Fed study finds crypto investors driven by beliefs, easily swayed by returns

A Federal Reserve Bank of Cleveland study finds crypto investors hold sharply different views on returns and risk, while information about Bitcoin’s past gains can increase both desired allocations and actual crypto purchases.

A new Federal Reserve Bank of Cleveland working paper offers a provocative explanation for why cryptocurrency behaves so differently from traditional financial assets: Americans who buy crypto don’t simply have different demographics or risk appetites, they have radically different beliefs about digital assets’ future returns.

The finding could help explain both crypto’s persistent volatility and the way rallies can attract new buyers, potentially creating a feedback loop in which rising prices reinforce bullish expectations and pull more investors into the market.

Using repeated surveys of as many as 25,000 US households per wave, researchers Michael Weber, Bernardo Candia, Olivier Coibion and Yuriy Gorodnichenko found that expectations about crypto returns explain more of the variation in who owns cryptocurrency than a broad range of demographic characteristics. 

The paper, titled “Do You Even Crypto, Bro? Cryptocurrencies in Household Finance,” also uses a randomized information experiment to show that simply giving people information about Bitcoin’s (BTC) recent performance can increase both their desired crypto allocation and their subsequent purchases. 

Perceived risk of crypto by ownership. Source: Federal Reserve Bank of Cleveland

The researchers say the results point to a potential mechanism behind speculative bubbles: past gains can attract new investors, whose purchases push prices higher and potentially attract still more buyers. 

“Positive returns attract new participants, which raises the price further,” the authors write

That dynamic is particularly striking because cryptocurrency remains poorly understood by a large share of the population. In the researchers’ 2021 survey, 87% of people who did not own crypto said they didn’t know what return to expect from it over the following year. Among crypto owners, the figure was still 54%. 

Related: Canadian crypto ownership increases to 25%: Ontario survey

For those willing to make a forecast, however, the gap was enormous. Crypto owners expected an average 22% return over the following year, compared with just 7% among non-owners. Owners also tended to view crypto as less risky than non-owners did. 

The researchers found that expected returns were unusually powerful in determining ownership. A one-percentage-point increase in an individual’s expected crypto return was associated with a 0.8-percentage-point increase in the probability of owning cryptocurrency. Expectations about returns and risk together explained considerably more variation in crypto ownership than observable characteristics such as age, income and gender.