crypto, then they should be careful about their investment based on certain behaviour.