Professor Coin: Evaluating Cryptocurrency Pricing Dynamics
This article explores the pricing of cryptocurrencies like Bitcoin and Ethereum, revealing that significant variables influencing asset returns in equity markets—such as size, momentum, and market data—also apply to cryptocurrencies. Professor Urquhart discusses relevant studies that highlight the importance of blockchain characteristics and introduces new on-chain factors, suggesting that a refined approach to analyzing cryptocurrency’s unique attributes can enhance return predictions.
In this third installment of the Professor Coin column, Professor Andrew Urquhart, Head of the Finance Department at Birmingham Business School, examines the intricacies of pricing cryptocurrencies, such as Bitcoin and Ethereum. He highlights the fundamental question within financial markets: “What drives the expected returns of assets?” This question has been extensively studied by academics and industry professionals in equity markets. Concisely, the work of Eugene Fama regarding the Fama-French factors—specifically the outperformance criteria that explain stock returns—serves as a foundation for analyzing cryptocurrency pricing. The challenge in cryptocurrency markets stems primarily from the lack of balance sheets, rendering traditional metrics such as book-to-market ratios ineffective. Existing academic literature has explored various factors influencing cryptocurrency pricing. A key study conducted by Yukun Liu, Aleh Tsyvinski, and Xi Wu in 2022 investigates price-driving factors typically applied in equity markets, including size, momentum, volume, and volatility, and concludes that these factors significantly impact the returns of over 1,800 cryptocurrencies. Further research by Siddharth Bhambhwani, George M. Korniotis, and Stefanos Delikouras emphasizes the relevance of blockchain-specific data, namely computing power and network size, as additional determinants of cryptocurrency returns. Their revelations suggest that the blockchain provides unique insights beyond conventional market data. In a recent collaborative study between Athanasios Sakkas and Professor Urquhart, the authors introduce 13 new on-chain factors derived from more than 35 different blockchains, such as the distribution of wealth among major holders—referred to as “whales”—and network valuations. Their findings indicate that a simplified model encompassing the excess market returns and the degree of decentralization offers a robust explanation for cryptocurrency return patterns. Notably, investors appear to demand a premium for cryptocurrencies exhibiting low decentralization, termed the “whale premium.” Collectively, the research underlines that although cryptocurrency pricing has similarities to equity markets, the abundance of data available on blockchain technology provides valuable tools for forecasting future cryptocurrency values.
The pricing strategies of cryptocurrencies like Bitcoin and Ethereum differ significantly from those of traditional financial assets due to the absence of balance sheets and conventional metrics. This understanding necessitates adapting established economic theories to the cryptocurrency domain, particularly in how factors such as market returns, size, and momentum influence these digital assets. The exploration of these factors is crucial for investors and academics alike, given that the inherent volatility and unpredictability of cryptocurrency markets yield a compelling case for specific analytical frameworks tailored to blockchain technology. The dynamics of blockchain provide unique insights that help bridge the gap in understanding cryptocurrency price movements, making this an essential area of research in modern finance.
In summary, Professor Andrew Urquhart elucidates the complexities involved in pricing cryptocurrencies, drawing parallels to equity markets through established financial theories. While the field is still evolving, the application of blockchain-related factors alongside traditional market indicators appears promising in comprehending cryptocurrency valuations. The emergence of methodologies focused on on-chain data underscores the need for ongoing research in this volatile domain. Ultimately, the exploration of concepts such as the “whale premium” offers fresh perspectives on cryptocurrency investments, justifying a blend of techniques to inform future market behavior.
Original Source: decrypt.co
Post Comment