AbstractIn created as a reward for a process

AbstractIn 2017 prices and capitalizations of cryptocurrencies have skyrocketed and sparked debates about their status in the global financial system.

 Central banks of many countries are struggling over the issue of regulating cryptocurrencies and cryptocurrency opponents consider it is a new bubble.  In this research I try to find common features for cryptocurrencies market dynamics (basically the price of bitcoin) with FX, equity and other financial markets and find some general patterns that can explain prices of bitcoin. IntroductionBitcoin as a first cryptocurrency with the biggest capitalization (331 bln. USD is record) is interesting object for research mostly because it’s novelty and complexity.

Also bitcoin is different from traditional assets by large number of open data sources that contain all necessary information about transactions, exchange rates and etc. This research is an attempt to understand principles used in cryptocurrencies,  find connection between bitcoin and other financial assets and indicators.Literature reviewBitcoin definitionAccording to the creator of bitcoin Satoshi Nakamoto: “peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution”. Bitcoin defined in Wikipedia as “decentralized digital cryptocurrency, as the system works without a central bank or single administrator. The network is peer-to-peer and transactions take place between users directly, without an intermediary.

These transactions are verified by network nodes through the use of cryptography and recorded in a public distributed ledger called a blockchain.  Bitcoins are created as a reward for a process known as mining. “There is no need to describe in details the nature of bitcoin in this work, since many other studies have been written on this topic. Basic concepts that everyone need to know in order to understand the essence of the bitcoin work can be find in popular internet resources.  Mining costs and electricity consumptions. “Mining is the process of adding transaction records to Bitcoin public ledger of past transactions. Mining is intentionally designed to be resource-intensive and difficult. The primary purpose of mining is to allow Bitcoin nodes to reach a secure, tamper-resistant consensus.

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Mining is also the mechanism used to introduce Bitcoins into the system: Miners are paid any transaction fees as well as a “subsidy” of newly created coins. This both serves the purpose of disseminating new coins in a decentralized manner as well as motivating people to provide security for the system. Bitcoin mining is so called because it resembles the mining of other commodities: it requires exertion and it slowly makes new currency available at a rate that resembles the rate at which commodities like gold are mined from the ground.”Bitcoin electricity consumption significantly increases every year and can be compared with Hungary electricity consumption. China is moving to wipe out its bitcoin mining industry following concerns of excessive electricity consumption and financial risk, in the latest sign of Beijing’s hostility to cryptocurrencies.We also think that mining costs are the key driver of bitcoin price. There are some estimations of mining costs.Comparing with other assetsBitcoin has a unique characteristics.

The main subject for discussion – what is bitcoin: a currency or an asset similar to gold. There are many points of view on bitcoin. Dirk G.

Baur, KiHoonHongb, Adrian D.Leec consider  “Bitcoins are mainly used as a speculative investment and not as an alternative currency and medium of exchange”.According to Dirk G.

Baur, Thomas Dimpfl, Konstantin Kuck:  “Bitcoin returns are not a hybrid of gold and US dollar returns. Bitcoin returns, volatility and correlation characteristics are distinctively different compared to gold and the US dollar.” At the same time Anne Haubo Dyhrberg claimed: “The analysis shows that bitcoin has many similarities to both gold and the dollar. Medium of exchange characteristics are clear and bitcoin reacts significantly to the federal funds rate which points to bitcoin acting like a currency. Most aspects of bitcoin are similar to gold as they react to similar variables in the GARCH model, possess similar hedging capabilities and react symmetrically to good and bad news.”As for hedging abilities of bitcoin Elie Bouri , Rangan Gupta , Aviral Kumar Tiwari , David Roubaud write: “This paper sat out to investigate the hedging capabilities of bitcoin against stocks in the Financial Times Stock Exchange Index and the American dollar. Overall bitcoin has clear hedging capabilities against the FTSE Index and can thereby be used alongside gold to eliminate or minimize specific market risks. Against the dollar, the conclusion slightly more vague as correlations were found though very small values.

