Bitcoin is notoriously volatile. The cryptocurrency hit a record high of more than $63,000 in April 2021, before quickly plummeting to less than $30,000. Wild overnight swings are common, driven by everything from the musings of Elon Musk to the actions of regulators.

These price surges are driven in significant part by optimistic, newer investors—many of whom are younger than average and have lower incomes and fewer assets, find University of California at Berkeley’s Matteo Benetton and Chicago Booth’s Giovanni Compiani.

On the premise that beliefs play an important role in determining economic outcomes, the researchers set out to understand what people are thinking when they invest in cryptocurrencies. After all, the digital tokens have no future earnings or cash flows and they aren’t even “real” currencies, lacking the backing of any major central bank.

The researchers analyzed three surveys of more than 30,000 Bitcoin investors between 2015 and 2018 as the digital token characteristically soared and plunged: the Survey of Consumer Payment Choice by the Federal Reserve Bank of Atlanta; the mobile-banking report from the 2018 ING International Survey; and a survey by an anonymous US-based trading platform with global customers.

Benetton and Compiani find that the enthusiasm of newer crypto investors tends to drive values up. This group—including younger, less-educated, and lower-income investors—was responsible for about 38 percent of the price appreciation during a boom in Bitcoin prices in December 2017, the research shows. Members of this group invested more than their seasoned counterparts and were potentially exposed to greater losses on the downside, raising questions about how to warn investors of the risks.

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“This broadens the horizon a bit to this idea of the democratization of finance,” Compiani says. Apps and trading platforms have made it easier for people to trade via their phones and tablets, and while there are many benefits to providing such easy access to the market, he notes that “the risk is that maybe this will facilitate some sort of bubble-like patterns like the one we found with cryptocurrencies.” He points, as an example, to GameStop, whose stock skyrocketed in early 2021, driven in part by enthusiastic retail traders.

The researchers also find that investor concerns about the massive amounts of computing power and the vast quantities of energy needed to create bitcoins and other cryptocurrencies such as Ethereum matter to their value. Using their model, Benetton and Compiani find that if investors became aware of these concerns they would move funds into digital tokens that rely on a more energy-efficient system such as the Ripple network. This would then translate into changes in market prices, with Bitcoin and Ethereum values falling by 12 percent and Ripple gaining 6 percent. Benetton and Compiani received financial support from Ripple’s University Blockchain Research Initiative. Ripple Labs supports the cryptocurrency XRP.

While it may be tempting to dismiss cryptocurrency pricing as purely sentiment driven, the work by Benetton and Compiani suggests that the priorities of crypto investors can be measured, understood, and potentially even predicted. This might help researchers develop valuation metrics using the principles of supply and demand that will help investors prudently incorporate the asset class into their portfolios.

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