Cryptocurrency Behavioral Finance: What You Need to Know

Why do people invest in cryptocurrency? Is it just about making money fast, or is there something else happening beneath the surface? In a Twitter post on FOMO (fear of missing out), Securities and Exchange Commission Investor Ed warned that many people buy a particular investment, solely because others have bought it.

It’s fascinating how, without even realizing it, we often let our feelings take control when it comes to buying or selling crypto. Whether it’s chasing a new coin or panic-selling during a dip, our actions aren’t always as rational as we think.

But what exactly drives these behaviors? And how can we improve our cryptocurrency behavioral finance? Let’s break down what influences your crypto moves and figure out how to stay ahead.

Key Takeaways

• Emotions drive crypto decisions – FOMO, overconfidence, and herd mentality often lead to impulsive moves.
• Automation reduces bias – Trading bots help minimize human error by sticking to predefined strategies.
• Cognitive tools help – Techniques like CBT can reshape emotional responses and improve trading discipline.
• AI is the future – AI and machine learning will play a crucial role in predicting investor behavior and reducing emotional investing.

“According to Chainalysis, around US$2.5 billion was laundered through Bitcoin between 2009 and 2018”

What is Cryptocurrency Behavioral Finance?

Source: Image by Freepik

Cryptocurrency behavioral finance refers to the psychological influences and biases that impact individuals’ decisions when investing in digital assets.

While traditional finance operates on the assumption that people make logical, well-informed decisions to maximize their financial returns, behavioral finance suggests otherwise.

It argues that investors are not always rational and are often driven by emotions, cognitive biases, and social factors that can cloud judgment.

Recommended reading: The Rise of Decentralized Finance (Defi)

Behavioral Finance vs. Traditional Finance in Crypto Investing

As earlier said, in traditional finance, the idea is that markets are efficient, meaning asset prices reflect all available information, and investors make decisions based on rational analysis. Applying this approach to crypto would mean investors thoroughly evaluate market conditions, token utility, and long-term growth prospects before buying or selling.

For example, suppose you’re using traditional finance principles in crypto. In that case, you might research a token’s whitepaper, assess the technology behind it, analyze historical price data, and consider global market trends before deciding whether to invest. Essentially, your decision would be driven by logic, data, and strategic analysis.

However, behavioral finance flips this notion, arguing that people don’t always act rationally—especially in the volatile cryptocurrency market. Instead, psychological factors often drive decisions.

Investors may be influenced by FOMO, following a herd mentality when everyone else is buying a hot token, or they might suffer from loss aversion, selling off assets in a panic during a market dip, even if they initially intended to hold long-term.

Aspect	Traditional Finance	Behavioral Finance
Rationality vs. Emotion	Assumes rational decision-making based on data and market trends.	Focuses on how emotions, such as fear and greed, impact investment choices.
Long-Term Planning vs. Short-Term Reactions	Emphasizes long-term strategies for consistent returns.	Acknowledges that investors often react impulsively to short-term price changes, especially in volatile markets.
Analysis vs. Herd Mentality	Relies on in-depth analysis and calculated risks.	Highlights how herd mentality—following the crowd—can lead to illogical investment choices like trend-chasing or panic-selling.

“60% of the total investors surveyed by forexcrunch said that they would invest more money in crypto if it were offered by a traditional financial institution.”

Key Psychological Factors Driving Crypto Investments

Cryptocurrency investments are largely influenced by a number of psychological factors that shape how people buy, sell, and hold digital assets. From the fear of missing out to overconfidence in one’s trading abilities, these drivers can make or mar how you invest in crypto.

Fear of Missing Out (FOMO)

FOMO is a powerful emotion in crypto markets, driven by the fear that others are making profits while you’re missing out on opportunities. This fear can lead to impulsive decisions that aren’t always rooted in sound financial logic.

How FOMO Shapes Crypto Buying and Selling Decisions

When you see a cryptocurrency skyrocketing in value, it’s natural to feel the urge to jump in, even if you haven’t fully researched the project. FOMO often compels investors to chase assets that are already at their peak, resulting in buying high and potentially selling low when the market inevitably corrects.

