Understanding Information Cascades in the Crypto Boom

Earlier this week, Bitcoin prices jumped greatly in response to the Ukraine-Russia conflict. In U.S. markets, bitcoin was recently trading near $44,000 Tuesday night, up more than 17% since two days before (WSJ). Surges in prices in financial assets are an example of information cascades. Information cascades can occur “when people make decisions sequentially, with later people watching the actions of earlier people, and from these actions inferring something about what the earlier people know” (E&K 484). I will go through the process of Bitcoin price increases in the context of the steps leading up to an information cascade. First, the decision to be made by the individual is whether or not to purchase Bitcoin. Secondly, people can observe the choices made by other individuals purchasing bitcoin based on the rise or fall of the price, which is visible to everyone. The private information that helps guide each person’s decision is their perceived value (and future value) of the asset. There is plenty of information available online about the value of Bitcoin, but each person can choose how to weigh the information they have access to in order to assign value to the asset, and people’s depth of and accuracy of knowledge can vary greatly. Lastly, people don’t know what other information other people know about bitcoin, or how they made their value judgment, but they can see what kind of value judgment was made.

This week, millions of people have decided to purchase bitcoin causing the price to rise drastically. Western sanctions imposed on Russia have effectively cut Russia off from the global financial network, and Ukraine has imposed strict capital controls as well. Some speculate that bitcoin and other cryptocurrencies could be an outlet for Russians trying to get around these sanctions, and this has bolstered the argument for blockchain products that could potentially compete with Russia’s existing system to process daily payments.

Certain investors assume if they buy bitcoin now in anticipation of an investment wave predicated on building blockchain products, they will get high returns as that industry is built out. This creates an information cascade, because as the price of bitcoin goes up on the basis of this sentiment, the more and more credible this sentiment seems as the asset increases in value. Additionally, because crypto currency is such a new asset class, imitating behavior is even more common as many people assume those who are buying crypto know more or know better than themselves.

References:

https://www.wsj.com/articles/bitcoin-demand-booms-in-ukraine-and-russia-11646165756

https://www.cs.cornell.edu/home/kleinber/networks-book/networks-book-ch16.pdf