Yale University economic scholars Yukun Liu and Aleh Tsyvinski have recently published a paper discussing the behavior of bitcoin and how the risk-return tradeoff of cryptocurrencies is different from that of other investment instruments and so are the factors affecting them.
Factors to predict the Cryptocurrency (Bitcoin, Ripple, and Ethereum) returns
In the study, Tsyvinski and Liu found that cryptocurrencies try to establish that the risk-return tradeoff of cryptocurrencies (Bitcoin, Ripple, and Ethereum) is distinct from those of stocks, currencies, and precious metals. The abstract of the paper reads as
“We establish that the risk-return tradeoff of cryptocurrencies (Bitcoin, Ripple, and Ethereum) is distinct from those of stocks, currencies, and precious metals. Cryptocurrencies have no exposure to most common stock market and macroeconomic factors. They also have no exposure to the returns of currencies and commodities.
In contrast, we show that the cryptocurrency returns can be predicted by factors which are specific to cryptocurrency markets. Specifically, we determine that there is a strong time-series momentum effect and that proxies for investor attention strongly forecast cryptocurrency returns. Finally, we create an index of exposures to cryptocurrencies of 354 industries in the US and 137 industries in China.”
While explaining various correlations and divergences, the paper investigates various factors that are specific to the crypto industry. The research considers, Cryptocurrency Momentum, Investor Attention towards cryptos and against cryptos, Crypto Price-to-“Dividend”, Crypto Volatility and Supply Factors. The study considers these factors to be key in determining the momentum, price of a cryptocurrency and the variations of cryptocurrency returns.
Cryptocurrencies have a potential to affect a number of important industries
While the paper considers only Bitcoin, Ethereum and Ripple for its research, it does significantly conclude that cryptocurrency returns have low exposures to traditional asset classes – stocks, currencies, and commodities. The paper’s findings s cast doubt on popular explanations that the behavior of cryptocurrencies is driven by its functions as a stake in the future of blockchain technology similar to stocks, as a unit of account similar to currencies, or as a store of value similar to precious metal commodities. It also casts light on the fact that the returns of cryptocurrency can be predicted by two factors specific to its markets – momentum and investors’ attention. The findings of this research questions popular explanations that supply factors such as mining costs, price-to-” dividend” ratio, or realized volatility are useful for predicting the behavior of cryptocurrency returns.
The research paper thus concludes that the blockchain technology embodied in cryptocurrencies has a potential to affect a number of important industries. With this conclusion cryptocurrencies especially, Bitcoin, Ethereum and XRP should definitely be a buy in every portfolio.