How psychology is shaping the Bitcoin bubble

‘Bitcoin promises to completely revolutionise commercial transactions'

‘Cryptocurrency is the best space to get into if you are looking to get some quick investment returns'

‘$1 million by 2020 … easily'

None of these claims are impossible, but they are unlikely – and, for some people, irresistible. Promises of quick riches often have a hypnotic power over investors, blinding them to dangers.

Research has shown that dopamine – the brain's reward chemical – is triggered by financial gains, but, curiously, the less likely and predictable the gain is, the more dopamine released if it pays off.

Consequently, we're particularly attracted to ‘lottery tickets' – speculative stocks, Bitcoin trading, and anything else that offers a ‘jackpot'. As the price of Bitcoin rises, buyers are being flooded with dopamine not because it was a sure thing but because it was an unsure thing. This combination of low probability and rapid gains encourages punters to make ever-increasing bets, chasing their next ‘fix'.

All aboard the bandwagon

The lottery ticket mentality might attract people to Bitcoin, but it's our compulsion towards pattern recognition that causes the most irrational buying.

We see religious figures in pieces of toast, rabbits in clouds, and trends in meaningless data. Researchers at Duke University demonstrated that people automatically anticipate repetition after an event happens only two times in a row. With the price of Bitcoin going up several weeks in a row, today's buyers are more likely to believe they see a trend, even though Bitcoin's future remains uncertain.

What's more, as prices rise, gut feelings are reinforced, which leads buyers to have more confidence in their predictions. The overconfidence effect fuels further buying and rising prices.

Any asset that shows consistent price rises over a long period is prone to being overvalued due to recency bias – our tendency to fixate on recent conditions and assume they will continue far into the future. We almost always assume the future is more certain than it is. Ironically, when a bubble is in full swing and prices at record highs, certainty among investors is at its highest (due to the history of positive reinforcement) – right when the risk/reward balance is most unfavourable due to the record prices.

A Stanford University study found that even if investors recognise that an asset is overpriced, their fear of diverging from the crowd and watching the price continue to go up means they often refuse to sell. The research found that what we fear most in investing isn't the risk of loss, but the risk that we do worse than everyone else. We don't fear being poor nearly as much as we fear being poor when those around us are rich.

If there's one thing driving the Bitcoin mania, it's a fear of missing out. However, just because it's theoretically possible for Bitcoin to hit a million doesn't mean it's predestined to happen – and avoiding lottery tickets will serve you far better over time than hoping to get lucky.