People aren’t investing in bitcoin because it’s currency of the future – they’re simply following what everyone else is doing, just like we evolved to do
Every Wednesday, 12 million people receive Martin Lewis’s MoneySaving email. Usually it’s crammed with consumer deals and advice on bank accounts. If you want to know how to snag a bottle of prosecco for £1.50, or where the cheapest place to buy a real Christmas tree is (it’s Ikea), Lewis has got your back. But the subject line of Lewis’s last email was a little different. “Buy Bitcoin?” it says, before going on to cover more usual territory: 80 per cent off vacuum cleaners.
In just a few months, bitcoin’s public perception has gone from that of an untraceable currency loved by dark web drug dealers to a potential get-rich-quick investment opportunity that everyone has an opinion on. Suddenly, it seems, everyone and their dog is talking about investing in bitcoin.
So why are so many people getting the bitcoin bug?
The current interest in bitcoin is naturally partly fueled by the huge rise in price. Since bitcoin hit $10,000 for the first time on November 28, things have gotten a little out of hand. Over the next week it went up $12,000. The jump to $14,000 took just 23 hours. In another 15 hours it reached $16,000. To put this in perspective, it took bitcoin more than eight years to reach a value of just $2,000. Seven months later, it’s now worth more than eight times that amount. (It’s important to note, however, that the upwards trajectory hasn’t been smooth. The price has fluctuated hugely over the last week, hitting an all-time high of $17,150 before dropping down to around $16,620 at the time of writing.)
With the rising price has come rising awareness and media attention. On the day bitcoin first hit $10,000, the Financial Timesput the cryptocurrency on its front page, citing its 850 per cent increase in value since January. The $10,000 threshold doesn’t mean much in itself, says neuroeconomist Benedetto De Martino, but humans tend to place a lot of significance on certain round numbers. “We have this kind of general feeling with numbers, when you cross one threshold it starts to feel like a completely different thing,” he says.
— Sky News (@SkyNews) 27 de noviembre de 2017
By the following Friday, December 8, bitcoin was at $17,000 and the CEO of one of the largest cryptocurrency exchanges, Coinbase, published a blog post urging people to invest responsibly and warning that its website may not be able to cope with the number of people buying and selling at peak times. For a brief moment on Thursday, its app topped the App Store rankings as first-time bitcoin buyers searched for a way to get in on the action – even though plenty of economists continue to warn that the current price spike is just a bubble, and bitcoin will come tumbling down soon enough.
“The attention in the media and elsewhere that has followed the spectacular rise in prices may have led to a bandwagon or herding effect, where the belief that bitcoin’s value will continue to rise has become contagious,” says Willemien Kets, an economist at the University of Oxford.
Bitcoin as a currency
Some go back to bitcoin’s original proposition as an alternative to existing currencies as a reason for its high price, and point to a small number of merchants outside the dark web that accept bitcoin for goods and services. Bitcoin has value, they argue, because it could become widely used as an alternative to existing currency.
But Nick Chater, a professor of behavioural science at Warwick Business School, says this may be too simplistic. “These kind of big asset bubbles can often be fed by a rather shallow but superficially compelling narrative,” he says.
Ironically, bitcoin’s current boom is making it very difficult to use as a currency. Last week the online game store Steam stopped accepting bitcoin as a method of payment, citing its high transaction fees and volatility as the reasons it was no longer suitable. Since the price of bitcoin fluctuates so wildly, it can often shoot up as gamers are purchasing a game. Steam then has to refund the price difference back to the customer, each time paying transaction fees of up to $20 a time. Rising prices are good news for people who have already invested in bitcoin, but they definitely don’t mean that the cryptocurrency is coming any closer to being used in the wild.
“A major determinant of the ‘fundamental’ value of bitcoin is whether it will be widely adopted,” says Kets. “Once bitcoins become ‘too valuable’, either substitutes will be created or people will stop using it for transactions and instead will hoard it, rendering it useless as a currency.”
The real reason people are now interested in bitcoin might be much simpler: because everyone else is.
As humans, we’re easily tempted to conform to what everyone around us seems to be doing, says Peter Ayton at City, University of London. Wide media coverage can heighten the sense that we’re missing out on something that everyone else is doing, and the more we hear about something like bitcoin, the less risky it seems to us. “Simply because it’s more familiar, people are more willing to get involved,” he says.
“Humans are incredibly influenced by other people in their environment,” says De Martino. “The only reason you buy bitcoin is because you think that other people value it too.” In other words, people buying bitcoin are assuming that someone else will come along soon enough who’s willing to pay more for the same amount of the cryptocurrency. “The social phenomenon is kind of an avalanche; it’s a self-fulfilling prophecy,” he says.
Theory of Mind
Even so, only a small number of people actually end up buying cryptocurrency. De Martino co-authored a study that looked at why certain people are more likely to get involved in a bubble market while others stay away. By looking at the areas of the brain that were active while people played a trading simulation, De Martino and his team found that the parts of our brain that are responsible for evaluating other people’s thoughts and feelings are also active when we make the decision to invest in an asset that is rapidly increasing in value.
The reason for the link, De Martino says, is to do with something called theory of mind. Humans use theory of mind to try and understand what someone else is thinking and to work out what they might do in the future. This is usually a useful skill, but it seems that people with heightened sense of theory of mind are also more likely to get involved in a bubble. It might be because they’re thinking that they can second-guess what other people will do, and are getting in on the bubble in the knowledge that other people are likely to follow them, thus pushing up the price.
“You can imagine that you can overinterpret the intention of other people,” says De Martino. This could be what leads to bubbles. A bunch of people think that other people are likely to buy into a particular asset, so they try and get in there before them. Other people see this as evidence that the asset is on the up, so they also buy in, thinking that non-investors are bound to make that decision eventually anyway. Pretty soon, the value an asset can start racing upwards.
If the bitcoin bubble does come crashing down, everything you just read about is likely to happen in reverse. The herd mentality will shift from buying to selling, and people with a more heightened theory of mind will sell their bitcoin, anticipating that other people are about to do the same. But there’s no telling if, or when, the bubble will pop. “The problem with the real bubble in economics is that we just don’t know it’s a bubble until it’s crashed,” says De Martino.
Disclosure: The writer of this piece owns bitcoin worth £75 as of the time of writing. This story was commissioned and edited by a colleague with no investment in bitcoin.