On the flip side, FOMO can also drive panic-selling during market dips, as people fear losing more than they already have, leading them to exit their positions prematurely.

Social media plays a significant role in amplifying FOMO. Seeing tweets or posts from influencers and friends about massive gains can create a sense of urgency, pushing you to invest quickly, even when the timing isn’t right.

The result? More investors are drawn into volatile markets, often without a proper understanding of the risks.

Case Studies of FOMO in Major Crypto Bull Runs

FOMO was a defining characteristic of the 2017 Bitcoin bull run, where Bitcoin’s price surged to nearly $20,000. As Bitcoin rose, more retail investors jumped in, fearing they would miss out on what seemed like a once-in-a-lifetime opportunity. Many bought at the top of the market, only to see prices plummet in early 2018.

Similarly, in the 2021 bull run, driven by hype around decentralized finance (DeFi) and NFTs, we saw FOMO in action again. Dogecoin, a meme cryptocurrency, surged over 12,000% at one point, fueled largely by celebrity endorsements and social media. Investors who jumped in late faced massive losses when the market corrected.

Herd Mentality in Cryptocurrency Markets

Herd mentality refers to the tendency of individuals to follow the actions of a larger group, often ignoring their own analysis or instincts. In crypto, this phenomenon is especially pronounced, as market moves are often influenced by large-scale reactions to news or social media trends.

Impact of Social Media and Crypto Influencers on Herding Behavior

Platforms like Twitter, Reddit, and Telegram are hotspots for crypto discussions, and the influence of high-profile figures like Elon Musk can drive herding behavior. When Musk tweeted about Dogecoin or Bitcoin, millions of investors followed suit, either buying or selling based on his comments.

This reliance on influencers or groupthink can be dangerous. It leads to less critical thinking and more reactionary behavior, as people feel safer in numbers, believing that if everyone else is doing it, it must be the right move.

Herding Effects in Crypto Pumps and Dumps

Herding is particularly evident in pump-and-dump schemes, where coordinated buying pumps up a cryptocurrency’s price, only for organizers to sell at a peak, leaving unsuspecting investors with heavy losses.

These schemes thrive on herding behavior, as inexperienced traders rush in, lured by the promise of quick profits. By the time they realize what’s happening, the price has already collapsed.

“Bitcoin’s price surged 400% during the 2020-2021 bull run, fueled largely by retail investor enthusiasm.”

Overconfidence Bias Among Crypto Traders

Overconfidence bias occurs when investors overestimate their knowledge or ability to predict market movements. This is common in the crypto world, where the complexity of the market often leads people to believe they have more control than they actually do.

Overestimation of Personal Knowledge in Crypto Market Predictions

Crypto markets are very difficult to predict, yet many traders believe they can time the market or predict future price movements with high accuracy.

This overestimation of personal knowledge can lead to reckless trading, such as using leverage without fully understanding the risks or making high-stakes bets based on minimal research.

Consequences of Overconfidence on Investment Decisions

Overconfidence often leads to excessive risk-taking. Traders may hold onto losing positions for too long, believing the market will turn in their favor, or they may enter into high-risk trades without proper risk management.

Over time, these behaviors can lead to significant financial losses.

For example, during Bitcoin’s 2021 bull run, many overconfident traders leveraged their positions, expecting prices to continue rising. When the market corrected, these traders were liquidated, losing much more than they initially invested.

Recency Bias and Crypto Market Volatility

Recency bias is the tendency to place too much importance on recent events while ignoring long-term trends. In the context of crypto, this bias can lead to unrealistic expectations based on short-term market performance.

How Recent Market Movements Influence Future Expectations

When Bitcoin or Ethereum has been rising steadily, investors often believe the trend will continue indefinitely, leading them to over-invest at the top of the market.

