Introduction

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?

Your typical office rivalry just got a crypto twist! In one corner, we have the European Central Bank (ECB), the not-so-happy critic of Bitcoin and its crypto pals, especially regarding environmental concerns and its reputed misuse. Think of them as the seasoned manager who just doesn’t get the new intern's fascination with TikTok. In stark contrast, we have the European Securities and Markets Authority (ESMA), the crypto-friendlier arm of European regulation, now seriously mulling over the idea of slapping crypto assets right into the Undertakings for Collective Investment in Transferable Securities (UCITS). Just picture Regina George and Cady Heron from "Mean Girls" arguing over who gets to control the school dance playlist. This regulatory tug-of-war has laid bare the EU's fragmented stance on crypto, setting the stage for what could be a heated, yet hilarious, debate.

The ECB has been vocally skeptical about Bitcoin’s supposed virtues, noting its limited use in legal transactions and the fact it’s about as green as an asteroid mining operation. Their stand has been pretty clear: Bitcoin as a viable financial asset? Nah, not really. On the flipside, ESMA’s potential nod to crypto in UCITS investments reveals a stark divergence within the EU’s corridors of power. The possible inclusion of cryptocurrencies in these mainstream funds could legitimize an industry still viewed by some as the Wild West of finance. This internal EU clash could complicate regulatory efforts, presenting opportunities for more synergy or leading to a full-blown regulatory battle royale. Either way, grab your popcorn!

What do experts think?

Herd mentality among regulators

Let’s not overlook the blindingly obvious: countries love a good follow-the-leader game, especially in the all-too-public financial playground. Edul Patel, CEO & Co-founder of Mudrex, and Rajagopal Menon, VP of WazirX, have some spicy insights on this herd mentality. Patel pointed out, with just the right amount of awe and sarcasm, that the U.S. is like the trendsetting Taylor Swift of financial markets. Everyone sees the SEC approve something, and—BAM!—suddenly everyone wants to be part of that club. Menon echoed this sentiment, highlighting how the U.S. status as a financial giant gives it a big megaphone in policy circles. It’s basically high school popularity all over again—the cool kids are doing it, so naturally, everyone else follows suit.

This herd mentality isn't just about jumping on bandwagons; it's also driven by serious FOMO (Fear Of Missing Out) among countries. The U.S. approval of spot BTC ETFs has set off a ripple effect, causing a domino line of regulatory green lights across other nations. According to our experts, this cascade of approvals is powered by a belief that if the U.S. says it’s okay, it must be the next big thing. Essentially, the world of financial regulation is just a giant game of Simon Says, but with way higher stakes than your average playground game.

Implications for the crypto market

Now that regulators are hopping on the crypto bandwagon, what does it mean for the market? Edul Patel suggests we're riding the wave of a market FOMO, driven by the end of a two-year bearish lull. This time around, thanks to spot BTC ETFs, crypto might just go from being that weird kid playing alone to the popular kid at the big investors' table. Patel is optimistic about the increased adoption and growth, likening it to how once we all got a taste of Wi-Fi, there was no going back. It's a tantalizing thought—imagine mainstream institutions and your next-door neighbor both chucking loads of cash into the crypto kitty.

Rajagopal Menon added some glitter to this optimistic vision by highlighting how retail investors have stirred up FOMO among institutional investors like never before. Basically, it’s like retail investors brought the best homemade snacks to the party, and now hedge funds and financial big shots can’t help but dive in, gobbling up ETFs like there's no tomorrow. Menon anticipates this could lead to a diversified crypto market structure where traditional finance meshes with innovative digital assets, ultimately driving collective growth and market expansion.

Countries likely to follow suit

As the headlines buzz with announcements, which countries are next in line to join the crypto ETF dance-off? Edul Patel pointed his crystal ball towards Australia, predicting they might roll out their own spot Bitcoin ETFs by year-end. Not to be outdone, the London Stock Exchange is also gearing up, hinting they might soon take applications for Bitcoin and Ether Exchange-Traded Notes (ETNs). So, it’s safe to say the financial bigwigs are on board, giving everyone else in the global crypto race significant FOMO.

Rajagopal Menon threw the spotlight on the APAC and MEA regions, known for their proactive and crypto-friendly stances. He expects these areas might soon unveil products allowing both retail and institutional investors to slip into crypto investment more comfortably. Countries in these regions have been making noise with crypto-friendly moves, positioning themselves as potential global hubs for digital assets. It’s like the crypto equivalent of a global talent show, with each country trying to showcase the most compelling crypto investment product to attract attention and investment.

Potential impact of an ETH ETF

Alright, we’ve talked Bitcoin, but let’s not forget Ethereum—Bitcoin’s younger, more versatile sibling. What happens if the ETH ETF goes live? Edul Patel highlighted Hong Kong’s recent approval of spot ETH ETFs and the ongoing review by the U.S. SEC, suggesting it's only a matter of time before other countries jump on the ETH bandwagon too. Patel sees this as a major catalyst that could spur additional countries to roll out similar Ethereum-based investment options, pushing the crypto market into new realms of mainstream acceptance.

Rajagopal Menon took the speculation a step further, noting how Grayscale recently yanked its application for an Ethereum Futures ETF due to regulatory ambiguity. Could Singapore or Japan step up next? Both economies boast progressive, yet investor-friendly regulatory approaches and could lead the charge if they choose to prioritize Ethereum futures ETFs. If approved, such products could draw substantial interest and investment, potentially reshaping the market dynamics dramatically.

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.

The U.S. and Hong Kong have set a precedent, creating a ripple effect that could revolutionize the global investment landscape. Financial powerhouses in the Asia-Pacific region and the Middle East and Africa may be the next in line to roll out their crypto ETFs. Australia, for instance, is predicted to launch Bitcoin spot ETFs by the end of the year, while the London Stock Exchange is making strides towards accepting Bitcoin and Ether Exchange-Traded Notes (ETNs).

This burgeoning trend highlights the intricate dance of competitive collaboration among nations vying to become crypto hubs. The motive? Attracting a slice of the expanding crypto pie. However, this race may trigger disparate regulatory frameworks, adding a layer of complexity for investors seeking clarity and harmonization across markets. Imagine walking into different kitchens; one serves crypto in a porcelain bowl, the other in a paper plate – same dish, different presentation, and possibly different dining experiences.

Experts like Edul Patel and Rajagopal Menon point out that this is just the beginning. Patel asserts that the advent of Bitcoin spot ETFs will ignite broader crypto adoption, drawing in an ever-growing mix of institutional and retail investors. Menon concurs, projecting that this influx of interest will further fuel market participation and potentially propel crypto into mainstream financial portfolios.

Moreover, anticipation is building around the potential approval of Ethereum ETFs. While the U.S. SEC reviews its stance, Hong Kong has already green-lighted spot ETH ETFs. If these dominoes keep falling, expect jurisdictions such as Singapore or Japan to take the lead, carved by their progressive yet investor-friendly crypto regulations. Picture a global relay race, where each nation passes the baton of crypto adoption, uniquely shaping the market’s future.

In the coming months, brace yourself for a lively parade of announcements across continents. However, beware of the conundrum of regulatory arbitrage – where divergence in rules might create fragmented markets, possibly testing your navigational skills. The crypto market is on an exhilarating journey, traversing nascent stages and promising vistas. Buckle up, as the road ahead is poised with both intrigue and innovation.