From Tulip Mania to crypto ETFs: a journey through herd mentality

How does the psychology of herd mentality influence regulators’ decisions on crypto, and what does it mean for the market’s future?

In January 2024, the U.S. Securities and Exchange Commission (SEC) made a landmark decision, approving the first-ever spot Bitcoin (BTC) exchange-traded funds (ETFs). This move sparked a global ripple effect, with other countries and regions quickly following suit.

Following the U.S.’s lead, Hong Kong regulators approved the launch of spot BTC and Ethereum (ETH) ETFs in April 2024. Now, the European Union (EU) is contemplating a similar move, with the European Securities and Markets Authority (ESMA) seeking expert opinions on adding crypto to the investment product market.

The ESMA’s inquiry includes assessing whether Undertakings for Collective Investment in Transferable Securities (UCITS) could include crypto assets. 

These investment funds, valued at a staggering 12 trillion euros ($12.95 trillion), are already diversified across various asset classes such as structured loans, commodities, and emission allowances and crypto could be next in line.

If approved, UCITS funds could become one of the largest mainstream funds with crypto exposure, albeit in a diversified manner.

This transition reflects a herd mentality among regulators, with jurisdictions like Hong Kong and the EU embracing crypto just months after the U.S. approval.

What does this say about regulators across the world, and what could it mean for the crypto market this year? Would it inspire other countries to follow suit? Let’s dive into it.

Is the crypto herd mentality at play?

Herd mentality bias is a psychological phenomenon where individuals rationalize their actions based on the behavior of a larger group. 

This behavior can manifest as buying or selling assets simply because others are doing the same, leading to market bubbles or panics. 

The psychology of herd mentality in trading suggests that individuals may follow the crowd out of a sense of safety or fear of missing out (FOMO).

The International Monetary Fund (IMF) identifies three key reasons for traders and investors succumbing to herd instincts: a belief that others have access to valuable information, incentives provided by compensation schemes, and an intrinsic preference for conformity. 

One of the earliest documented examples of herd mentality in finance is the Dutch tulip mania of the 17th century. During this time, the prices of tulip bulbs reached extraordinary levels, driven by speculation and herd behavior. The bubble eventually burst, leading to a dramatic collapse in prices.

In more recent times, the dotcom bubble of the late 1990s and early 2000s is another example of herd mentality in action. Investors flocked to internet-related technology stocks, driving up prices to unsustainable levels. When the bubble burst, many of these companies went bankrupt.

Meanwhile, the U.S. currently ranks as the third-largest crypto market in the world based on the total number of users, standing at roughly 52 million. This large user base, coupled with approximately 45% of users holding $5000 or more in crypto, suggests the U.S.’s importance in the global crypto trade and commerce market. 

As a result, regulatory decisions in the U.S. carry substantial weight and often influence other jurisdictions to follow suit. It is likely that regions like Hong Kong and the EU are following the U.S.’s lead, possibly due to the belief that regulated crypto investments are the future of finance and FOMO.

However, this alignment could also lead to regulatory arbitrage and competition among countries vying to attract crypto businesses and investors.

ECB vs ESMA: rivalry in making?

Just a few months ago, in February 2024, the European Central Bank (ECB) expressed strong skepticism towards crypto assets, particularly Bitcoin. 

This skepticism echoes their stance from November 2022, where they mentioned Bitcoin’s shortcomings, such as its limited use in legitimate payments and environmental concerns related to its mining process.

The ECB’s position is clear: Bitcoin has not fulfilled its promises of becoming a global decentralized digital currency or a viable financial asset. 

In contrast, the ESMA has shown a more open approach to crypto assets. This raises the question of why there is a discrepancy between the ECB’s caution and ESMA’s stance.

This divergence between the ECB and ESMA raises concerns about the coordination and coherence of regulatory efforts within the EU, leaving several questions unanswered.

Meanwhile, ESMA’s consideration of adding crypto assets to UCITS has several implications for the crypto market:

• Increased legitimacy: Inclusion in UCITS would grant crypto assets a higher level of legitimacy and recognition in mainstream investment circles.
  
