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7 Cognitive Biases that Are Plaguing the Cryptocurrency Industry

PAX Trading > Crypto News > 7 Cognitive Biases that Are Plaguing the Cryptocurrency Industry

“We can be blind to the obvious, and we are also blind to our blindness.” — Daniel Kahneman from his bookThinking Fast and Slow

Whether you are a new cryptocurrency investor or a self-declared “crypto-expert,” your decisions on which cryptocurrency to purchase require you to make estimates on the future. However, with whitepapers, “expert” opinions and ratings, increased coverage of cryptocurrency news in mainstream media, and many other things to consider, you are more likely than ever before to make poor decisions that are heavily influenced by cognitive biases.

What Are Cognitive Biases?

One of my favorite definitions of cognitive biases comes from Kendra Cherry, who writes that cognitive biases are “systematic errors in thinking that affect the decisions and judgments that people make.” As Buster Benson points out in his cognitive bias cheat sheet, cognitive biases are most likely to affect your decisions when at least one of four problems exist:

  • there is too much information to appropriately weigh and consider,
  • the context around the issue is very confusing,
  • the decision must be made quickly, and/or
  • we have a limited experience with the issue/topic.

In the world of cryptocurrency, unfortunately, nearly all four of these problems are present.

  • Mainstream media coverage on cryptocurrencies, particularly Bitcoin, and initial coin offerings (ICOs) has increased significantly over the past year (too much information to weigh and consider).
  • The rate of ICOs have increased significantly in the past year alone across many industries. That, along with the lack of regulatory guidance, has created a bit of a Wild West in cryptocurrency investment (the context around the issue is very confusing).
  • Startups conducting an ICO often structure their rounds in a way that takes advantage of the fear of missing out among investors, which adds urgency to investment decisions (the decision must be made quickly).
  • Meanwhile, ICOs are still a new fundraising method — no older than five years old (we have limited experience with the issue/topic).

Kai Sedgwick recently wrote a searing critique of self-proclaimed crypto-investment experts on Bitcoin.com. While there is plenty of hyperbole and flat-out lying to go around, there is a failure to combat, or even be generally aware of, cognitive biases as they relate to cryptocurrency decisions across the industry — regardless of their “experience” in crypto-investments.

The 7 Deadly Biases

I am an intelligence analyst by trade. Making estimates on the market potential of a given industry or company is very difficult, and its something market intelligence analysts must do everyday. In order to make as accurate an estimate as possible, an intelligence analyst must be aware of cognitive biases.

Cryptocurrency investors are faced with the same difficult tasks and the same deadly biases. While this is not a complete list, here are some of the key cognitive biases that are plaguing the crypto-investment industry.

The Availability Heuristic

The availability heuristic refers to a flawed thought process in which the more easily you remember or imagine a scenario, the higher the likelihood you assign that scenario of occurring. Unfortunately, many new cryptocurrency investors can easily recall and imagine a cryptocurrency rising in value due to the significant news coverage of Bitcoin. However, the return on investment (ROI) of Bitcoin is not the rule, it is the exception.

A video that visualizes the availability heuristic.

The Anchoring Bias

The anchoring bias refers to our tendency to rely too heavily on the first or a preferred piece of information offered when making decisions. The anchoring bias is particularly prevalent when numbers are involved. This is where ICO ratings become particularly harmful. Imagine you go to an ICO calendar site that has a rating system from 1 to 10, where 1 is a “very risky” ICO and 10 is a “very safe” ICO. If you see an upcoming ICO with a rating of 10, it will be harder to convince you that the ICO is actually a risky investment than it would be to convince someone who never saw that rating at all. The anchoring bias is stubborn, and it shows it ugly face everywhere — particularly in negotiations (which is why you should always set the price first) and shopping.

A video that visualizes the anchoring bias.

The Confirmation Bias

The confirmation bias refers to our tendency to search for, disproportionately weigh, and recall evidence in a way that confirms our preexisting beliefs. It also refers to our ability to interpret unclear evidence in a way that supports our preexisting beliefs. As badly as you may want to believe in a particular cryptocurrency, be sure to give the negative factors its appropriate consideration.

A video that visualizes the confirmation bias.

The Gambler’s Fallacy

The gambler’s fallacy is the false belief that if something happens more frequently than normal during some period, it will happen less frequently in the future — or vice versa. For example, if you flip a quarter five times and all five flips result in heads, a tails result does not become any more likely in the next five flips. It is still 50/50 per flip. Like the stock market, cryptocurrency values are complex. An early increase in value of a cryptocurrency does not mean it is less likely to increase in the future. There are far more factors to consider.

A video that explores the gambler’s fallacy.

The Optimism Bias

The optimism bias is our tendency to believe that positive outcomes are more likely to happen for us than negative outcomes. We all have the one friend who is an eternal optimist — the one says, “Everything will work out” after we’ve been dumped for the eighth time in the past ten years… but I digress. It is important to remember that not every cryptocurrency is destined to have 1,000x, 10x, or even 2x returns — despite how much you want to believe it.

A video that demonstrates the optimism bias.

The Halo Effect

The halo effect refers to our propensity to give a significant and disproportionate amount of attention to the positive attributes of someone or something, and overlook many negative attributes. The halo effect is often associated with our perception of other people, but it can apply to business-related considerations too. A noble and admirable cause may not result in a valuable cryptocurrency, despite what your brain tells you. There are many other factors to consider.

A video that visualizes the halo effect.

The Overconfidence Bias

The overconfidence bias refers to a person’s confidence in their estimates and predictions usually being greater than the accuracy of those judgements. In other words, we (yes, you too) are not nearly as accurate as we think we are in our predictions. Even when we try to estimate something with a range, we tend to be overly precise and, worse, way too confidence in our range. Be cautious of this bias when estimating the future value of cryptocurrencies you’re considering

A video demonstrating the overconfidence bias.

“I Get It… My Brain is Broken. Now What?”

Now you know some of the many cognitive biases that are negatively influencing your crypto-investment decisions. Is all hope lost though? Absolutely not.

First, the best defense against flawed decision-making caused by cognitive biases is awareness of those biases. It may sound too simple to be true, but it is true.

Second, do your own homework. The cryptocurrency space is becoming increasingly complicated, so you must do your due diligence on every cryptocurrency you are considering. You should know what the underlying value or function of the token is. You should know about the industry the startup conducting the ICO is aiming to disrupt. You should know the startup’s leadership team, and assess if their experience, knowledge, and skillset is likely to lead them to success. Experts and cryptocurrency ratings agencies will try to persuade one way or another, but it’s ultimately yourmoney. Do your best to protect it.

While I am an intelligence analyst by trade who has had to study cognitive biases’ effects on judgements, I am not an expert. This is not a complete list. Feel free to add other cognitive biases or thoughts that you believe are affecting the cryptocurrency industry, and how to combat them to make the industry as sustainable as possible.

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