Bitcoin as an Information Cascade
https://www.scmp.com/business/banking-finance/article/2124079/why-bitcoin-could-trigger-next-global-financial-crash
Recently in class we learned about information cascades. There are two types of information cascades. This articles focuses specifically on informational effects. The articles discusses how many investors are leveraging their bets on bitcoin, which could lead to the next global economic crash. Many investors do not know what they are investing in rather they have learned that bitcoin is a buzzword and hear that it is the currency of the future. They see many people around them investing in bitcoin and wonder, “What am I missing?”. This has led investors to bet heavily on bitcoin making it one of the most overvalued “currencies” in the world. People believe that bitcoin will continue to raise in value forever because that has what it has done historically. This has led investors to leverage their bets on bitcoin in the hopes of receiving returns that are exponential. These leveraged bets when bitcoin begins to fall will cause people to lose their money exponentially fast also. However, people continue to invest in the cryptocurrency because they see many people around them doing the same. It is important to consider investments, especially leveraged investments, based on your calculations of the value and not just going with the flow.
What I find truly interesting about bitcoin is that while the investment in bitcoin is an informational effect, the true value in bitcoin comes from the direct benefit effect. Bitcoin is nothing more than a super secure set of numbers. There is no currency to back up bitcoin. The only way in which bitcoin has any value is if many people accept it as currency. This is a direct benefit effect in that you only the more people use bitcoin the more its worth. If you are the only person to own bitcoin then nobody will assign value to it and it becomes useless. However, if many people begin to accept bitcoin as currency, it gains value. People will desire to have it thus making it a worth something. The decision of others directly influence your payoff. If nobody uses bitcoin your payoff is instantly zero no matter how much bitcoin you own.