Does Bitcoin encourage the bandwagon effect for investors.
Bandwagon effect implies that people are doing some activity just because others are doing it, and not because of any value they see in the activity. history is replete with such examples, e.g. the california gold rush, the tulip mania, the dot com boom etc.. Is bitcoin similar?
Below I try to describe why the recent price rise may not be entirely because of the Bandwagon effect.
Firstly, Bitcoin is an asset that is not controlled by a central entity, and that is secure, international and fungible, liquid and is available in a limited supply for trade. The demand for such an asset has caught attention of hedgefunds(1), retail investors and futures markets alike. This sudden surge in demand, coupled by global economic uncertainties has created a surge in demand for an asset class that is not controlled by the government. This demand, at near constant supply, has caused prices to go up disproportionately in a short period of time, attracting more investors. What we have in Bitcoin for the very first time is an asset, that is not controlled by the government, is very liquid, does not need institutional backing, and is fungible globally for a wide variety of fiat currencies. The bandwagon effect is because of the large demand, owing to limited supply of a globally traded asset.
Secondly, the Price of Bitcoin has reflected the overall information in the marketplace. If one were to trace the rise and fall of bitcoin prices, they are all driven by events. In scientific terms, a classic event study would show a high correlation between bitcoin prices and global events. Some of the more recent events are: India’s decision to demonetize 80% of the circulated currency, China’s decision to ban Bitcoin exchanges on Mainland China and the approval of CME and CBOE to start a Bitcoin Futures instrument, Each of these main events, have reflected positively (in the case of the first and last event discussed above), and, negatively(in the case of China’s ban). Bitcoin prices markets, similar to securities markets are sensitive to all kinds of news and information.
Lastly, there is a scarcity in supply (partly decided by the algorithm, and partly because most investors are HODLers of Bitcoin). This scarcity in supply, for, a global asset that can easily be purchased with a few clicks of a mouse has caused prices to rise disproportionately.
While the number of new investors may not increase significantly, what is seemingly happening is that most buyers who buy BTC are holding onto it and not actively trading the asset class. Coinmarketcap.com shows that less than 5% of BTC is traded on an average per day, and the rest 95% are just being held. This 5% includes new BTC mined every 10 minutes, etc…