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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