Psychological truth about crypto currencies

Traditional Finance and Rational Behavior

In the world of traditional finance, there's this idea that people always act rationally. It's all about how they should act to make the most out of their money. Essentially, a "rational" person in this context is someone who can adjust their expectations based on new info, knows everything there is to know about the market, keeps up with all the latest updates, and doesn't make the same money mistakes again and again when choosing investments.

Behavioral finance came about because, well, people aren't always as rational as traditional finance assumes.

They don't stick to a consistent decision-making pattern, which kinda throws theories like Efficient Markets and Prospect Theory out the window.

Emergence of Behavioral Finance

See, in traditional finance, they picture investors as these emotionless beings, totally devoid of feelings like self-control or regret. It's all built on this assumption that humans always act rationally when it comes to money. But here's the kicker: both economics and psychology research show that people don't always behave rationally. In fact, their irrational behaviors tend to follow patterns and can be predicted. That's what shook up the world of finance.

Human Elements in Financial Choices

When it comes to understanding how people make financial decisions, behavioral finance shakes things up in the world of economics. It introduces a fresh perspective, suggesting that individuals might not always act rationally. Their behavior can vary based on different situations and environments, shedding light on the significance of emotional intelligence and various perceptions. Unlike traditional finance, behavioral finance doesn't just crunch numbers; it delves into the human psyche. This approach incorporates psychological, sociological, and anthropological factors into the mix, forming theories that go beyond mere mathematical analysis.

Limited Rationality and Objective vs. Subjective Perspectives

Factors like risks, uncertainties, asymmetric information, and psychological motivations such as the desire for status, ownership, popularity, and the tendency to follow the crowd all contribute to the diverse behaviors we observe in individuals. It's a fascinating exploration into the complexities of human decision-making in the financial realm. Achieving universal rationality is just not feasible. The limits of our knowledge and abilities make it essential to embrace models of "limited" rationality rather than clinging to the idea of a one-size-fits-all rational approach. Here's where we get into the distinction between objective and subjective rationality. Traditional economics often assumes an "rational person" under the banner of objective rationality. On the flip side, subjective rationality argues that everyone is rational in their own opinions, but an individual's behavior might seem irrational when viewed objectively.

Rationality and Crypto Assets

Consider this: an economic unit, feeling its knowledge is lacking, might engage in herd behavior, thinking it's rational. Yet, an outside observer might see it as irrational. In crypto asset markets, especially, these dynamics are a hot topic among behavioral finance enthusiasts critiquing financial markets. So, when it comes to rationality, the line between objective and subjective perspectives can get a bit blurry, especially in the world of crypto assets.

Nature of Crypto Assets

In crypto asset markets, Bitcoin and other subcoins are traded, much like stocks and options are traded in traditional markets. However, there's something unique about crypto assets—they don't fully function as a medium of exchange or a stable unit of account. Why? Well, it all comes down to their price volatility in the market. Crypto assets struggle to embody these characteristics because their value tends to swing wildly. Compared to other currencies, the volatility of crypto assets is significantly higher, which exposes users to short-term risks when using them for transactions or as a reliable unit of measurement. Cryptocurrencies show little correlation with everyday foreign exchange rates, widely-used currencies, and even gold. This disconnect makes them pretty ineffective for managing investment portfolios. Here's why: crypto assets face daily risks like attacks and theft, plus they're not widely accepted for regular financial transactions. There's also a lack of transparency and solid legal authority backing them up. All these factors make crypto assets more of a speculative investment tool than a reliable currency.

Speculative Nature of Crypto Markets

The thing is, crypto assets tend to yield crazy high returns due to their wild price swings. This extreme volatility can lead to speculative bubbles in the crypto market, where prices surge unrealistically. This instability is what puts them in the spotlight as speculative investments rather than reliable currencies. In times of price bubbles, high demand can either drive prices even higher or cause rapid drops when prices fall. This surge in demand often stems from herd behavior among speculative buyers, triggered by the fear of missing out on opportunities or losing out. Now, classic economic theories suggest that markets operate based on all available information, dismissing the idea of irrational markets led by herd mentalities. However, another perspective argues that herd behavior in financial markets can actually disrupt the link between knowledge and market outcomes. This is where behavioral finance steps in. It dives into the real-world beliefs and decisions of investors, aiming to uncover how markets react in the presence of a large group of irrational investors.

Behavioral Influences in Crypto Markets

When it comes to crypto assets, investors often rely on two major sources for their investment decisions: news and social media. Numerous forums discussing these markets have cropped up, where investors share and track recent news, unexpected price shifts, and innovations in blockchain technology. These forums serve as hubs where community ideas form, leading to different investment strategies, like discovering new subcoins or crafting "smart" price models. This environment often fuels herd behavior among investors in these markets. As the literature suggests, community discussions within these forums play a significant role in shaping investment trends and triggering herd mentalities.

Decentralization and Functionality of Crypto Assets

Crypto assets are essentially currency systems that are gaining popularity worldwide. They stand out because they're decentralized—meaning no government, company, or authority controls them. Instead, they rely on cryptology, a science of encryption, to exist digitally and securely. Stored in virtual wallets using specific ciphers, these assets allow individuals to make real transactions and profits. The value of crypto assets isn't tied to physical commodities or controlled by a central entity. Instead, it fluctuates based on users' perceptions of its usefulness as both a means of exchange and a commodity. Take Bitcoin, for example—the most successful crypto asset so far. It aligns with the goals of fintech companies by reducing transaction costs and bypassing the need for financial intermediaries. In essence, crypto assets like Bitcoin aim to revolutionize the way we transact by making it more efficient and cutting out unnecessary middlemen.