Unraveling Cognitive Dissonance in Crypto and DeFi: A Closer Look
In the world of cryptocurrency and decentralized finance (DeFi), the term “cognitive dissonance” might not be one that immediately comes to mind. However, it plays a significant role in the decision-making processes of investors, traders, and enthusiasts in these rapidly evolving and often volatile markets. In this article, we will explore what cognitive dissonance is, how it manifests in the crypto and DeFi space, and provide real-world examples backed by research to illustrate this phenomenon.
Understanding Cognitive Dissonance
Cognitive dissonance is a psychological theory developed by psychologists Leon Festinger and Elliot Aronson. It refers to the discomfort and mental tension individuals experience when they hold two contradictory beliefs or attitudes or when their actions contradict their beliefs. In such situations, people are motivated to reduce this dissonance by altering their beliefs or behaviors to create consistency.
In the context of cryptocurrency and DeFi, cognitive dissonance often arises due to the following factors 👇👇
1️⃣ High Volatility: Cryptocurrency markets are known for their extreme price swings. Investors may experience cognitive dissonance when they hold an asset they believe will increase in value but observe it plummeting in a bear market. This is also commonly referred to “bag-holding” or “diamond-handing”, the former being a label used by non-holders and the latter by holders.
This dissonance further extends to participants with self-proclaimed “high-risk tolerance.” Extreme volatility can lead to significant gains or losses very quickly. Investors with “high-risk tolerance” may experience heavy dissonance when they find themselves anxious or regretful after substantial losses (aka gambler’s dissonance).
2️⃣ Confirmation Bias: Investors often seek information that confirms their existing beliefs about a cryptocurrency’s potential. When contradictory information arises, they may struggle to reconcile it with their preconceived notions.
When a token is rising in value, holders tend to extol its utility as the cause of the rise, and when that same token is dropping in value, the same holders tend to criticize the lack of utility and/or the marketing of its utility.
3️⃣ Fear of Missing Out (FOMO): The fear of missing out on potential gains can lead individuals to invest in cryptocurrencies or DeFi projects without conducting thorough research. Later, they may experience cognitive dissonance when confronted with negative news or outcomes.
This especially occurs when the price charts do not continue moving in the expected direction and soon this investor becomes a “community member” for that token.
4️⃣ Decentralization vs Centralization: The crypto and DeFi space is built on the principles of decentralization and trustlessness. However, some projects or platforms within the space may compromise on decentralization for scalability or convenience. Users who value decentralization may experience cognitive dissonance when using or supporting such platforms — or especially when they discover their favorite “decentralized” platform is actually quite centralized.
This dissonance is amplified in the case of a DeFi exploit as many victims will then call out for centralized assistance (governments, law enforcement, blockchain leaders) to save them.
5️⃣ Regulation vs. Anonymity: Some crypto users appreciate the anonymity and privacy offered by blockchain technology, while others are concerned about potential government regulation. Individuals who want both privacy and regulatory compliance may struggle with cognitive dissonance. Anyone wishing to see this dissonance in a community can simply mention the idea of KYC (know your customer) in a DeFi discord and observe the resulting conversations.
How to Mitigate Cognitive Dissonance in Crypto and DeFi
1️⃣ Diversify Your Portfolio: Rather than putting all your resources into a single cryptocurrency or DeFi project, diversify your holdings to reduce the impact of cognitive dissonance caused by extreme price volatility. Additionally, it is important to diversify your entire investment portfolio so that DeFi and cryptocurrency takes up a healthy ratio.
A common expression in DeFi is “only risk what you can afford to lose” and the way to effectively check yourself on this is in the frequency of your DeFi portfolio monitoring. If you are checking your portfolio hourly (or even daily) then you’ve most likely invested more than you can afford to lose.
2️⃣ Stay Informed: Continuously educate yourself about the assets you invest in. Be open to new information and be prepared to reevaluate your beliefs and actions if new evidence emerges.
This may seem counter to the suggestion above, but that one refers more to “price checking”. In this point, it’s more about getting to know your DeFi token intimately (just as you might research a company for stocks), and then be prepared to “divorce your bags” when your differences become “irreconcilable”.
3️⃣ Seek Diverse Perspectives: Engage with a diverse community of investors and experts who can provide different viewpoints and challenge your preconceptions.
Token tribalism is one of the leading contributors to dissonance in this space. Get to know your token and of course participate in the community, but do the same for its “competitors” — this will go at the root of your dissonance and help maintain a healthy mental balance.
There are many more examples of cognitive dissonance in this space and I’d love to hear your thoughts!
What am I missing and what are some of your suggestions for lessening or preventing DeFi dissonance?
