Your Brain on Bitcoin

You buy in with some spare bucks you have lying around. You’ve heard the news of lucky young investors making millions, and you decide to get in on the action while you can. At first, you check every couple of days- whether it increases or decreases, it’s not the end of the world. But over time, something starts to click. The price has increased- you just made some spending money. Checking once in a while turns into once a day turns into once an hour. You start selling and buying more. Just when you think you have it figured out, the price plummets, and when you lose all hope, it spikes again. Regardless of how much money you’ve made or lost, one thing is certain: when that price goes up, it feels good.

© [Parilov] / Adobe Stock

Chances are if you have invested in cryptocurrency or even talked to someone who has, this story sounds familiar. Reaching the price of $10,000 on November 29, Bitcoin quickly became famous (and, to some, infamous), taking only two weeks to nearly double to its peak of over $19,0001 before crashing back down to a measly $8,000 or so. While it is difficult to predict if the cryptocurrency’s value will resurge, it is clear that, at the very least, Bitcoin and its altcoin counterparts have attracted a whole new market of investors2. Whether cryptocurrency is the future of everything or a doomsday bubble sent from the dark web to punish us for dreaming, its explosive growth provides a fascinating look at how our brains respond to rewards. This is because, unlike stocks, it is hard to see the utility of a Bitcoin3 (though the Blockchain, or the technology on which Bitcoin is based, is a different story). Much like a paper currency, the value is almost entirely in the minds of the people willing to use it.

Price of Bitcoin in US dollars, from 2015-today.

This begs the question, what are the psychological drivers behind diving into this new market? What caused the value of cryptocurrencies to rise and fall so dramatically in such little time? To answer this question, we must combine insights from social psychology, behavioral economics, and neuroscience.

Everyone’s doing it, so it must be right.

Representation of stimulus from Asch’s (1951) conformity experiment. The goal was to identify which line on the right was most equal in length to the line on the left. When surrounded by others choosing incorrectly, participants chose incorrectly on 32% of the total trials, as opposed to less than 1% of the time when the participant was alone.

Humans are naturally social creatures. The actions of others influence our own decisions constantly. This generally happens out of a desire to fit in (normative conformity), an idea that others know more about the subject than you (informational conformity), or both. Solomon Asch famously demonstrated4 how social pressure can cause people to make overtly wrong decisions; in this case, judging two clearly unequal lines to be the same length simply because a room full of people said so. While the effect of conformity is not this strong for everyone, it is still an important driver of our decision-making, even at a physiological level. In fact, when we conform, the brain recruits neural mechanisms like those involved in reinforcement learning5. For instance, when our decisions conflict with the group’s, activity in the nucleus accumbens, an area of the brain heavily associated with reward, decreases. Basically, our brains keep track of when our beliefs differ from those of others and may try to nudge us in the other direction.

Locations of several parts of the brain involved in reinforcement learning, including the nucleus accumbens. Brain illustration ©[nicolasprimola]/Adobe Stock

In the case of Bitcoin, it is easy to see the role of conformity. As the number of people championing Bitcoin increased, so did the power of social pressure, especially if you knew very little about cryptocurrency. We start to think that if all those people are doing it, they must be onto something, and we don’t want to be the chumps who missed out.

Of course, conformity works both ways. When the price drops and people start to panic, those more susceptible to social influence often follow the crowd once again and sell. This has been seen in the past few months. As adverse news spreads, often about Bitcoin’s bubble-like nature6 or about potential new regulations7, bearish investors panic and sell before the price can drop. As more people sell and the price drops, those with little knowledge of the market often have one source of recourse- to again follow the group. Thus, the price plummets further, and the panic is fueled until either the market collapses or a change convinces enough investors to start investing once again. This contributes, in large part, to the volatile, swinging nature of cryptocurrency. Importantly, whether conformity results in wise or unwise decision-making, it is an undeniably powerful influencer of our decisions. It is a mistake to view perception solely from the standpoint of the isolated individual, since humans largely do not act in isolation.

Working with what we have

Of course, while conformity can be influential, it is not the only cognitive process at play. Indeed, the way we respond to social influence can vary based on our own beliefs, even sometimes pushing us further away from the group consensus. Thus, a large piece of the puzzle is perception and how we internalize the cryptocurrency-related information around us.

As it turns out, the way we process this information can be influenced as much by our own minds as by the information itself. This is due to the brain’s nature to operate heuristically, or by using preconceptions to inform future decisions.  It does this for an important reason- if we had to fully process all available information every time we were presented with a choice, we would be paralyzed with each trip to the grocery store. Yet, as Behavioral Economics tells us, it can also cause biases that lead to illogical decision-making.

When examining cryptocurrency, a source of bias that immediately comes to mind is the availability heuristic. This refers to the tendency to make decisions based on information that is most readily available in memory. Often, such information will be a particularly salient, emotion-inducing, or a recent event. For instance, if I was asked my opinion on enforcing a mandatory curfew in my neighborhood, I would be much more accepting if I had just seen a news story about a string of nighttime muggings.

With Bitcoin, these events take form as stories of people whose lives were transformed by Bitcoin. As the price started to soar, stories emerged8 of “Bitcoin millionaires,” a lucky group often hailed as “crypto geniuses” who made a fortune from Bitcoin. Whether these newfound millionaires quit their jobs and founded their own companies or simply spent their days traveling around the world, their story sticks with us. It makes us think, what if that had been me. This deep emotional relevancy encodes the story strongly into our memories, so that when we evaluate whether to invest, it weighs heavily on our minds, pushing us to pull the trigger. Of course, for every Bitcoin millionaire, there are many others who lost money through cryptocurrency. Our brains are simply trying to process information as efficiently as possible, causing them to weigh more heavily the information that is easily available. In this case, that happens to be the multitude of striking, get-rich-quick stories. This effect has been utilized in many successful ad campaigns, such as “The Real Cost” series for anti-smoking9. By creating visuals that are particularly memorable and emotionally salient, their campaign sticks in our heads, and in turn, disproportionately drives our decision-making.

Importantly, these perceptions often act like snowballs, in that they are largely determined by initial belief formation. This is mainly thanks to two other cognitive biases, the anchoring effect and confirmation bias. The anchoring effect refers to the tendency to rely more heavily on the information we see first. This is a large driver of the effectiveness of discounts- I will likely attribute more value to $100 pair of pants discounted by 50% than the same pair of pants at a starting cost of $50, because the former situation anchors my perception of how much the pants should cost to $100. Future evaluations are then judged from that $100 anchor. Confirmation bias is the tendency to search for evidence that confirms our beliefs and ignore evidence that contradicts them. This bias often plays a role in customer loyalty. For instance, since my first phone, I have been an Android loyalist, originally due to some of the physical features of the phones when I had first purchased. Now, even though the specs of all the phones have changed drastically, I cannot deny that I evaluate Androids and iPhones differently. When I look at Androids, I usually focus my search on cool features and benefits, whereas when I look at iPhones, I often catch