Mental Accounting for Crypto Investing: the Safe and the Adventure Chest

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Investing in cryptocurrencies presents some new psychological problems you rarely see from investing in traditional instruments, like equities and bonds.

  1. Uncertain risk profile. It’s not clear how risky cryptocurrencies are. Whereas we think we have good historical data of how well equities and bonds will do, there isn’t agreement on how we should value cryptocurrency markets. Moreover, counterparty risk from holding cryptocurrencies is significant. There’s the chance that cryptocurrency exchanges shut down: Mt. Gox infamously declared bankruptcy, mining services like NiceHash have been hacked, and exchanges have shut downbecause of regulatory pressure. It’s also difficult to weigh the convenience, liquidity, and exposure of buying coins on different exchanges against holding a physical wallet or running a full node, then forgetting your keys or having it robbed.
  2. Mental accounting bias. The lack of clear valuation bounds for crypto has made as many uplifting rags-to-riches stories as sad ones. Paying constant attention to the ups and downs of cryptocurrency markets takes a serious toll, especially when traders perceive their fear of missed opportunities as a loss. For example, see this painful apocryphal story on r/Bitcoin/ of an enthusiast committing suicide after missing out on $50M.

How, then, do you effectively invest in a growing array of cryptocurrencies, altcoins, and newcoming derivative instruments, without losing your mind in the process? This is where behavioral economics can help.

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The Future of Blockchain Needs Economics

 A Marketplace in Hong Kong

A Marketplace in Hong Kong

The cryptocurrency industry has been talking about 2018 as the year of rising decentralized blockchain platforms. These platforms broadly fall under two categories: 1) technologies that scale rapid, secure, and cheap asset transactions — for instance Lightning Network, Stellar, and 0x; and 2) technologies that enable tools and modules for people to easily write contracts — for instance REQ, LINK, and various technologies that facilitate Ethereum dApps.

To see these platforms live up to their promise, we’ll have to build structures on top of them. The future will have to see the design of new decentralized markets that can build upon these platforms to tap into existing allocative inefficiencies, and empower people to coordinate with each other with incentives aligned across time.

A subfield of economics, applied market design, can help! In the past, successfully designed markets — for instance, Hal Varian’s work with Google on ad auctions and Al Roth’s residency matching program — were key to making systems profitable. Here are some examples of ways we can use economics to solve problems through blockchain tech.

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