Though bitcoin did show hedging capabilities against the dollar in the short-term indicating that the high frequency trading of bitcoin creates suitable conditions for such hedging to be conducted. In conclusion bitcoin has a clear place in the market for portfolio analysis and risk management as it can be used as a hedge against the FTSE Index and the American dollar. “In this work we consider, that bitcoin could contain qualities of currency and gold. Factors that influence on currencies in countries, where bitcoin is very popular, and factors that influence on gold price will be analysed. One of our hypothesis was that FX rates and macroeconomics situation in countries, where bitcoin is mined or used as a currency ( China, South Korea) can significantly influence on bitcoin price. Approaches to bitcoin valuation.

The literature suggests different approaches to valuation of bitcoins. Authors of this  article  propose a framework to explain the Bitcoin price from the perspectives of technology and economics. Jeffrey Chu, Saralees Nadarajah found a systematic difference between the early market and the later market. The early market exchange rates are driven predominantly by speculative investment and deviate from economic fundamentals. Later, the market matured and the price dynamic followed more closely with changes in the economic factors, while market speculation cast no significant impact in the long term. Additionally this paper shows that the later market price closely tracks economic fundamentals. Alexander Kroeger and Asani Sarkar studied price differences of the virtual currency bitcoin trading on 6 exchanges.

They found that price differences across exchanges are related to the magnitude of arbitrage frictions. Some of these differences are related to the implicit costs of trading, such as illiquidity and return volatility. Absolute values of price differences are positively related to the bid-ask spread, order book depth and volatility and negatively related to volume. In 2015 Ladislav Kristoufek considered some factors that could affect the value of the crypto currency.Bitcoin has received much attention in the media and by investors in recent years, although there remains scepticism and a lack of understanding of this cryptocurrency. News has big influence on bitcoin.

It’s price and popularity are very correlated.  Abnormally high profitability attracts more new customers and increases demand for bitcoin, and hence its price. Other crypts can influence of bitcoin. Now bitcoin competes with other cryptocurrencies, such as the ethereum and ripple, which lack the drawbacks of bitcoin.

Data analysisMain idea of this part is finding as much as possible factors that could influence on bitcoin price and could be used for price prediction. Data collection and processing Unlike traditional assets, for cryptocurrency there are a large number of platforms that provide free access to aggregated data on cryptocurrencies, for example:  https://blockchain.info/ and https://coinmarketcap.com/ .

There are also resources that aggregate various data from the largest exchanges https://www.cryptocompare.com/coins/btc/markets/USD . All data was processed and visualized using a python. Exploratory analysis One of the main tasks of this work is to determine the factors that can affect the bitcoin price. Figure 1. Average USD market price across major bitcoin exchanges.

Figure 2. Bitcoin price volatility.Figure 3.

Bitcoin daily returns.Figure 4. Bitcoin daily returns volatility.In this work we used data from 2015-01-01 to 2018-01-06,  because since 2015, shocks have become more rare and the price has become more stable, except it sharp increase in 2017.

Confirmed Transactions Per Day – the number of daily confirmed Bitcoin transactions. this graph shows us that the number of transactions using bitcoin increases monotonically, except for periods before and after forks. Fork – division of the block into two independent branches and the emergence of a new cryptocurrency. Bitcoin Cash: Forked at 1 August 2017 and Bitcoin Gold: Forked at 24 October 2017Figure 5. Confirmed Transactions Per DayThe number of transactions can be influenced by the transaction commission and the transaction confirmation time on the network.Median Confirmation Time  – The median time for a transaction to be accepted into a mined block and added to the public ledger (note: only includes transactions with miner fees).Figure 6. Median Confirmation TimeThis is the time through which money will be available on the wallet after deal.

Perhaps this is one of the strongest restrictions for arbitrage and speculation. Cost per transaction – miners revenue as percentage of the transaction volume.  Figure 7. Cost per transaction                Hash rate –  The estimated number of tera hashes per second (trillions of hashes per second) the Bitcoin network is performing. This value reflects the activity of the miners that support the network operation.Figure 7. Bitcoin network hash rate Total Transaction Fees – The total value of all transaction fees paid to miners (in BTC).

