Abstract
We develop a strong diagnostic for bubbles and crashes in Bitcoin, by analysing the coincidence (and its absence) of fundamental and technical indicators. Using a generalized Metcalfe’s Law based on network properties, a fundamental value is quantified and shown to be heavily exceeded, on at least four occasions, by bubbles that grow and burst. In these bubbles, we detect a universal super-exponential unsustainable growth. We model this universal pattern with the Log-Periodic Power Law Singularity (LPPLS) model, which parsimoniously captures diverse positive feedback phenomena, such as herding and imitation. The LPPLS model is shown to provide an ex ante warning of market instabilities, quantifying a high crash hazard and probabilistic bracket of the crash time consistent with the actual corrections; although, as always, the precise time and trigger (which straw breaks the camel’s back) is exogenous and unpredictable. Looking forward, our analysis identifies a substantial but not unprecedented overvaluation in the price of Bitcoin, suggesting many months of volatile sideways Bitcoin prices ahead (from the time of writing, March 2018).
Highlights
In 2008, pseudonymous Satoshi Nakamoto introduced the digital decentralized cryptocurrency, Bitcoin [1], and the innovative& 2019 The Authors
We develop a strong diagnostic for bubbles and crashes in Bitcoin, by analysing the coincidence of fundamental and technical indicators
We detect a universal super-exponential unsustainable growth. We model this universal pattern with the Log-Periodic Power Law Singularity (LPPLS) model, which parsimoniously captures diverse positive feedback phenomena, such as herding and imitation
Summary
In 2008, pseudonymous Satoshi Nakamoto introduced the digital decentralized cryptocurrency, Bitcoin [1], and the innovative. Existence of large bubbles and crashes—being radically non-stationary with nonlinear tipping point dynamics— makes modelling these mechanisms difficult and risky with stationary linear models and conventional econometric techniques Many of these studies attribute some technical feature of the Bitcoin protocol, such as the ‘proof-ofwork’ system on which the Bitcoin cryptocurrency is based, as a source of value.. We combine—as a fundamental measure—a generalized Metcalfe’s Law and—as a technical measure—the LPPLS model, in order to diagnose bubbles in Bitcoin When both measures coincide, this provides a convincing indication of a bubble and impending correction. We show that the generalized Metcalfe’s Law provides a support level, and that the ratio of market capitalization to ‘the Metcalfe value’ gives a relative valuation ratio On this basis, we identify a current substantial but not unprecedented overvaluation in the price of Bitcoin.
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