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Munich Personal RePEc ArchiveFactors Influencing CryptocurrencyPrices: Evidence from Bitcoin,Ethereum, Dash, Litcoin, and MoneroSovbetov, YhlasLondon School of Commerce8 January 2018Online at https://mpra.ub.uni-muenchen.de/85036/MPRA Paper No. 85036, posted 18 Mar 2018 05:00 UTC

Journal of Economics and Financial Analysis, Vol:2, No:2 (2018) 1-27Factors Influencing Cryptocurrency Prices: Evidence fromBitcoin, Ethereum, Dash, Litcoin, and MoneroYhlas SOVBETOV*Department of Economics, London School of Commerce, United KingdomAbstractThis paper examines factors that influence prices of most common fivecryptocurrencies such Bitcoin, Ethereum, Dash, Litecoin, and Monero over 20102018 using weekly data. The study employs ARDL technique and documentsseveral findings. First, cryptomarket-related factors such as market beta, tradingvolume, and volatility appear to be significant determinant for all fivecryptocurrencies both in short- and long-run. Second, attractiveness ofcryptocurrencies also matters in terms of their price determination, but only inlong-run. This indicates that formation (recognition) of the attractiveness ofcryptocurrencies are subjected to time factor. In other words, it travels slowlywithin the market. Third, SP500 index seems to have weak positive long-runimpact on Bitcoin, Ethereum, and Litcoin, while its sign turns to negative losingsignificance in short-run, except Bitcoin that generates an estimate of -0.20 at 10%significance level.Lastly, error-correction models for Bitcoin, Etherem, Dash, Litcoin, and Moneroshow that cointegrated series cannot drift too far apart, and converge to a longrun equilibrium at a speed of 23.68%, 12.76%, 10.20%, 22.91%, and 14.27%respectively.Keywords: Cryptocurrency; Bitcoin; Ethereum; Cointegration; ARDL Bound Test;Error Correction Model.JEL Classification: G12, D40, C51, C59.*Research Fellow, London School of Commerce, Chaucer House, White Hart Yard, LondonSE1 1NX, United Kingdom.Email: ihlas.sovbetov @lsclondon.co.ukTel: 44 (0)207 403 1163/ Ext.364Page 1Electronic copy available at: https://ssrn.com/abstract 3125347

Y. Sovbetov / JEFA Vol:2 No:2 (2018) 1-271. IntroductionCryptocurrencies have become one of the most trending topics in recenteconomic and financial issues. Since Dotcom crisis, the commerce on internet (ecommerce) has been rapidly increasing and retail industries have beenundergoing a revolution as internet sales are booming with more and more techsavvy consumers go online to shop. The appetite of stock market investors for ecommerce shares seemed insatiable as investments on internet retailer weremassively oversized, despite fears over the future of the Internet after the dotcombubble burst and serious concerns about the safety of online shopping by creditcards. Until birth of first cryptocurrency -Bitcoin- in 2009, the online commercewas mainly intermediated by financial institutions serving as trusted third partiesto process electronic payments. Although this system was well enough for mosttransactions, it was working very slowly due to controls of financial institution(problem of privacy and trust) and it was somewhat cost (transaction andcommission costs).It triggered emerge of decentralized cryptocurrencies that bypass financialcontrollers, thus, transactions are very fast, smooth, and has zero cost. Acryptocurrency is defined as “a digital asset designed to work as a medium ofexchange using cryptography to secure the transactions and to control thecreation of additional units of the currency”. First ever use of cryptocurrency inonline trade was on May 22nd 2010 by Laszlo Hanyecz, a computer programmerfrom Florida, for two pizzas with the amount agreed at 10,000 Bitcoins (Yermack,2013), which would be equivalent to 155.80 million today (December 2017).In 2017, the popularity and use of cryptocurrencies has increaseddramatically. People are "investing" vast sums of money into "assets" that haveno history of producing revenue, and those assets are rising in price only becauseother people are also pouring money into them. Billions of dollars have beenpoured into more than 1,000 new digital coins issued by start-ups in 2017. Thesecoins mimic the construction of Bitcoin, meaning they can be freely traded ondigital exchanges and have no central bank standing behind them. This has raisedmany doubts and questions about current and future of decentralizedcryptocurrencies. There are two major views. One side argues that it is a bubblewith no real assets that inevitably will end with burst. The other side opines thatcryptocurrency markets will become an avenue that will give millions of people anopportunity to participate in a global financial network worth tens of trillions ofdollars. From young millennials in developing nations with small savings and bigambitions to mom-and-pop business owners looking to reinvest some profits inPage 2Electronic copy available at: https://ssrn.com/abstract 3125347