Conversely, after a sharp decline, they may assume that the market will keep dropping, even when historical data shows a pattern of recovery after corrections. This shortsightedness can lead to poor decision-making, like buying into bubbles or panic-selling at a loss.

Example of Recency Bias in Bitcoin’s Price Swings

In early 2021, Bitcoin surged past $60,000, and many investors believed the price would continue to climb due to recent upward momentum.

However, when the price dropped below $30,000 a few months later, recency bias took hold again, and some investors exited the market, fearing further declines. In both instances, focusing on short-term trends rather than long-term potential led to misguided decisions.

Anchoring Bias in Crypto Valuations

Anchoring bias occurs when investors fixate on a specific reference point. This is often the price at which they first buy a cryptocurrency, or a historical high, and then use it to guide their future expectations, even when it may no longer be relevant.

How Initial Price Anchors Affect Perceived Value

For example, if you purchased Ethereum at $2,000 and it rose to $4,000, you might anchor your expectations around that $4,000 figure, assuming it represents the token’s true value.

When the price drops, you may refuse to sell, believing that the market will return to that anchor. This bias can prevent you from cutting losses or recognizing when a new trend has formed.

The Role of Historical Highs and Lows in Price Predictions

Many traders also anchor their expectations around historical highs or lows. For example, Bitcoin’s all-time high of $69,000 in 2021 became an anchor for many investors, who now expect the price to reach or exceed that level again.

However, anchoring to past performance can create unrealistic expectations, leading to poor investment choices if the market doesn’t behave as predicted.

“58% of crypto investors studied agreed to being influenced by social media platforms like Twitter and Reddit.”

Cognitive Biases and Heuristics in Crypto Investments

Source: Corporate Finance Institute

Cognitive biases and heuristics significantly impact how we make decisions in cryptocurrency investments. These mental shortcuts often lead investors to deviate from rational behavior, relying on limited or biased information, and sticking to emotionally charged decisions. 

Confirmation Bias in Cryptocurrency Research

Confirmation bias is the tendency to seek out and prioritize information that confirms our pre-existing beliefs or opinions while ignoring evidence to the contrary. With how volatile the crypto market is, confirmation bias can cloud judgment, leading investors to make poorly informed decisions.

How Investors Seek Information That Aligns With Their Views

When investors have a positive outlook on a particular cryptocurrency, they often focus on news, articles, or social media posts that reinforce their optimism, while dismissing critical analysis or negative reports.

For example, someone bullish on Bitcoin might follow influencers or news outlets that consistently praise Bitcoin’s future, while ignoring experts who warn about potential risks or market corrections.

This bias can lead to overconfidence, causing investors to hold onto coins longer than they should, buy into overhyped projects without proper due diligence, or neglect warning signs that a bubble might be forming.

Availability Heuristic and Market Hype

The availability heuristic is a mental shortcut that causes people to rely on immediate examples or recent events when making decisions.

In crypto investing, this often manifests when investors base their choices on the most prominent or recent news, without thoroughly considering long-term trends or deeper analysis.

The Role of Recent News in Influencing Investment Choices

Recent headlines can easily sway crypto investors. For instance, when a coin experiences a rapid surge in price due to a new partnership or positive media coverage, investors may rush to buy in, basing their decision on the immediate hype rather than long-term fundamentals.

This heuristic leads investors to believe that because something is widely discussed or trending, it must be a good investment.

In cryptocurrency, this can lead to chasing the latest “hot coin” or entering the market during bubbles, often resulting in buying at inflated prices.

An example is the effect of media coverage on meme coins like Dogecoin and Shiba Inu. Media coverage and celebrity endorsements drove widespread awareness, making these coins seem like legitimate investments, even when they lacked strong fundamentals.

As a result, many investors bought in, not because they believed in the technology or utility, but simply because they were heavily influenced by the recent buzz and perceived popularity.

The Endowment Effect in Holding Cryptocurrencies

The endowment effect is the tendency for people to overvalue assets they already own, simply because they own them. In cryptocurrency, this bias can lead investors to become emotionally attached to their holdings, which clouds their judgment when it comes to selling.

