A Behavioral Finance View of Cryptocurrencies


We are in the grip of a social phenomenon like no other we’ve ever experienced. People are paying thousands of dollars for something that is essentially a reward for playing a computer game. It has no physical properties, questionable use, no regulation, and only exists when a sufficient number of other people’s computers say it does. It may already qualify as the greatest asset bubble in recorded history, yet may only just be getting started. National governments have been compelled to denounce it or restrict their citizens from purchasing it out of concerns for mass hysteria and the corruption of their youth. It exists on a software system that is maintained through a consensus of volunteer software engineers, and no one seems to know the true identity of the creator. If it were a futuristic novel, it would certainly be on the best seller list, but it’s a striking reality – a live theater performance unfolding before us in real time, and a financial, political, and social phenomenon of historic proportion. It may yet end up as having been a total farce or the beginning of a radically new global payment system.

Opinions on the cryptocurrencies are buzzing all over the Internet. Most, however, rely upon conventional financial analysis and historic comparisons, mixed with a stew of personal emotions and biases. Representative bias is rampant in these assessments, as people try to evaluate the concept of a cryptocurrency in the context of , which is as grossly inadequate as comparing an i-phone to a dial telephone. While elements of conventional finance and economics do exist, they must be viewed as only partially applicable here and elements totally unique to cryptocurrencies must be considered. In sum, I contend that... 

the cryptocurrency phenomenon is better understood
from a behavioral perspective – one that understands the key behavioral groups involved and the motivations of each.


The intent of this writing is to add a behavioral dimension to the current discourse on cryptocurrencies and to raise awareness of the behavioral impact on financial markets. It should be viewed in the context that behavioral science is still a relatively new approach to financial markets and that there is extremely little empirical data to draw from regarding cryptocurrencies.

Nonetheless, I expect to provide insights I believe will be valuable to those involved or looking to get involved and I expect to build upon this foundation with future writings on the topic. References to other articles and contributions from others on the subject are welcome.

Rick Lehman
Adjunct Professor of Behavioral Finance,
UC Berkeley Extension
Golden Gate University

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A market driven almost entirely by behavioral factors


As a behavioral science academic, it is almost impossible not to be captivated by the cryptocurrency phenomenon, which is easily the most significant behavioral event to occur since the emergence of behavioral science and its application to financial markets (which the world is only now beginning to comprehend). For a behaviorist, this could be as momentous as a physicist witnessing the discovery of a new atomic particle. Bitcoin may be as pure a behaviorally driven market as we will ever see. Among other things, we are witnessing herding, fear of regret, speculation, envy, and anti-establishment sentiment on a grand scale. In addition, adopters are placing faith and trust in a radically new concept. Wherever it eventually goes, it will undoubtedly provide some of the most enlightening information to date on the psychological and emotional mechanisms that drive human financial actions.

A common view is that the bitcoin market is totally irrational and therefore simply a house of cards waiting to collapse. By historic standards, this would be true, but such an approach fails to see irrationality as a human reality, and forces one to treat events such as the market crashes of 1987, 2000, and 2008 as either never having happened or simply unexplainable, neither of which represent a constructive conclusion. Behavior has been proven to violate the principles of Rational Utility in many instances, and efforts to deny or ignore irrational behavior are therefore counterproductive. How humans should act is often different from how humans do act, and those who only look at the should part are simply altering reality to suit their own judgments. Evaluated on the basis of conventional financial fundamentals, the intrinsic value of bitcoin would most certainly be zero and the market value considered to be 100% anomalous. Where does that leave you? Evaluated on a behavioral basis, you can at least make judgments about the speculative value of a potential new world currency, the speculative value of a possible a gold substitute, the merits of cryptography for securing value, the effectiveness of blockchain as a secure and sustainable technology, and the value of supporting bitcoin’s anti-establishment mission. I find this to represent a far more insightful and productive approach.

In other words, to properly understand and assess
 the behavior of any market, one must appreciate the behaviors,
 and the constraints or influences on those behaviors,
of all major participant groups.

