Bitcoin and the Bandwagon

The Hutch Report

Bitcoin and the blockchain have been around since 2008 when the elusive Satoshi Nakamoto presented his/her white-paper to the world outlining its structure. Since its core is based on cryptography and mathematics, in the beginning it only attracted the attention of those in that area of research. However, because it was proposing a new medium of exchange that could not be altered and promised anonymity, the dark side of commerce quickly joined in. From here, the value of Bitcoin has begun to increase, as has the attention. After 9 years in existence, the mainstream media has begun to chime in and before you know it, Bitcoin charts and quotes have been all over the news.

The other day, my father-in-law asked me if I heard about the action in Bitcoin. He used the term as loosely as he would “Google search,” however I knew that his understanding of what Bitcoin actually was, was severely limited. My neighbor stopped to chat and told me her son (15 years old) was having a friend over. I said, “To watch a movie?” and she told me, “No, to trade Bitcoin.” She had provided her son with a few hundred dollars to trade! Last night I was in a restaurant in town that I know very well. It is a small place with the tiniest kitchen. I popped my head in to say hello to the chef. The first thing he said to me was, “Hey, did you buy any Bitcoin lately?” At that moment I realized the wagon was getting very full.

The chance that people begin to adopt certain ideas or choices tends to increase when they realize that other people have adopted similar ideas and choices. This is a human cognitive bias known as the “Bandwagon Effect.”

In 1848, Dan Rice, at the time a famous and popular circus clown, decided to use his bandwagon (a wagon that carried a band during parades) and its music to gain attention for his political campaign appearances. His campaign became more and more successful and this obviously attracted the attention of other politicians who fought for a seat on the bandwagon, hoping to be associated with his success. Bandwagons eventually became a standard centrepiece in political campaigns and the phrase “jump on the bandwagon” was born.

It is a powerful principle that is used constantly in marketing. The concept describes how the increasing popularity of a product or phenomenon will encourage more people to “jump on the bandwagon.” We see it everywhere. #America’s No 1 choice, #the fastest selling product, #most wished for, #most gifted or the myriad of top 10 lists that we see everyday.

The tendency to follow the actions or beliefs of others occurs because individuals directly prefer to conform, or because individuals derive information from others. Normally, when an individual makes a “rational choice” (see our article on the Rational Price here), it is based on the information they compile from various sources with which to come to a decision. However, as information cascades, or when people start passing on information they assume to be true, but cannot know to be true, based on information on what other users are doing, they will ignore their personal information signals and follow the behaviour of others.

The phenonmenon of Bitcoin and cryptocurrencies does not stop with the bandwagon effect. The speed at which it is moving, where fortunes are being made and lost in the most unlikely areas of society has stirred a variety of other cognitive biases into action.

Closely related to the bandwagon effect, and becoming clearly evident in the cryptocurrency mania, is the “fear of missing out” or FOMO. The fear of missing out is a type of motivation that is described as a drive not to miss current or future opportunities. It’s associated with a fear of missing chances for competitive advantage, rewarding experiences or financial opportunity gains. It is considered a common and strong form of motivation that can explain a wide range of human behaviors. However, as with other similar biases,  the fear of missing out can result in excessive or compulsive behaviour and poor decisions.

Robert Cialdini, author of the widely popular Influence: The Psychology Of Persuasion, popularized the term “Social Proof.” The Social Proof Theory, affirms that a person who does not know what the proper behavior for a certain situation is, will look to other people to imitate what they are doing and to provide guidance for his actions. Uncertainty is the fuel that activates and feeds the mechanisms of social proof. This is especially fitting in the case of cryptocurrencies, as the technology and mathematics behind them is not so simple for the average person to immediately grasp. Therefore, social proof becomes more influential when the surrounding people are perceived as particularly knowledgeable about a situation or are even just slightly more familiar with the situation than the observer is.

As the price of Bitcoin and a thousand other cryptocurrencies have risen to lofty levels, so has the debate around what cryptocurrencies respresent.  Are they a medium of exchange? Do they have true value? Do you have to pay taxes on gains? Are they something else other than a tool for speculation? This debate has come to just about every financial media news outlet; CNBC, FOX, Bloomberg or CNN Money where they present daily their panels of financial experts. So where better to gain an understanding about cryptocurrencies.

The trap that many viewers are falling into is known as the “Authority Bias.” The Authority Bias is a where you defer to any position of authority to either dismiss or confirm evidence. The thought process follows the following reasoning pattern: Person X is an authority in a particular field. Person X says something about a  topic in their respective field. Person X is probably correct because they’re an expert. Because of this reasoning, the Authority Bias maintains that if you don’t know something better yourself you will likely trust the advice or information from someone who is considered an expert in that field.

The Hutch Report has been following Bitcoin and other cryptocurrencies for a while now. We recently completed our current feature report related to Gold Backed Cryptocurrencies, which can be downloaded here. We don’t profess to be experts regarding this technology but we do follow it with interest. We believe that, although a large number of opinions exist about where all these cryptocurrencies will be in the future, nobody really knows. Nobody is even certain about true identity of the originator, Satoshi Nakamoto.

We are currently living in unchartered territory so it is up to each individual to protect themselves, keep their bias in check. Don’t blindly follow and do your best to inform yourselves.