Why Investors Overvalue Their Own Crypto Holdings

Crypto investors often develop an emotional attachment to their coins, especially if they’ve seen substantial gains in the past or were early adopters.

This emotional connection can lead to an inflated sense of value, making it difficult for investors to part with their assets, even when market conditions indicate that selling might be a wise decision.

For example, an investor who bought Bitcoin early and watched it rise significantly might continue to hold onto their investment, even when market signals suggest that a sell-off is imminent.

They overvalue their Bitcoin, not based on its actual market potential, but on the emotional satisfaction of having owned it during a bull run.

Sunk Cost Fallacy and Crypto Losses

The sunk cost fallacy occurs when investors continue to commit resources to an investment based on the time, effort, or money they’ve already spent, rather than the asset’s current and future potential.

In crypto, this bias leads investors to hold onto losing positions or even double down on investments, hoping to recover losses.

How Previous Investments Influence Future Decisions

When an investor has already sunk money into a cryptocurrency that has since lost value, the temptation is to hold on, believing that they will eventually break even or make a profit.

This thought process is flawed because it focuses on past investments rather than the current market outlook. Continuing to hold or even invest more in a losing coin just to recoup losses often leads to more significant financial harm.

“Did you know that the global user base of cryptocurrencies increased by nearly 190 percent between 2018 and 2020, only to accelerate further in 2022?”

External Factors Influencing Crypto Investor Behavior

Source: Image by Freepik

External factors like macroeconomic events, technological developments, and geopolitical issues also influence cryptocurrency investor behavior.

While internal psychological factors like FOMO or overconfidence affect individual decisions, external forces create broader trends and shape market dynamics that impact the entire crypto ecosystem.

The Role of Macroeconomic Events in Crypto Investments

Macroeconomic events, such as inflation, interest rates, and global regulations, have a direct impact on how investors perceive cryptocurrencies. As economic conditions shift, so does investor sentiment, often resulting in sharp market movements.

How Inflation and Interest Rates Influence Crypto Market Movements

Inflation and interest rates are two of the most critical economic indicators that influence the crypto market. Cryptocurrencies like Bitcoin have often been touted as a hedge against inflation, with many investors turning to digital assets when the value of fiat currencies decreases.

When inflation rises, traditional assets such as government bonds or savings accounts offer low or even negative real returns, driving investors to seek alternative stores of value. Bitcoin, due to its capped supply, is often seen as “digital gold” during these periods, attracting a surge of interest.

Conversely, rising interest rates can dampen enthusiasm for cryptocurrencies. Higher rates typically make traditional financial instruments more attractive, reducing the risk appetite of investors and leading to capital outflows from riskier assets like crypto.

For example, when central banks like the Federal Reserve raise interest rates to combat inflation, crypto markets often experience a dip as investors look for safer, yield-bearing investments.

Global Regulatory Changes and Their Impact on Investor Behavior

Regulatory changes, especially at a global level, can dramatically influence investor behavior. Governments worldwide are still struggling with how to regulate cryptocurrencies, and these regulations—whether restrictive or supportive—have immediate effects on the market. 

For instance, when China announced a complete ban on cryptocurrency transactions in 2021, the market reacted with a sharp sell-off. On the other hand, more positive regulatory developments, such as El Salvador adopting Bitcoin as legal tender, can boost investor confidence and drive market rallies.

Global regulatory uncertainty often leads to volatility, with investors reacting quickly to policy announcements.

Many investors become cautious when the regulations become unclear, choosing to pull out of positions or delay investments until the rules are more defined. Conversely, clear and supportive regulations often result in more institutional investments entering the market, leading to increased confidence and stability.

“As of 2024, global cryptocurrency ownership is estimated at an average of 6.8%, with over 560 million crypto owners worldwide.”

Influence of Technological Developments on Crypto Adoption

The technological structure in which cryptocurrencies operate is continuously evolving. Blockchain advancements and the adoption of AI in crypto trading significantly affect investor expectations and behavior.

