Innovation abounds in the world of finance, with new financial products coming online at a dizzying pace. Until now, academic research has focused mostly on how and why new financial instruments get created, rather than what happens after they are introduced, notes Nagpurnanand Prabhala, a professor of finance at Johns Hopkins Carey Business School.
In a new working paper, he and his collaborators aim to fill that gap by analyzing the diffusion of today’s hot digital asset: cryptocurrency.
“In particular, we look at two outcomes: the ownership of cryptocurrency and the intent to adopt,” said Prabhala, the Francis J. Carey, Jr. Endowed Professor in Business. In characterizing both early adopters and later intended adopters of cryptos, he and his colleagues highlight what they describe as “the adopters’ dilemma.”
“Because cryptocurrency is an investment whose return depends on subsequent adoption, the early holders profit only if later adopters arrive,” writes the study team, which also includes Vikramaditya S. Khanna of Michigan University and Manju Puri of Duke University.
The dilemma, as the researchers lay it out, is that early and later adopters “are different households that want different things.” Those who got in early on cryptos are, for example, risk-tolerant and distrust financial institutions, while later adopters are put off by the absence of a regulatory framework. So, for cryptocurrency to succeed, Prabhala says, early adopters “are led to accept the regulatory and institutional features that they originally rejected.”
Impatient vs. risk averse
For their study, the team designed and fielded a survey of 1,774 U.S. households through the University of Michigan’s Survey Research Center and obtained data on more than 400 demographic, psychometric, sociodemographic, attitudinal, and belief metrics. Of those households surveyed, 14% own crypto and 19% of the never-owners would consider owning it.
“We found the crypto owners are disproportionately young, male, risk-tolerant, impatient, and prone to gambling, which we measured by lottery purchases and participation in fantasy sports leagues,” said Prabhala. Moreover, adopters tend to be financially literate, viewing crypto as a complement, not a substitute, for the traditional financial system. “In general, people who jump in are impatient. They want to make the quick buck,” he says.
In contrast, Prabhala notes, prospective adopters have lower financial literacy and tend to rely on financial advisors for investment guidance; their largest barrier to adoption is lack of knowledge, followed by concerns around scams, cyber-theft and failure of the platform. “Most tellingly,” the researchers write, “access to cryptocurrency through retirement plans — the most direct measure we have of institutionalization — carries a negative coefficient for current owners and a strong positive one for prospective adopters.”
Therein lies the rub, says Prabhala. “The people who own crypto are anti-institution risk-takers; the people who might adopt next want the institutions, clarity, and protections that the early adopters were fleeing.”
“The people who own crypto are anti-institution risk-takers; the people who might adopt next want the institutions, clarity, and protections that the early adopters were fleeing.”
Setting guardrails
Two decades have passed since the first white paper on Bitcoin, which essentially introduced the world to the concept of cryptocurrency, conceived as an alternative to the formal financial system and fiat money.
The unique nature of cryptocurrency — it is highly decentralized, reliant on blockchain technology, and blends multiple financial roles — has made it difficult for regulators and legislators to develop regulatory frameworks, even all these years later, the researchers note.
But based on their study findings, Prabhala believes some regulatory protections are necessary in order for cryptocurrency to ultimately find its financial footing by luring later, more risk-averse investors. The regulatory question, he said, “is really about how to set guardrails to channel digital asset innovation without strangling it."
Prabhala looks to the securities industry for a model that might be most effective: “a regime that turns on disclosure — initial and ongoing — backed by liability for what is disclosed.” Later adopters of crypto are looking for clarity about the rules, as well as protection against theft and fraud, he says.
“Transparency and governance — later adopters are craving that,” he said. “Such protection needs to be brought into the cryptocurrency market. Sunlight is good.”