Y. Sovbetov / JEFA Vol:2 No:2 (2018) 1-27promising crypto-projects, these kinds of people will be the backbone of thisindustry.This also has increased interest of cryptocurrencies in economics andfinancial research sphere. Although their literature is scant, number of empiricalresearch are growing remarkably. In this respect, we also conduct a study thatexamines price influences of cryptocurrencies both in short- and long-run over2010-2018 using ARDL technique on weekly basis. As statistical data ofcryptocurrency are newly established, we build the "Crypto 50" index with its totaltrading volume and volatility to be used in our analysis. This index is comprised oftop 50 cryptocurrencies according to their market capitalisation rank. We samplemost common five digital currencies such as Bitcoin, Ethereum, Litecoin, Dash,and Monero, and we scrutinize how these currencies interaction with stockmarket (SP500 index), gold prices, and with macroeconomic indicators (Interestrate) both in short- and long-run.2. Characteristics of CryptocurrencyA cryptocurrency is a digital or virtual currency that uses cryptography forsecurity. A cryptocurrency is difficult to counterfeit because of this securityfeature. A defining feature of a cryptocurrency, and arguably its most endearingallure, is its organic nature; it is not issued by any central authority, rendering ittheoretically immune to government interference or manipulation. It is designedfrom the ground up to take advantage of the internet and how it works. Instead ofrelying on traditional financial institutions that verify and guarantee yourtransactions, cryptocurrency transactions are verified by the user's computerslogged into the currency's network. Since the currency is protected andencrypted, it becomes impossible to increase the money supply over a predefinedalgorithmic rate.One cryptocurrency, in particular, has entered the public lexicon as the go-todigital asset: Bitcoin, often is regarded as father of cryptocurrencies and all othercryptocurrencies are referred as altcoins. Since 2009, the finance world has beenwatching the crackerjack rise of Bitcoin with a combination of fascination and, inmany cases, severe skepticism. Characteristics of Bitcoin make it fundamentallydifferent from a fiat currency, which is backed by the full faith and credit of itsgovernment. Fiat currency issuance is a highly centralized activity supervised by anation’s central bank. On the other hand, the value of a Bitcoin is whollydependent on what investors are willing to pay for it at a point in time. It usespeer-to-peer blockchain network (chronologically arranged chain of blocks whereeach block has a list of transactions information) where all members are equalPage 3

Y. Sovbetov / JEFA Vol:2 No:2 (2018) 1-27and there is no central server that tells everyone what to do (Nakamoto, 2008).This decentalisation is maintained on Satoshi Nakamoto’s (2008) idea ofcombining "proof of work" (PoW) with other cryptographic techniques. The PoW,mathematically, is a hash function with a large number of answer variances, theso-called "beautiful" hash is considered to be the one that is characterized bystarting with 15 zeros. The hash of each block is algorithmically directly linked tothe previous block. That is, if we hypothetically represent the hash function in theform,𝐻𝐻𝐻𝐻𝐻𝐻ℎ 𝑜𝑜𝑜𝑜 𝑐 𝑏𝑏𝑏𝑏𝑜𝑜𝑐𝑐𝑏𝑏 𝑜𝑜(𝜃𝜃, 𝜙𝜙, 𝑍𝑍)where θ is the hash of the previous block; ϕ is current difficulty level; and Z is arandom key uniquely specific to the current block. This indicates that eachsubsequent block is inextricably linked to the previous one due to θ, and if anydishonest miner at some point decides to generate an invalid block, the othernetwork members will not confirm it, because the hash of the previous block willnot be used in it. And if spammer decides to change the hash of the previousblock, then he will have to do this for the previous one as well, and so on until thegenesis block (the very first block created by Satoshi Nakamoto himself). It wouldbe incredibly time consuming to comb through the entire ledger to make surethat the person mining the most recent batch of transactions hasn't tried anythingfunny. This will require huge amount of work, which at the moment is almostbeyond the power of one person or even a large organization. Therefore, PoWalso maintains defense mechanisms for cryptcurrencies against hacking.However, PoW miners invest into advanced computer machines that 24/7works (consuming energy) with the goal of validating transactions (solving hashes)and creating new blocks. Once it finds "beautiful" it declares that the block isresolved and every miner gets reward (bitcoins) proportional to their work spenton solving the hash. Therefore, cryptocurrency mining under PoW protocol ispainstaking, expensive, and only sporadically rewarding. Alternatively, manyaltcoins started to use “proof-of-stake” (PoS) protocol which is more cost effective(cheaper) and eco-friendly (greener) comparing to PoW that requires a lots ofcomputer energy consumption to solve mathematical algorithmic hashes. In caseof PoS, miners do not need expensive computer machines, the creator of a newblock is chosen in a deterministic way, depending on its wealth, also defined asstake.Majority of cryptocurrencies has roof limit of production. It means thatsupply of cryptcurrencies would decrease over time and under ceteris paribuscondition should lead to higher price (inflation). However, unlike centralized fiatcurrencies, the cryptocurrencies are unique since their block reward schedule isPage 4