Effects of Blockchain Advancements in Shaping Investor Expectations

The underlying blockchain technology that powers cryptocurrencies is a key driver of investor sentiment. Every advancement in blockchain—whether it’s in scalability, interoperability, or security—can shape how investors perceive the long-term potential of the crypto market.

For example, Ethereum’s transition from Proof of Work (PoW) to Proof of Stake (PoS) through the Ethereum 2.0 upgrade was a monumental shift that had significant behavioral implications. 

Investors were not only excited about the energy efficiency and scalability improvements but also about the staking rewards, which offered a new incentive structure. This technological upgrade increased confidence in Ethereum’s future, leading to a price surge and widespread positive sentiment across the market.

Blockchain advancements in cross-chain interoperability also influence how investors allocate their funds. As solutions for seamless transfers between blockchains emerge, investors feel more comfortable diversifying their portfolios across different crypto assets, reducing the risks of being overly dependent on one blockchain ecosystem.

Adoption of AI in Crypto Trading: Behavioral Implications

Artificial Intelligence (AI) is becoming an integral part of crypto trading, reshaping how investors approach the market. AI-driven trading algorithms can analyze vast amounts of data in real-time, and execute trades more efficiently. This reduces human biases such as emotion-driven decision-making.

The adoption of AI in crypto trading has led to a shift in behavior among both retail and institutional investors. Retail investors, previously swayed by emotional decision-making, now increasingly rely on AI-driven platforms that provide automated strategies, such as stop-loss triggers or portfolio rebalancing.

The reliance on AI tools reduces impulsive actions, like panic-selling during market dips or overconfidence during bull runs, promoting more disciplined investing behavior.

At the institutional level, AI-driven trading strategies have introduced new dynamics, as institutional traders are more likely to rely on data and predictive models rather than speculative sentiment.

This shift has also increased liquidity and stability in the market, as AI systems help smooth out extreme price fluctuations by quickly capitalizing on market inefficiencies.

Geopolitical Events and Their Effects on Crypto Investments

Geopolitical events, such as sanctions, wars, and political instability, can have profound effects on cryptocurrency markets.

Cryptocurrencies are often seen as safe havens or alternatives to traditional financial systems during periods of geopolitical uncertainty, driving significant shifts in investor behavior.

Example of the Impact of Sanctions and War on Crypto Prices

The Russia-Ukraine conflict in 2022 highlighted how geopolitical crises can influence cryptocurrency markets. When traditional financial systems were disrupted due to sanctions on Russia, cryptocurrencies became an attractive alternative for bypassing financial restrictions. 

Many Russian citizens turned to Bitcoin and other digital currencies to preserve wealth, leading to a spike in crypto activity and a noticeable impact on market prices.

Similarly, Ukrainians used crypto donations to fund humanitarian and military efforts, showcasing the role of crypto in circumventing traditional financial blockades. These events drove a temporary increase in crypto prices as global investors recognized the utility of cryptocurrencies in crises.

How Political Instability Drives Investors Toward Cryptocurrencies

Political instability, especially in regions with volatile economies or authoritarian regimes, often pushes investors toward cryptocurrencies. In countries with high levels of government censorship or restrictions on capital movement, cryptocurrencies provide an alternative means for individuals to protect and transfer wealth.

For example, in Venezuela, hyperinflation and strict government controls over foreign exchange have driven citizens to adopt Bitcoin and other digital assets.

The political instability and economic uncertainty have made cryptocurrencies an appealing option for wealth preservation, leading to widespread adoption despite governmental attempts to regulate or ban their use.

In politically unstable regions, investors often view cryptocurrencies as a way to safeguard their assets from government seizure or devaluation of the local currency.

“Did you know that FTX was once a leading cryptocurrency exchange, valued at $32 billion before it collapsed in a matter of days in November 2022?”

