Fun and Games - Investment Gamification and Implications on Capital Markets

Presenting to you our latest publication on gamification! Authored by Sivananth Ramachandran, CFA, CIPM, the report discussed gamification techniques, capital markets implications and reforms to enhance investor protection.

Summary

The Oxford English Dictionary defines gamification as “the application of typical elements of game playing (e.g., points, competition with others, rules of play) to other areas of activity to encourage engagement with a product or service.” Gamification—and the broader use of behavioural techniques—is used increasingly in a variety of settings, including education, health care, and financial services. When used well, these techniques can be a powerful tool for engagement, literacy, and driving positive outcomes. In the financial services context, gamification can attract new audiences to investing. It attracts younger audiences, those at a stage of their lives where they can and should take investment risks. The increase in trading activity as a result of engagement improves liquidity and reduces transaction costs. However, these same techniques can also be leveraged by firms to drive excessive trading, induce trading in complex or high-risk products, or encourage other harmful behaviours, all at the expense of clients.

The set of digital engagement practices adopted by market intermediaries, many of which are considered under the umbrella term gamification, is varied. They include such things as default game features—points, badges, and leader boards (PBLs)—and more sophisticated reward systems. They also include behavioural nudges, such as attractive app designs, attractive presentation of information and notifications, news stories based on trading activity, and encouraging investors to copy popular traders.

Gamification is accompanied by business model innovations that increase convenience—or reduce frictions—including zero-commission trading, fractionalisation of shares, increased ease of account opening and fund transfers, and lower investor due diligence requirements for complex derivatives and cryptocurrency trading. They are also supported by marketing, advertising, and distribution practices, including joining and referral bonuses (particularly free shares), evolving narratives in advertisements and promotional materials that amplify social status, and the use of social influencers.

Although gamification is commonly associated with brokerages, it is by no means exclusive to them. Also, not all gamification practices are designed to induce excessive or risky trading behaviours. We discuss some of the counterexamples in this report. Gamification is an important driver of the rise of selfdirected trading (SDT) by the new and growing class of retail investors since the COVID-19 pandemic, but social media is equally, if not more, important. Stock market investing has always been a social activity and has been likened to a beauty contest, where “we devote our intelligences to anticipating what average opinion expects the average opinion to be” (Keynes 1936, p. 156). With social media, it is easier than ever to infer the average opinion in real time, as evidenced by the success of such groups as WallStreetBets, or to be led by the opinion of the few, as the rise of social influencers attests.

In our fifth biennial CFA Institute Investor Trust Study (Trust Study), published in 2022, we surveyed more than 3,500 retail and 976 institutional investors across 15 markets on their overall trust in financial services and explored the drivers of trust, investors’ use of digital platforms, and their opinions on gamification and cryptocurrencies (select findings from the study are found in CFA Institute 2022a). We found that overall trust in financial services among retail investors is at an all-time high— 60% of those surveyed had high or very high trust in financial services (86% for institutional investors)—and technology is a significant driver of this trust. In terms of demographics, younger investors are more likely to use digital trading platforms, trust digital nudges, and report that digital platforms increase their frequency of trading, compared to older investors. These findings have important implications for market integrity and investor outcomes. 

Gamification and the rise of social validation–driven investing raise ethical concerns. At least some critics of gamification, such as Werbach and Hunter (2020), describe it as “high-fructose corn syrup of motivation” or “exploitationware” because it is addictive and may incentivize individuals to take actions that are against their interests (see, e.g., Bogost 2011). Investors’ motivation for investing varies, but in many surveys, they cite building financial security, supporting the nurturing of families, and expressing their values through product choices as the top reasons for investing, with social status routinely being lower in the order of importance (see, e.g., Statman 2019, Chapter 2). Desires for high social status are common, even if they are not easy for individuals to admit, but overall, we can interpret these motivations as reliably reflecting investors’ best intentions. If that is the case, gamification, which amplifies the importance of social status, may encourage investors to weight investment decisions toward emotional preferences (i.e., for social reward) at the expense of decisions weighted toward utilitarian motivations. In other words, gamification may nudge investors away from decisions focused on financial security and other intrinsic needs. As importantly, gamification can exacerbate many of the problematic biases that have been found in behavioural finance studies.

Furthermore, even if investors find gamification entertaining (in our Trust Study, nearly 20% of retail investor respondents reported entertainment/ speculation as the primary reason for using their retail trading accounts) and are willing to accept the risks, there are concerns that gamification is used deceptively by providers, with nudges directed toward outcomes that are most profitable for the financial intermediary, without informing users in plain language of that fact.

In the case of social influencers, there could be clear conflicts of interest with respect to how these influencers are compensated that are not disclosed to users. Also, there are risks associated with fake accounts and social media messages driven by bots. While influencers who make questionable product recommendations are troubling, it is worse when they also overstate their number of followers, which is a metric that is purported to imply a greater level of credibility.

In addition to ethical and investor protection concerns, these trends have implications for market integrity. The share of trading by retail investors overall has risen, driven by both their increasing numbers and their trading behaviours (International Organization of Securities Commissions 2022). Emerging research suggests gamification features can increase trading in riskier, popular stocks and strategies (Chapkovski, Khapko, and Zoican 2021). The risks to market infrastructure were visible in early 2021, when the stress caused by trading on meme stocks caused prominent brokerages, such as Robinhood, to face bankruptcy. The recent crash in cryptomarkets has led many experts and investors to reassess the purported stability of algorithmic stable coins and potential contagion effects. 

But there are hidden long-term risks as well. Retail investors’ early experiences may have an impact on their risk appetite and attitudes toward stock markets, to the detriment of their financial health. For example, individuals who have lived through stock market crises are more likely to stay away from stock markets altogether or reduce their investments in stocks (Malmendier and Nagel 2011). The pandemic created a new class of investors for the first time, and some of these investors had better outcomes than others. The lucky ones might mistake their luck for skill and increase their risk taking, and the risk-taking effects may last for a long time. In contrast, for those who lost money, their risk aversion may linger too, to their own detriment. 

Given these dynamics, regulators face difficult choices in how they respond. There are a variety of approaches under discussion. One popular approach by some regulators is to treat gamification and nudges as active recommendations, with associated responsibilities pertaining to, for example, enhanced due diligence and suitability requirements. Other approaches include a ban on or regulation of gamification techniques (sometimes referred to as “confetti regulation”), stepping up oversight of social media and enforcement of laws pertaining to social media, and licensing requirements for social influencers and cross-border firms offering cryptocurrencies, forex derivatives, and other complex derivatives. With respect to licensing requirements for social influencers, we believe that they should be agnostic to platforms, but regulators could make a distinction between general and personal advice, with a limited licensing requirement for the former. 

We believe gamification and other trends are here to stay, and we need to develop the right set of approaches to maximize their benefits. As we discuss more fully in this paper, our recommended approach is three-pronged—comprising principles, conduct, and disclosures.