Shimon Kogan, Igor Makarov, Marina Niessner, Antoinette Schoar recently finalized a project sponsored by Inquire Europe.
Cryptocurrency prices over the last decade have famously been marked by significant volatility and large boom and bust cycles, which have given rise to new investment mantras, such as FOMO — “fear of missing out” or FUD — “fear, uncertainty and doubt”. Yet only little evidence exists on how investors trade in these new assets and how they form price expectations about cryptocurrencies.
Unlike traditional markets, trading in cryptocurrency markets has been dominated by retail investors. To study their investment behavior, we use a dataset of trades from 200,000 individual retail accounts on eToro, a large international retail discount brokerage, over the period from 2015-2019. eToro was one of the first platforms to allow retail investors to trade in cryptocurrencies along with traditional assets. This unique set up allows us to analyze differences in trading behavior across assets, holding constant individual preferences and circumstances.
We document a set of new facts by contrasting trading in cryptocurrencies with trading in stocks and commodities. First, we show a stark dichotomy in investors’ trading strategies across different assets. Retail investors largely trade as contrarian in the stock market but in contrast they are willing to hold on to their crypto currency investments even after large changes in the returns which results in investors following momentum strategies when trading in crypto currencies. Importantly, these results even hold when we focus on the same investors trading across these different assets. We confirm that this dichotomy in trading behavior is not driven by composition effects of who trades crypto, nor inattention to crypto prices so that people are passively affected by price swings. We also show that the results are not a naïve version of optimism where investors had never seen crypto prices crashing before and believe that they can only go up. In a nutshell, cryptocurrencies indeed seem to be special in retail traders’ minds. Interestingly, this dichotomy in trading behaviors holds for a majority of retail investor types and heterogeneity in individual characteristics explains only a very small fraction of how people invest in cryptocurrencies. In other words, independent of age, financial education, income, and several other characteristics, we see the same momentum trading in cryptocurrencies. Finally, we show that our results are not the outcome of inattention, differential preferences for lottery-like assets, lack of cash flow information about cryptocurrencies, or differences in fee structures.
Our results point to a model where investors seem to form adaptive expectations about cryptocurrency prices. What is behind this type of beliefs? On the one hand, retail investors might be prone to positive and negative sentiment cycles, or they might have convinced themselves that crypto currencies are the newest investment vehicle and thus they need to invest in them no matter what the price dynamic is. On the other hand, there might be a less sentiment-driven explanation. The value of cryptocurrencies is largely based on expectations about potentially wider future adoption, which in turn might be influenced by their current value. Positive returns of cryptocurrencies might increase the likelihood that regulators look more favorably at them, or that institutional investors start investing in them. This would create positive (and negative) feedback loops and could naturally justify the momentum strategies we see in our data. This same price dynamic is not observed for other assets where adoption has already happened and most people who ultimately want to invest in the asset are already participating.
You will find the full paper on our website