This has rarely been done effectively for current, let alone historic markets, even by professional analysts. Market analysis, whether fundamental, economic, or technical tends to be far too limited in context and all too frequently tainted by the author’s employment, training, self-interests, or inherent biases to be objective or complete. In addition, most market assessments have paid too little attention to behavioral science to appreciate the full nature and scope of emotional and psychological influences.

Behaviorally-defined (psychographic) market segments


Viewed through a behavioral lens, cryptocurrencies come into focus not only as an entirely new concept with unique characteristics, but as an item that has a different identity and appeal to different people. We know that people use cognitive shortcuts to simplify their purchase or investment decisions, often reducing the decision to perhaps only one or two key criteria or rationales. We can take these key purchase rationales and define arbitrary market segments around them. While this represents an oversimplification of the market, it can be very useful for establishing a high-level view of the key psychographic variables at work here.

People are purchasing bitcoin, for example, not just because it has multiple characteristics as a currency (costless transferability, cryptographic security, etc.), but different groups are buying it for entirely different reasons altogether. Using the cell-phone analogy again, a certain group of people purchase i-phones because they represent the next generation of telephones. Another group purchased because i-phones represented the next generation of music-playing devices. A third group purchased because i-phones represented a new type of personal data assistant, and a fourth may have purchased primarily to have hand-held access to the Internet. Of course, there is overlap in these purchase rationales, but the incredible popularity and acceptance of i-phones was at least in part due to its ability to appeal to different audiences for different reasons, and bitcoin has these same properties.

If we were to ask people who purchased bitcoin why
they did (or what they perceived they were buying), we
would get a variety of answers, and we could use those answers to separate the buyers into groups based on their motives, essentially developing psychographic market
segments for cryptocurrencies.

In the absence of empirical data, we can hypothesize that we would probably see segments such as these:



This is the inner circle of bitcoin developers, originators, miners and major backers. It includes Satoshi, the Winklevoss Brothers; miners; etc.

Bitcoin founders, insiders, and whales



This group holds most of the largest positions in bitcoin and stands to gain the most from its success or lose the most from its failure. They are the insiders who are dealing most closely with the evolution and sustainability of the concept.

Behavior profile: These are the most ardent promoters and supporters. They are most likely to hold their assets for some time and see it through. They are also the strongest advocates of the bitcoin mission and they would likely act to preserve the mission before they would be tempted to sell out.

Large numbers of small players who support the mission and who view bitcoin as a political statement

Bitcoin believers

These would be small players from around the world who bought into the mission during the initial years. They were likely making a statement of support rather than investing. Some might be tempted to take a profit, but most are probably going to support the cause for as long as they can.

Behavior: This group is likely to represent net buyers and holders rather than sellers for some time.

Young investors with a tech orientation who embrace digital technology as the driving force of the future and who buy into every new technology. This includes programmers, technophiles, gamers, etc.)

Techies, millennials & disruption hopefuls.

These are the early adopters who view this as a valid alternative investment and a worthy cause. Many thrive on the idea that they can use clever software to disrupt the global financial system and governments.

Behavior: This group is likely to hang on as well, and is likely still adding to its overall stake as more enter the market.

Those who see bitcoin as replacing fiat currencies as a medium of exchange

Currency players

These are people (or institutions) that trade the currencies or who make markets I the currencies and who will simply add new ones that come online.

Behavior: The traders will do pairs and spreads using bitcoin, mostly in the futures markets. Exchange players (banks & forex firms) will need to own bitcoin for inventory, but will likely hedge it to remain neutral.

Those who see bitcoin as a get rich quick or trading vehicle (these are people who day trade, buy small-cap stocks, etc.) Gold-rushers and gold-bugs

Gamblers, speculators, day traders, etc.

This is arguably the largest and fastest growing group of participants now. These are small to medium-sized individual traders who are the ones propelling price into the stratosphere and creating all the volatility.