How to Reduce Behavioral Biases in Crypto Investing

Source: Image by Freepik

Cryptocurrency investing is rife with behavioral biases that can lead to emotional decision-making and significant financial losses. Fortunately, there are practical strategies that investors can adopt to minimize these biases and make more rational, long-term investment decisions.

Have a Long-Term Investment Plan

One of the most effective ways to reduce emotional biases in crypto investing is by sticking to a well-defined, long-term investment plan.

Unlike short-term trading, which is highly susceptible to psychological factors like FOMO or panic-selling, long-term strategies emphasize consistent, steady growth.

Try Out Automated Trading Bots

Automated trading bots have become an essential tool for investors who wish to eliminate emotional decision-making from their trading process.

These bots are programmed to follow specific strategies based on market signals, allowing them to execute trades with precision and consistency—without the influence of human emotions like fear or greed.

For example, many bots are designed to implement dollar-cost averaging (DCA), where investments are made at regular intervals regardless of market conditions. This helps reduce the impact of market volatility on purchasing decisions and encourages a disciplined investment approach.

Moreover, bots can be programmed with stop-loss and take-profit mechanisms, ensuring that trades are executed as planned even if the market turns unexpectedly.

This removes the emotional element from buying and selling decisions, helping investors avoid common pitfalls like holding onto a losing position out of hope or doubling down on an overconfident bet.

Apply Cognitive Behavioral Therapy (CBT)

Cognitive Behavioral Therapy (CBT) is a proven psychological technique that can help investors overcome destructive emotional patterns and behaviors.

Originally developed to treat conditions like anxiety and depression, CBT is now being applied to the realm of investing to improve decision-making.

Case Studies of Successful Implementation in Trading Psychology

There are numerous case studies of traders and investors who have successfully used CBT techniques to transform their approach to crypto investing.

For example, some traders have reported overcoming the anxiety associated with market dips by identifying their irrational fears and challenging them with rational counterarguments. 

Through CBT, they learned to recognize emotional triggers like panic during a downturn and reframed their thought patterns to focus on the bigger picture, ultimately reducing the likelihood of rash decisions.

Another group of investors has benefited from using CBT to combat overconfidence bias. By regularly reflecting on their trading mistakes and keeping a “trading journal,” they were able to identify patterns of overestimating their market knowledge.

Through CBT exercises, they developed more realistic expectations and reduced the frequency of high-risk trades.

Overall, CBT has proven to be a valuable tool in reshaping the psychological landscape of crypto investing, helping investors detach from short-term emotions and develop a more rational, level-headed approach.

Diversify Your Crypto Portfolios for Better Risk Management

Diversification is a well-known investment strategy that helps reduce risk by spreading investments across different assets. In crypto, where volatility is a constant challenge, diversification becomes even more critical.

By holding a mix of cryptocurrencies—ranging from established assets like Bitcoin and Ethereum to smaller altcoins—investors can mitigate the risks associated with the unpredictable price movements of individual coins.

A well-diversified portfolio ensures that even if one asset performs poorly, the overall portfolio remains balanced, reducing the chances of significant losses.

Risk management is another essential factor in reducing emotional biases. Having a clear risk management strategy can help investors avoid impulsive decisions driven by fear or greed. 

This usually involves setting stop-loss orders and determining the percentage of capital to allocate to each trade.

Recommended reading: Cryptocurrency High-frequency Trading Tactics For Every Trader

Conclusion

So, there you have it! How much you invest in crypto, is deeply influenced by these psychological factors and biases mentioned. These factors can cloud judgment and lead to emotional decision-making.

As an investor (or even an enthusiast), you need to fully understand cryptocurrency behavioral finance—such as FOMO, overconfidence, and herd mentality— to avoid or reduce their impacts.

Implementing long-term strategies, making use of tools like automated trading bots, and adopting cognitive techniques like CBT, can help maintain a level-headed approach.

I believe as AI and machine learning continue to evolve, they will further empower investors to make more rational, data-driven decisions. This will ensure a more stable and informed path in the crypto market.

Frequently Asked Questions