It’s official: Bitcoin has reached mainstream consciousness that even the man on the street talks about it. Most people call it an investment, some call it speculative, and others consider it a gamble. What is it, really?
To answer this, we need to understand why people put money in an endeavor, may it be a business, stocks, or
cryptocurrency, on the expectation of obtaining additional income or profit. Behavioral finance sheds light on how people behave in these situations. There are two major attributes that determine a person’s behavior when it comes to this.
The first is knowledge, that is, how well informed the person is or how he or she is misinformed about an investment or a potential source of income. This is a continuum – from total ignorance to completely knowledgeable.
The second is risk appetite and tolerance, which defines the amount of risk a person is willing to take to pursue the objective of making a profit or earning an income. This is also a continuum – from total certainty to extreme uncertainty.
There are four behaviors with different levels of knowledge and risk appetite combinations:
Well-informed investing. This is characterized by moderate to high knowledge, and low to moderate risk appetite. Warren Buffet defines an investment as “one where you look to the asset itself to determine your decision to lay out some money now, to get some more money back later on.” This can apply to stocks, bonds, real estate and commodities. The holding time horizon is usually long term. Expertise in investing is gained through learning and experience.
Speculating. Investopedia defines this as “conducting a financial transaction that has a significant risk of losing most or all of the initial outlay with the expectation of a substantial gain.” Speculators are forever trying to be smarter than the market, which means they hoard and consume a lot of information. They focuses more on the action rather than the asset, such as speculating on whether quarterly earnings are going up, or a commodity will double its price in several months.
Gambling. This is a combination of low to moderate knowledge and extremely high risk. Buffet said that gamblers are “encouraged when they see some successes around.” But it “has terrible odds attached.” Gamblers lose more when they erroneously assume that the more they lose now, the better the chances of winning in the future; hence they make more bets.
Ill-informed and misinformed investing. This is characterized by low to moderate knowledge and low- to high-risk investing. These people put money in certain investments with sure or safe returns such as time deposits and mutual funds. Due to lack of knowledge, they also invest in high-risk stocks and other investments because of the bandwagon or herding effect. They follow their friends, popular hearsay and early successful investors.
Gambling and ill-informed/misinformed investing belong to the zone of behavior anomalies where people make decisions based on biases, herd behavior and the gambler’s fallacy. This is because of the lack of knowledge of these individuals.
Going back to bitcoin, where are you in these four types of individuals? The late majority investing in it now are the ones driving up its price. They are those who follow the bandwagon, with limited information and taking a high level of risk.
Some of those playing with bitcoin are astute speculators that are well-versed in cryptocurrency and its workings. There are a few others who place big bets in bitcoin but with limited knowledge on how it works. The true, well-informed investors in bitcoin are those that are part of its early start – those that built on it as a medium of exchange, using applications that facilitate its exchange.
Is it wise to invest in bitcoin? The answer is no. It’s never an investment in the first place. Just like rare baseball cards or Beanie Babies, bitcoin is being driven to absurd prices by speculators, misinformed investors, and even gamblers who think they could sell them to someone else for more money in the future.
Just this Monday, over $60 billion value was wiped off cryptocurrencies as bitcoin dropped below $8,000 again. Speculation, misinformation, lack of information and gambling are all driving down the price.
It’s always best to strive to acquire knowledge when placing money in an endeavor or investment.
The author is the president of Hungry Workhorse Consultancy, a digital and culture transformation consultancy, and co-founder and counsellor of Caucus Inc., a data privacy consulting firm. He teaches strategic management in the MBA Program of De La Salle University. He is also an adjunct faculty of the Asian Institute of Management. Email at firstname.lastname@example.org.