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Crypto-manias?

Posted in Animal Spirits, Currency Trading

Are there rational ways to decide whether cryptocurrencies such as Bitcoin are in bubbles? In their December 2017 paper entitled "Datestamping the Bitcoin and Ethereum Bubbles", Shaen Corbet, Brian Lucey and Larisa Yarovaya test for bubbles in Bitcoin and Ethereum price series. For valuation, they consider three potential cyrptocurrency price drivers:

  1. Blockchain length, reflecting difficulty of finding a new block and receiving payment relative to past difficulty. As more miners engage, the rate of block creation increases, raising the level of difficulty.
  2. Hash rate, indicating speed of blockchain code execution during mining. A higher hash rate increases probability of finding the next block and receiving payment. 
  3. Liquidity, measuring the relationship between cryptocurrency daily returns and volatilities. 

They then apply ratios constructed from these variables to detect times when price series are substantially disconnected from fundamental drivers. Using Bitcoin data since July 18, 2010 and Ethereum data since July 30, 2015, both through November 9, 2017, they find that:

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