The movements of cryptocurrencies, like Bitcoin, often seem to be based on no concrete measures, but research from the Illinois Institute of Technology nonetheless proposes evidence that can help to guide investors.

The researchers found that Bitcoin is largely detached from standard economic fundamentals, which means it doesn’t really provide much to diversify portfolios or act as a safe-haven asset. Indeed, returns on other securities and commodities fail to predict returns on Bitcoin particularly well.

Predicting movement

The researchers used predictive analytics alongside dimension-reduction models on Bitcoin data from Jan 2011 to Jan 2020. In total, they analyzed 25 different variables, including other asset prices, macroeconomic factors, and investor sentiment.

“We find that blockchain technology, investor sentiment, and stress level have predictive power for bitcoin returns,” they explain. “Similar to traditional assets, bitcoin shows higher return predictability with longer return horizons. These findings support the dual nature of bitcoin as a technical artifact and speculative asset.”

The study comes to a number of key findings:

1. Mining Bitcoin has become increasingly challenging, and this difficulty level positively correlates with the returns on investment. This observation supports the theory that as the demands of blockchain technology rise, the available supply of Bitcoin diminishes, thereby boosting its potential for generating returns.
2. The returns on Bitcoin investments are strongly influenced by investor sentiment, indicating the speculative nature of this cryptocurrency as an asset. This finding highlights the significance of market perception and investor behavior in driving Bitcoin’s performance.
3. Economic conditions characterized by higher stress levels or financial turmoil are associated with a decline in future Bitcoin returns. This underscores the risks associated with holding Bitcoin as an asset during periods of economic instability, emphasizing the importance of considering external factors when evaluating potential returns.

A key role

The researchers propose that Bitcoin has played distinct roles within the economy across different time periods. Initially, it functioned as a form of currency, providing a decentralized and digital means of exchange. Subsequently, it assumed the characteristics of speculative security, attracting investors seeking high-risk/high-reward opportunities. Finally, due to its scarcity and the costs associated with mining, Bitcoin has also served as a safe-haven commodity, offering potential protection during times of economic uncertainty.

These findings shed light on the multifaceted nature of Bitcoin’s economic impact and its evolving significance within financial markets. Understanding these roles can inform investment strategies and help individuals navigate the complexities of the cryptocurrency landscape.

“In academia, there is a research methodology called the asset return predictability study,” the authors conclude. “An underlying principle is that variables predicting the future movement of an asset price may be important in the economic system. So understanding what those variables are is important not only to traders who want to take a position in bitcoin, but also to economists who want to understand the nature of bitcoin.”