Does the virtual currency have an asset price bubble?

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Since the birth of Bitcoin in 2009, the types and market value of virtual currency have increased dramatically. According to the statistics of citicoins.com website, as of May 2, 2018, there were 1602 kinds of global virtual currencies, with a total market value of USD 425.71 billion. As more and more investors participate in the investment of virtual currency, virtual currency has gradually become another new channel for global asset allocation.

However, while paying attention to the opportunities brought about by the development of virtual currencies, investors and regulators are gradually aware of the risks behind virtual currencies. One of the most important risks is that the virtual currency is likely to have an asset price bubble. The so-called asset price bubble refers to the fact that the price of an asset is far higher than the fundamental value of the asset, which manifests itself in an explosive rise in asset prices. The emergence, expansion, and collapse of price bubbles may increase systemic risks and trigger instability in financial markets.

The characteristics of virtual currency determine that asset bubbles are likely to appear in their prices. First, the virtual currency lacks a clear value base. What is the value of 1 Bitcoin? How much is it worth? As a “currency”, what are the advantages of bitcoin over other currencies? What kind of costs? There are many factors that affect the answers to the above questions. For example: The extent of the development and application of blockchain technology, the calculation power of miners, and the regulatory authorities’ policy on virtual currency may all affect the value of Bitcoin. Therefore, it is difficult to estimate the price of virtual currency.

The difficulty in estimating the basic value makes the virtual currency trading market have a strong speculative atmosphere. Investor sentiment plays a central role in the trading of virtual currencies. When market sentiment soared, investors’ expectations for the value of virtual currencies rose rapidly, causing the price of virtual currencies to soar and a price bubble to appear. Once the market sentiment suddenly turns, the virtual currency price may go to the other extreme and the price bubble bursts. At the same time, due to the inability to accurately assess the value of the virtual currency, investors may be following the trend: When the expected value of the currency rises, there will be an influx of prices, causing prices to soar, resulting in asset price bubbles. However, the slightest sign of trouble has caused another bubble to be sold, quickly breaking the bubble and causing serious losses to investors who entered the market.

The actual price trend of virtual currency also shows that there may be bubbles. Take Bitcoin as an example. On November 15, 2017, Bitcoin’s U.S. dollar was priced at about 6,635.75 U.S. dollars, but after just one month, bitcoin U.S. dollar prices rose to 1,6506.7 U.S. dollars, an increase of 148%. In the two months after that, Bitcoin’s price fell by another 44%. The price fluctuations during the above period of time are like the price trend of the asset price bubble in China’s A-shares in 2007. It is hard to believe that the fundamental value of Bitcoin can fluctuate so much in just three months.

The three researchers at Intesa Sanpaolo in Italy used the econometric approach to conduct academic research on the existence of price bubbles in virtual currencies and published the working paper “Arecryptocurrenciesreal financial bubbles? Evidence from scale analyses” on the SSRN website.

The three researchers used Bitcoin and Ethereum as the main research objects with the two largest virtual currencies currently in market value. The study period was from December 2016 to February 2018. Their research uses two methods: The first method is to examine whether there is an exponential growth trend in the price sequence of virtual currency. If the price of virtual currency has an exponential growth trend for a certain period of time, it indicates that the virtual currency has a price bubble during this period. The second method uses the LPPL model to study whether the currency price crashes and the number of crash signals. If the currency price shows a crash risk signal, it indicates that there was a bubble in the virtual currency price in the previous period.

Using the above two empirical methods, the three researchers found that in the time period from the end of 2016 to the early 2018, Bitcoin and Ethereum both showed signs of price bubbles on several occasions. In the short period of time after the signs of price bubbles were found, the prices of the two currencies mentioned above had dropped sharply. This further confirms that the aforementioned signs of bubbles are indeed a reflection of the asset price bubble.

To be continued....