Bitcoin — and other cryptocurrencies like Ethereum or Ripple — has been compared to traditional currencies, gold, stocks, and even shell beads. But do cryptocurrencies really behave like these other assets?
A new NBER working paper by Yukun Liu and Aleh Tsyvinski shows that although cryptocurrencies can be analyzed as an asset class using simple finance tools, that asset class is radically different from others. Cryptocurrencies do not react to the normal factors that drive stock markets, gold, broad macroeconomic movements, or major currencies like the U.S. dollar. Liu and Tsyvinski’s evidence supports the view that cryptocurrencies are a hedge against standard macroeconomic risks, and opposes the view that cryptocurrencies are a substitute for other assets.
If cryptocurrencies don’t respond to the factors that drive traditional assets, what do they respond to? The authors find two factors that drive returns and two other factors that do not.
First, cryptocurrencies show momentum. The authors calculate that a one-standard-deviation increase in Bitcoin’s return on one day predicts a 0.33 percent increase in the return over the next day.
Second, cryptocurrency returns respond a lot to the attention they receive. When Google searches for the word “Bitcoin” experience a one-standard-deviation increase, there is a 2.3 percent increase in Bitcoin returns over the two weeks ahead. A one-standard-deviation increase in the number of tweets with the word “Bitcoin” leads to a 2.50 percent increase in one-week-ahead Bitcoin returns.
Third, cryptocurrency returns do not respond to ratios of the price to the number of Bitcoin-wallet users. The authors argue that the number of Bitcoin-wallet users is a proxy for the “dividend” of Bitcoin, which doesn’t pay a true dividend. In that interpretation, cryptocurrency returns do not respond to price-dividend ratios.
Finally, cryptocurrencies respond a little to supply factors related to the cost of mining. Proxies for the cost of mining have little impact for Bitcoin and Ripple, but for Ethereum, cryptocurrency returns are exposed to the stock returns of one of the main manufacturers of specialized mining hardware, Advanced Micro Devices.
As the authors sum up, “The risk-return tradeoff of cryptocurrencies is distinct from those of stocks, currencies and precious metals. Hence, there is little evidence, in the view of the markets, behind the popular narratives that there are similarities between cryptocurrencies and these traditional assets.”