Y. Sovbetov / JEFA Vol:2 No:2 (2018) 1-27public. It means that public already knows the approximate date of each decrease(or reward halving). Thus all expectation should have been purchased by themarket, and therefore shrunk in supply should not affect cryptocurrencies tradingprice. For instance, Bitcoin’s first block halving happened on 28th November 2012.The block reward dropped from 50 BTC per block to 25 BTC per block. The pricelater climbed to 260 BTC in April 2013, followed by 1,163 BTC in November2013. It is unclear, however, whether these price rises were directly related to theblock reward halving. In this research, we investigate factors that influencecryptocurrency prices both in short- and long-run.3. Literature ReviewThe cryptocurrency market has seen an unprecedented level of interest frominvestors in 2016. Bitcoin, the world's largest digital currency, has risen more than1,500 percent since the start of 2017. However, the market is significantly morecomplex than the public lexicon might suggest. And while there have been plentyof studies examining the future of Bitcoin and its volatility (Polasik et al. 2015;Letra, 2016; Bouoiyour and Selmi, 2016; Katsiampa, 2017; Chiu and Koeppl, 2017;Chu et al. 2017), there have been few that explore the broader cryptocurrencymarket and how it is evolving. Bitcoin is currently trading at around 16,000; atthe beginning of the year, Bitcoin price was at 1,000, raising warnings from someanalysts and prominent financial figures that it’s a bubble. The currency isextraordinarily volatile despite its recent ever-peaking performance, rising bythousands of dollars in value on one day only to fall by even more the next.Katsiampa (2017) estimates the volatility of Bitcoin through a comparison ofGARCH models and finds that the AR-CGARCH model gives the most optimal fit.He underlines that the market is high speculative. Bouoiyour and Selmi (2016)study daily Bitcoin prices using an optimal-GARCH model and show that thevolatility has decreasing trend comparing pre- and post-2015 data. Even tough,they still observe significant asymmetries in the Bitcoin market where the pricesare driven more by negative than positive shocks. Likewise, Dyhrberg (2016)investigates the asymmetric GARCH methodology to explore the hedgingcapabilities of Bitcoin and he finds that it can be used as a hedging tool againststocks in the Financial Times Stock Exchange Index and against the Americandollar in the short term.On the other hand, El Bahrawy and Alessandretti (2017) examine behaviourof entire market (1469 cryptocurrencies) between April 2013 and May 2017. Theyfind that cryptocurrencies appear and disappear continuously and their marketcapitalization is increasing (super-)exponentially, several statistical properties ofPage 5

Y. Sovbetov / JEFA Vol:2 No:2 (2018) 1-27the market have been stable for years. Particularly, market share distribution andthe turnover of crytocurrencies remain quite stable.There is a wide agreement on that the cryptocurrencies will not only affectthe trading practices of different countries and business organizations, but theywill also affect the dynamics of international relations. There are still a lot ofpeople who are never accommodating the idea that cryptocurrencies willrevolutionize how we do businesses. They can't figure out how the wholeblockchain technology and other annexes work. Plus, advancements in technologyare introducing digital tools that companies can use to better interact with theircustomers. A rising shift from traditional platforms to digital platforms has alsobrought about an abundant supply in data from sources like social media, mobiledevices, online retail platforms, etc. Due to technology advancements in the areasof gathering, storing, and sharing data, large sets of data are easily shared amongcompanies in every sector and country for little to no costs. The widespreadaccessibility of data has also brought about concerns over data privacy ofindividuals and their online transactions. Because every transaction or activitycarried out online leaves a digital trail, individuals are opting for more anonymousways to use the internet and conduct online transactions. The Bitcoincryptocurrency was introduced to address the issue of privacy concern.Although cryptocurrencies’ decentralization, anonymity of transaction, andirreversibility of payments offer plenty advantages, Brill and Keene (2014) opinethat these features also attract illegal activities (cybercriminals) such as moneylaundering, drug peddling, smuggling and weapons procurement. This issue hasattracted the attention of powerful regulatory and other government agenciessuch as the Financial Crimes Enforcement Network (FinCEN), the SEC, and eventhe FBI and Department of Homeland Security (DHS). In March 2013, FinCENissued rules that defined virtual currency exchanges and administrators as moneyservice businesses, bringing them within the ambit of government regulation. InMay that year, the DHS froze an account of Mt. Gox – the largest Bitcoin exchange– that was held at Wells Fargo, alleging that it broke anti-money laundering laws.And in August, New York’s Department of Financial Services issued subpoenas to22 emerging payment companies, many of which handled Bitcoin, asking abouttheir measures to prevent money laundering and ensure consumer protection.Plus, economist Kenneth Rogoff writes that Bitcoin will never supplantgovernment-issued money because that “would make it extremely difficult tocollect taxes or counter criminal activity.” (see Bitcoin legality in Appendix table1A).Page 6