• Market growth: Mainstream acceptance could drive increased liquidity and market expansion. More investors, both institutional and retail, might enter the market, boosting demand for crypto investments.
  
• Regulatory harmonization: Aligning regulatory approaches across jurisdictions could lead to greater harmony and reduced uncertainty for market participants.

What do experts think?

Crypto.News spoke with Edul Patel, CEO & Co-founder of Mudrex, and Rajagopal Menon, Vice President of WazirX, and gained key insights into this discussion.

Herd mentality among regulators

Both Patel and Menon acknowledged the trend of countries following the lead of the U.S. in regulatory decisions. 

Patel emphasized the U.S.’s status as the largest and most influential power in financial markets. He pointed out that the SEC’s approval of spot BTC ETFs was a key catalyst for other countries to consider similar products.

“The United States has long been the largest and most influential power in financial markets, largely due to its status as a developed nation….Cryptocurrency was first introduced and widely adopted in the U.S. before spreading to the rest of the world…Following the SEC’s approval and observing the traction and inflows into these ETFs, Hong Kong has also approved both Bitcoin and Ethereum spot ETFs. This approval has instilled confidence, leading more countries to plan similar actions in the coming months.”

Menon echoed similar sentiments. He noted that the U.S.’s approval of policies often leads to their mainstream adoption.

“The U.S. has a strong advocacy network in the crypto community which is instrumenting regulatory green flags. Usually all policies become mainstream after the U.S. approval due to it being one of the largest economies and the strength of the dollar and its index impacting prices of different assets.” 

Implications for the crypto market

Discussing the implications of these trends for the crypto market, Patel noted that the approval of spot BTC ETFs could lead to increased crypto adoption as mainstream investment options.

“There is currently FOMO in the market as prices peaked following a two-year bearish cycle. But in the long run, with the launch of Bitcoin spot ETFs and more institutions and retail investors entering the market, it is likely to drive increased adoption and growth.”

Menon echoed Patel’s remarks. He suggested that the approval of ETFs could potentially lead to increased market participation and growth in the long term.

“The impact of Bitcoin post halving is different this time as the range of stakeholders are broader than any other time in history. For the first time ever retail investors’ enthusiasm induced FOMO among institutional investors and they are heavily gobbling up ETFs to add to their portfolio.”

Countries likely to follow suit

Both experts identified different regions as potential candidates to follow the trend of approving similar products. Patel mentioned:

“Australia is currently on track to launch Bitcoin spot ETFs by the end of the year. In a similar move, the London Stock Exchange has recently announced its plans to start accepting applications for Bitcoin and Ether Exchange-Traded Notes (ETNs).” 

Menon added that countries in the APAC and MEA regions have facilitated many crypto-friendly moves and are actively trying to establish themselves as crypto hubs. He suggested:

“Countries in APAC and MEA could be in line to come up with products that let Trad Fi retail investors and institutional investors get exposure to crypto through services like ETFs. They have facilitated many crypto friendly moves and are actively trying to build a crypto hub.” 

Potential impact of an ETH ETF

Regarding the potential approval of an Ethereum spot ETF, Patel highlighted Hong Kong’s approval of spot ETH ETFs and the ongoing review by the U.S. SEC as major catalysts. He suggested:

“Hong Kong has already approved spot ETH ETFs and the U.S. SEC is reviewing it. So, it is likely that other countries might also follow the trend shortly.” 

Meanwhile, Menon added:

“Ethereum ETFs are at a speculative stage. Grayscale recently withdrew its application for an Ethereum Futures ETF because of the ambiguity around the approval. However, if there is a chance that other economies could take the lead on this, it could be Singapore or Japan given their progressive yet investor friendly approach to crypto adoption.”

What to expect next?

Following the approval of spot BTC ETFs in the U.S. and Hong Kong, expect a global trend of countries considering similar products. Look for announcements from regions like APAC and MEA, Australia, and the UK. 

However, as countries compete to attract crypto businesses, regulatory competition may arise, leading to both challenges and opportunities. Overall, these developments indicate that crypto has come a long way and still has a long way to go.