Abstract
The phenomenal rise in the price of bitcoin, prior to the trend reversal of early 2018, resembles a bubble as spectacular as any other bubble. A mere observation of the price rise and a comparison with the common characteristics of a bubble provide anecdotal evidence for the bitcoin bubble. Based on price and volume data up to the end of November 2017, formal empirical evidence is presented by using procedures that do not require the estimation of a fundamental value for bitcoin. The empirical evidence shows that (i) the volume of trading can be explained predominantly in terms of price dynamics; (ii) trading in bitcoin is based exclusively on technical considerations pertaining to past price movements, particularly positive price changes; and (iii) the price of bitcoin is an explosive process. These findings are interpreted to imply a price bubble.
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Notes
This is quite a contrast in views but it seems more plausible to suggest that bubbles can be identified as they form.
Naturally, it would be interesting to find out why those who have done their work do not think that pure speculation is responsible for bitcoin’s price rise.
This is what is known in the behavioural finance literature as a “bubble followed by a crash”. The phenomenon is triggered by inefficiencies, such as under-reaction and over-reactions to the arrival of new information. See, for example, Moosa and Ramiah (2017).
Some economists believe that rationality precludes the possibility of bubbles. In an interview with John Cassidy, Eugene Fama rejected the very notion of bubble, suggesting that he did not even know what a bubble meant (Cassidy 2010). He added that he became so tired of seeing the word “bubble” in The Economist that he did not renew his subscription.
It is unlikely that the bubble is correlated with fundamentals because fundamentals do not change at an explosive rate. Dividends are fairly stable and, apart from exceptional circumstances such as hyperinflation, macroeconomic fundamentals move slowly. One of the main points raised by the proponents of behavioural finance is their denial of the possibility of significant changes in valuation. For example, Shiller (2000) concludes that stock prices move in excess of changes in valuation.
There is also the problem that different tests of cointegration provide different results—see, for example, Moosa (2017).
Perhaps the current mining rules are so strict by design to induce scarcity and buying frenzy.
Metcalfe’s law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system. .
Gandal et al. (2018) find that by driving up the transaction volume, one or two traders managed to manipulate the price of bitcoin, pushing it up by some 700% in 2013. This kind of increase in volume cannot be considered a rise in the value of bitcoin.
Perhaps the word “causes” should be replaced with “associated with” because there is no evidence for a causal relation.
Whenever a successful Ponzi scheme emerges, and just before it is recognized as being so, entrepreneurs try to emulate it. As of January 2018 some 1384 cryptocurrencies exist (and still counting). According to The Economist (2018), “a new crypto-currency is born almost daily” with fascinating names such as UFO Coin, PutinCoin, sexcoin and InsaneCoin.
The data were obtained from https://data.bitcoinity.org/markets/price_volume/all/USD?t=lb&vu=curr.
While nothing is special about 2015, the objective here is to demonstrate that the bubble still shows when the extremely high prices recorded in 2017 are not measured relative to the low levels of 2010 but rather to the subsequent higher prices.
It was stated earlier that cointegration is not a valid test for bubbles, but that is only because the stationary residual is considered to be the bubble component. Here, it is different because it is not claimed that the residual of Eq. (5) is the bubble component. Rather, the objective is to show that a bubble may be indicated by a close relation between volume and price dynamics.
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Moosa, I.A. The bitcoin: a sparkling bubble or price discovery?. J. Ind. Bus. Econ. 47, 93–113 (2020). https://doi.org/10.1007/s40812-019-00135-9
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DOI: https://doi.org/10.1007/s40812-019-00135-9