Risk and Uncertainty in finance: we hate not knowing, but why is crypto worse?

Jul 1, 2021

the anchoring effect

The need for certainty is a basic human desire. We get queasy when we feel like we don’t have a good handle on what’s going on. And this discomfort is especially sharp for those in the decentralized finance (DeFi) space because there’s much more at stake than the value of their crypto portfolios.

In typical equities investing, we don’t interpret the price of a single asset as the oracle for the unfolding future of an entire industry, money, or commerce. But in DeFi, the stakes seem much higher, because there’s the perception that BTC price is tethered to DeFi adoption itself and forecasts its creative destruction of the known financial system.

Indeed, playing out before our eyes is the future of money, transactions, creation of novel asset types, the evolution of laws and regulations, and new fixes for old problems (and old problems for new fixes), in what often feels like perpetual chaos. As cryptocurrency markets unpredictably heave and ho amidst this-or-that celebrity tweet, we can’t help but collectively wonder whether we’re amidst a revolution and if crypto prices are the leading indicator for where it’s all going.

In economics we distinguish between scenarios of risk—where we know the range of outcomes and how likely each one of those outcomes is (think roulette)—from situations of uncertainty—where we don’t know what can happen or how likely. We strongly prefer knowing probabilities and our call our dislike for not knowing “ambiguity aversion”. We dislike it so much that we are likely to choose worse options solely to avoid ambiguity.

The DeFi space is new and ever changing so everyone contends with constant, unpleasant uncertainty. But remember, chances are that BTC price is not an accurate fortune teller for the fate of the financial world. Instead, look for genuine innovations, letters of intent, commercial agreements, patents, and other traditional measures of material integration and creation to guide your decisions and reduce that nagging sense of not knowing to a manageable minimum.

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