Y. Sovbetov / JEFA Vol:2 No:2 (2018) 1-27To summarize, Poyser (2017) points three types of crypto price driversorganized into internal and external factors. Supply and demand of cryptcurrencyis main internal factors that have direct impact on its market price. On the otherhand, attractiveness (popularity), legalization (adoption), and few macro-financefactors (interest rate, stock markets, gold prices) can be regarded as externaldrivers (see figure 1).Internal FactorsSupply & Demand Transaction Cost(PoW / PoS) Reward System Mining Difficulty(Hash Rate) Coins Circulation Forks (RuleChanges)External FactorsCryptomarket Attractiveness(Popularity) Market Trend SpeculationsMacro-financial Stock Markets Exchange Rate Gold Price Interest Rate OthersPolitical Legalization(Adaptation) Restrictions (Ban) OthersCryptocoinPriceFigure 1. Factors that Influence Cryptocurrency PricesIn this respect, we examine short- and long-run factors that influence pricesof cryptocurrencies over 2010-2018 using ARDL technique on weekly data basis.First, we build Crypto 50 index by sampling top 50 cryptocoins that haveproportional contribution to market capitalization weights. Thus, we derive fewcryptomarket factors such as total market capitalization, trading volume, andvolatility. We use these factors as explanatory variables for cryptocoin pricemovements alongside with attractiveness and control variables such as stockmarket movements, gold prices, and interest rates. In this study, we provideevidence for significant long-run role of attractiveness of cryptocurrencies indetermination of their prices. We also observe a weak form of negative impactrunning from stock markets (SP 500 index) to cryptocurrency market, in particularBitcoin.Page 7

Y. Sovbetov / JEFA Vol:2 No:2 (2018) 1-27The contents of the paper are organized as follows. Next section describesthe data with descriptive analysis and explains methodological set up ofexamination. Then, we present our key findings including our comments andsuggestions. The final section gives concluding remarks of the study.4. Data and MethodologyThe literature about economics of cryptocurrency is scantrecently gained focus on research fields. We contribute toexamining factors that influence prices of most common fiveover 2010-2018 with weekly data. For this examination,econometric set up as following.𝑚𝑚3𝑖𝑖 1𝑖𝑖 1𝑏𝑏as the topic justthis context bycryptocurrencieswe define our𝑃𝑃𝑐𝑐,𝑐𝑐 𝛽𝛽0 𝛾𝛾𝑖𝑖 𝑃𝑃𝑐𝑐,𝑐𝑐 𝑖𝑖 𝛽𝛽𝑖𝑖 Ω𝑐𝑐 𝛽𝛽4 𝐴𝐴𝐴𝐴𝐴𝐴𝑐𝑐,𝑐𝑐 𝛼𝛼𝑖𝑖 𝑍𝑍𝑖𝑖,𝑐𝑐 𝜀𝜀𝑐𝑐(1)𝑖𝑖 1where m is optimal lag length which is determined by information criteria; Pc,t isendogenous variable in the system and it denotes price of cryptocurrency "c" innatural logarithmic form at month t. We treat all other variables in the system asexogenous variables. The Ω represents three cryptomarket variables of MARPt,MARVt, and MARSt that are Crypto 50 index price (see section 4.1), its tradingvolume, and its volatility at week t; and ATRc,t is attractiveness of currency "c".Plus, we also account k set of control variables of Zi such as stock market (proxiedby SP500 index), exchange rates (EURO/USD), the U.S. interest rates, and worldgold price.Data for cryptocurrencies are gathered from BitInfoCharts 1 website; price ofSP500 index is retrieved from Yahoo Finance 2, and macroeconomic data areobtained from World Bank 3. The attractiveness of cryptocurrency is proxied by itsGoogle search frequency; we derive related data from Google search trends 4.4.1. Building Crypto 50 indexFirst of all, we sample big 50 market capped cryptocurrencies (these 50cryptocoins forms about 92% of entire cryptomarket). We derive data for marketcapitalization, trading volume, opening-closing prices, and high-low prices from1BitInfoCharts - https://biti

examines price influences of cryptocurrencies both in short- and long-run over 2010-2018 using ARDL technique on weekly basis. As statistical data of cryptocurrency are newly established, we build the "Crypto 50" i

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