The volatility of cryptocurrencies has become something of a joke. The fact its value bounces around like a kangaroo in a clown car has given rise to countless memes about the emotional toll of being an investor.
A cryptocurrency’s price depends on a number of factors, at least according to the exchanges they are traded on. There’s supply and demand, the energy required to secure the blockchain, the ‘difficulty level’ of calculations, a currency’s utility, market dilution, the media, government action – so says a blog on the now defunct Bitconnect (which fatally crashed in January this year and had been described as a Ponzi scheme).
Or maybe it’s all just perception. According to new research from the UK’s University of Warwick Business School cryptocurrency prices are not influenced by any economic factors and are instead “driven purely by the mood swing of investors”.
Researcher Daniele Bianchi studied and analysed the weekly trading patterns of 14 of the largest cryptocurrencies, including Bitcoin, from April 2016 to September 2017 and found no correlation with any economic indicators that investors would base decisions on or with commodities.
She concluded – in a working paper entitled Cryptocurrencies as an Asset Class: An Empirical Assessment – that pricing is entirely influenced by past returns and the “hype and emotion of investors as they watch the price climb or drop”.
“These are not like normal currencies where a country’s economy will influence the price. Instead they share similarities to investing in an equity from a high-tech firm. As a matter of fact, most of these cryptocurrencies come to existence through unregulated crowd sales similar to IPOs, the so-called Initial Coin Offering,” Bianchi said.
“As a result, the market for cryptocurrencies may look similar to the dot.com bubble at the end of the 1990s, and it may be that only a handful of them survive, so for investors it is like choosing who will be today’s Amazon.”
Of course, established stock markets are hugely susceptible to investor mood – their so called ‘sentiment’. It is essentially gambling on the future, an ‘anticipatory beast’. Even gold, which like cryptocurrencies doesn’t yield income, is linked to the realities of production, output, and publicly declared reports by mining companies.
Bianchi, from the business school’s finance group, shows that traded cryptocurrency volume is “primarily driven by past returns and by a short-lived effect of aggregate market uncertainty”. Additionally, she found that trading activity had no significant relation to “macroeconomic factors”.
The paper indicates that Bitcoin made up more than 80 per cent of the overall traded cryptocurrency volume before early 2017, but then declined to about 40 per cent towards the end of the sample period in September 2017. It also found that up to early 2017 almost all trading in Bitcoin was done in Chinese Yuan before the Chinese Government embarked on shutting down the exchange platforms. The majority is now done in US dollar, followed by Japanese Yen and Euros.
“Cryptocurrencies have more in common with an equity investment in a company than an investment in a traditional currency. For instance, holding Bitcoin can be ultimately seen as an investment in the blockchain technology rather than a simple speculation,” Bianchi said.
“Having said that portfolio returns are highly volatile, thus negating the chances of using the popular momentum strategy for trading in cryptocurrencies. Although there is some predictive power of past performance for future returns, the profitability of a momentum strategy in cryptocurrency markets is significant only in the very short term.”
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