Miners support the operation of the network as long as it is beneficial to them, as the costs of each transaction are significant.Figure 7. Total Transaction FeesDifficulty – A relative measure of how difficult it is to find a new block. The difficulty is adjusted periodically as a function of how much hashing power has been deployed by the network of miners.Figure 8. Mining difficulty. The factors discussed above are internal to the network of bitcoins and, in our opinion, influence its course.

The main difficulty in measuring the degree of this influence is the interconnectedness of all the quantities considered.We test some hypothesis and resulted in the table below the most interesting for further research.   Modelaba std. err.b std. err.

R-squareda t-valueb t-valueLog (Market price) = a*Confirmed_Transactions_Per_Day +b1.13e-054.2003.74e-070.0850.

62630.26849.463Log (Market price) = a*log(hash_rate) + b0.9203-6.4700.0130.1870.90070.

330-34.664Log (Market price) = a*log(difficulty) + b0.9387-17.8130.

0130.3390.90572.200-52.600Log (Market price) = a*lag_1_Confirmed_Transactions_Per_Day+b1.135e-054.20563.


03949.252Log (Market price) = a*log(lag_1_hash_rate)+b0.9222-6.4910.0130.1870.

92070.190-34.652The most interesting finding that bitcoin price significantly depend on hash rate. This phenomenon can be given several explanations.Firstly, hash rate is proportional to the costs of mining and miners can not not sell created bitcoins at a price below the cost. The second explanation: a sharp rise in the cost of bitcoin led to an increase in the number of people wishing to earn with mining.

In order to find a real  causal relationship additional research is needed.Figure 9. Bitcoin price and hash rateComparing with other assets Macroeconomics indicatorsWe test hypothesis that bitcoin price and returns connected with macroeconomics indicators such as  FX rates, rates, inflation (CPI) and other macroeconomics in countries where bitcoin is fairly widespread: China, Japan, South Korea, USA. We use data from FRED but  regression analysis did not yield any meaningful results. Perhaps more sophisticated research methods will allow us to establish a connection between the variables of interest to us.

GoldWe didn’t find any significant correlations between gold price  and returns and correspondingly BTC price and returns, despite the fact that some consider it digital gold.EquityBy itself, simultaneous growth in stock indices does not explain the price of bitcoin. Some experts suggest the existence of bubbles in stock market and bitcoin,  and these events are connected.Cryptocurrency exchangesAnother area of research is the study of the influence of exchanges and speculators on the exchange rate of bitcoin. In connection with the growing popularity of the cryptocurrency, the number of crypto-exchange exchanges has significantly increased,. Their activities are not regulated in any way and carries significant risks for investors. Prices on this exchanges are correlated, but not perfectly and there is opportunity for arbitrage.

What factor can influence on price differences Price Dynamics on different exchanges? Possible factors are volatility, trade volume, bid-ask spreads, market depth, commissions. Today bitcoin does not exist in a vacuum: there are another 1413 cryptocurrencies. Bitcoin competitors such as ripple and ethereum and their growing popularity create an impact on the cost of bitcoin. Table 2. Cryptocurrencies prices correlation BTCETHRippleBTC10.


7340.8131 Table 3. Cryptocurrencies returns correlation BTCETHRippleBTC10.


081Figure 10. ?omparison of three cryptocurrencies (in log-scale) . ResultsWe analysed literature about cryptocurrencies and blockchain .

We aggregate all data connected with cryptocurrencies: macroeconomic data, blockchain data, exchanges data and etc. We also found some patterns that will need to be explained in the future but now the main problem in interpreting these data is the search for causality.Discussion and conclusionIn this paper we try to find as much as possible factors, that could influence on bitcoin price. The next task is to combine all these factors into one model. We would highlight another directions for the continuation of this study: Additional analysis for forks (Bitcoin cash) and news – it seems that prices of cryptocurrencies are sensitive to such events.Consider regime shifts in bitcoin price because cryptocurrencies market has undergone significant changes in the last year.

This events can make this and all previous studies irrelevant.Also repeat the same analysis  for  other crypto assets (Ethereum,  Ripple) because they have the similar nature like bitcoin but they are less popular today.