An analysis of bitcoin exchange rates by Jake Smith (University of Houston)

Introduction
Empirical Analysis
Conclusion
An Analysis of Bitcoin Exchange Rates
Jake Smith
University of Houston
Hashers United Conference
Download Working Paper Here
10 October 2014
Jake Smith An Analysis of Bitcoin Exchange Rates

Introduction
Empirical Analysis
Conclusion
What is Bitcoin? B
“Bitcoins are digital coins which are not issued by any
government, bank, or organization and rely on
cryptographic protocols and a distributed network of users
to mint, store, and transfer.” (Ron and Shamir, 2012)
Introduced by the pseudonymous Satoshi Nakamoto in
2009
“Anonymous” peer-to-peer transferability
Traded for currency as well as goods and services
Non-fiat, non-commodity

Introduction
Empirical Analysis
Conclusion
Economics of Bitcoin
How to characterize bitcoins?
Relative prices
Bitcoin exchange rates vs. conventional exchange rates
What explains bitcoin exchange rate fluctuations?
Predictability?

Introduction
Empirical Analysis
Conclusion
Preview of Results
Implied and Market rates are highly cointegrated
Innovations in the conventional market have persistent
eects in the bitcoin market
Innovation in the bitcoin market have no eects on the
conventional market
Rapid return to parity
Exchange rate fluctuations explain much of the bitcoin
price volatility
Behaves much like physical gold

Introduction
Empirical Analysis
Conclusion
Motivation
Most popular “cryptocurrency”
Sizable market
$6.4 billion market cap., $90 million transactions/day
M2 = $11.4 trillion, Visa processes $12 billion
transactions/day
Popular in news and blogs
Attention in computer science literature
Very little research on the economics of bitcoin

Introduction
Empirical Analysis
Conclusion
Yermack, 2013
Bitcoin exchange rates (USD price of bitcoins)
“Bitcoin has exchange rate volatility an order of magnitude
higher than the volatility of widely used currencies.”
Uncorrelated with “bona fide” currencies
Behaves more like a speculative asset than a currency

Introduction
Empirical Analysis
Conclusion
Contribution
Think of bitcoin as a digital commodity (gold)
The price of a bitcoin is not an exchange rate but
commodity price
The relative price of an asset traded in two dierent
currencies implies an exchange rate
How does the exchange rate implied by the relative price
of bitcoins compare to “bona fide” exchange rates?

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Bitcoin as Commodity Money
Data
Bitcoin prices 1 September 2011 - 31 January 2014
$=B
AC=B
£=B
A$=B
Mt. Gox
Implied exchange rate = relative price of bitcoins
$=AC = $=B
AC=B
$=£ = $=B
£=B
$=A$ = $=B
A$=B
Gold Implied exchange rate = relative price of gold
FRED for conventional market exchange rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Prices

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
$=AC Exchange Rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
$=£ Exchange Rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
$=A$ Exchange Rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
$=AC Spread

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
$=£ Spread

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
$=A$ Spread
-.1 0 .1 .2
Nominal Exchange Rate Spread
1Jul11 1Jan12 1Jul12 1Jan13 1Jul13 1Jan14

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Johansen Test for Cointegration
Series appear highly cointegrated
Johansen tests for cointegration all show evidence of one
cointegrating vector
Table 2
y on x is misspecified
Fit a Vector Error Correction Model

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
VEC Results
Table 3
Cointegrating vector is highly significant for all three
currencies
Bitcoin implied rates rapidly return to equilibrium
Convention market rate does not respond to
disequilibrium
Fail to reject the null that the equilibrium condition is
parity
Innovations to the market rate have significant and
persistent eects (R2 as high as 0.49) on the implied rate
but not vice versa

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Market-to-Implied IRF for $=AC Rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Market-to-Implied IRF for $=£ Rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Market-to-Implied IRF for $=A$ Rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Implied-to-Market IRF for $=AC Rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Implied-to-Market IRF for $=£ Rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Implied-to-Market IRF for $=A$ Rates

Introduction
Empirical Analysis
Conclusion
Data
Methodology
Results
Is Bitcoin a Commodity?
Replicate the methodology using gold prices and implied
exchange rates ($/AC, $/£)
One highly significant cointegrating vector for both
exchange rates (Table 4)
Arbitrage opportunities much smaller
Convention market rate does not respond to
disequilibrium, gold prices do all the changing (Table 5)

Introduction
Empirical Analysis
Conclusion
Conclusion
Relative bitcoin prices are exchange rates
Yermack (2013) incorrect: bitcoin exchange rates highly
correlated with “bona fide” currencies
Innovation in the bitcoin market have no eects on the
conventional market
One-way causality explains a significant portion of bitcoin
price volatility
Mirrors the behavior of other physical assets such as
physical gold

Introduction
Empirical Analysis
Conclusion
Questions?
Questions?

An analysis of bitcoin exchange rates by Jake Smith (University of Houston)

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