Behavior: These are primarily traders and they will hedge and short as necessary. They will create liquidity and will attempt to trade bitcoin in the short term along with the other cryptos. They will likely be net long as they accumulate trading positions.

Broad section of mom and pop investors, many of which may already hold gold or other alt investments

Traditional investors

This group is ripe for diversifying into any reasonable new asset class, just to augment their stock and bond holdings. Also included are those who (mistakenly) believe that they are essentially investing in blockchain technology. Little of this group is probably in yet, but they could represent a huge upswing when they do get in. When an ETF is available, this is the group that will be the prime market for it.

Behavior: This group will also be looking to execute long holdings, which will force the ETFs to buy. These people may hedge a little with derivatives, but will not short.

Hedge funds, big banks, exchanges, ETF issuers, Goldman Sachs, etc.

Professional traders & Arbitrageurs

These are the professionals who are purchasing to establish market-making inventories, hedge derivatives, build ETFs, etc. They would love to get a shot at an inefficient market like this with lots of volume from non-professionals to exploit and they will jump in to the maximum extent liquidity allows. For arbs and market-makers, it will be like shooting fish in a barrel. However, there will have to be improvements in electronic connections and clearing before they can jump in whole hog. The derivatives will also be rich with arb opportunity, but few players are likely to short without hedging.

Behavior: Professional traders will primarily be scalpers, market makers, and arbitrageurs. They will improve the market tremendously once they can easily trade, clear, and cross trade. They may end up net long or short at different times, but they can make plenty of money just being neutral and making markets for others.

Exchanges, banks, ETF issuers, broker/dealers, currency dealers,

US financial institutions

They want in, lest they be caught on the outside. Bank America received a patent for Cryptocurrency exchange already and several others have announced others are definitely working on participating.

Behavior: Banks are extremely defensive here as they have a lot to lose. They will likely look to provide exchange services and maybe even offer wallets. But they are unlikely to take net positions unless required for their operations.

The social component of bitcoin

Occupy Wall Street.png

Importantly, there are new behavioral factors inherent to this phenomenon that transcend formal finance and economics, and which bear serious consideration. 

The founders of bitcoin did not conceive it in a vacuum, nor was it put into effect frivolously. There are clearly stated goals that seek to remedy global problems such as inflated fiat currencies, mistrust of financial institutions, high payment transaction fees, and the impracticalities of using gold as an international store of value. These are unique rationales that can appeal to different audiences. This adds a non-trivial social component – a statement being uttered by (and on behalf of) a large and agitated segment of earth’s population. We have witnessed these statements through populist events around the planet and in elections in numerous countries, including our own. They convey highly charged emotions of mistrust and frustration regarding the actions and policies of governments and large financial institutions. 

For many people, the purchase of bitcoin may thus be the
Equivalent of donating to a political cause, except
that in this case their money is not just helping to get a message out, it is actually funding the program.

Gold rush

Gold rush.png

By design (and as a direct snub to central banks), bitcoin has also been positioned as a possible replacement for gold as a long-term store of value. As the argument has both inherent merit from a practical viewpoint (easy storage and transferability, limited supply, etc.) and a healthy techno-appeal to the younger generations, bitcoin is experiencing a speculative rush, not unlike the dotcom rush of the late 1990s and the California gold rush of 1848. This introduces a behavioral group interested almost solely in making fast money. A few years ago, bitcoin was an interesting experiment that few took seriously, except for the usefulness of the underlying blockchain technology. But it appears to have hit a tipping point, arguably around June of 2017 when the price broke out of a long slow multi-year trend to go parabolic. This was likely caused, or at least aided by the addition of this speculation group. 

As a result, some aspects of the phenomenon are now
simply following the tried and true speculators’ playbook,
fueled by an intriguing story, scarcity, untold potential,
and unbridled herd instinct.


It is also this group who is likely adding the most to price volatility, though that will abate as the bitcoin exchanges become more efficient and the professional market makers enter the fray.