7 minute read
Stepping Stones for Cryptocurrency Nikhil Singh Gangwar, IIFT
RISK- RETURN TRADE OFF
BY NIKHIL SINGH GANGWAR, IIFT
Advertisement
One of the most sweltering innovations in the world of finance has been the creation and evolvement of cryptocurrencies. These digital innovations have been the epicenter of extensive news coverage, especially the Bitcoin: frontrunner, determined to provide an alternative to investors that involves tremendously high risk and return.
The cryptocurrency
phenomenon unconventional sources of risk and
Measures of crypto returns have been a high multiple of conventional currency, equity and commodity investments and the pattern has been very robust relative to the time frame. The financial press addresses new vocabulary such as block chain, hash, proof-of-nodes and the role of distributed cryptographic proof replacing the need for trust (the distributed ledger and transaction verification), privacy (anonymity), and the potential haven for transfers of illegally obtained funds. The potential returns are comparatively much bigger than those of more conventional investments.
Traditional Approach Return analysis with respect to other asset classes
Cryptocurrencies return predictors:
Exposure of cryptocurrency returns to currencies as a medium of exchange and precious metal commodities as a store of value and to macroeconomic factors has been not statistically significant
It has been proven, via standard tools of empirical asset pricing by mathematically constructing cryptocurrency momentum, proxies for average and negative investor attention, a proxy for price-to-dividend ratio, realized volatility, and proxies for the supply conditions.
Time-series crypto momentum, for example, a one-standard-deviation increase in the current day’s Bitcoin return predicts a 0.33 percent increase in the daily return over the next day.
Proxies for investor attention, show that high investor attention predicts high future returns over 1–2-week horizons for Bitcoin, a 1-week horizon for Ripple, and 1, 3, and 6-week horizons for Ethereum.
A one-standard-deviation increase in the Google search for the word “Bitcoin” yields a 2.3 percent increase in the 2-week ahead Bitcoin returns Twitter post counts, a one-standard-deviation increase in the Twitter post count for the word “Bitcoin” yields a 2.50 percent increase in the 1week ahead Bitcoin return A ratio between Google searches for the phrase “Bitcoin hack” and searches for the word “Bitcoin, show that a one-standarddeviation increase of the ratio leads to a 2.75 percent decrease in Bitcoin returns the following week
Proxies for the cost of mining to capture the supply factors, some evidence exist that Ethereum returns are exposed to the stock returns of Advanced Micro Devices, Inc. (AMD), one of the main manufacturers of specialized mining hardware, but not significant in Bitcoin and Ripple.
Proxies to exposures of various industries to cryptocurrencies. These results indicate which industries may benefit or may be disrupted by the blockchain technology
Thus, it could be concluded, that cryptocurrency represents an asset class that can be assessed using simple finance tools and but it also comprises an asset class which is radically different from traditional asset classes.
Risk Exposures
Stock Factors - Bitcoin returns comove more with high profit rather than low profit firms. Currency: Systematic currency exposures of Bitcoin returns over the shorter periods are small and statistically insignificant as the alpha estimates barely change. Precious metal commodities: Exposures of all other cryptocurrencies to these commodities are not statistically significant, the alphas of Bitcoin and Ripple decrease, when gold and platinum are considered with the exception of Ethereum. Macroeconomic : Some significant loading against non-durable consumption growth, durable consumption growth, industrial production growth, and personal income growth Cryptocurrency specific factors:
Time-series momentum is estimated by grouping weekly returns into quintiles and evaluating their performance going forward. The momentum effect is statistically significant for all the crypto currencies namely, Bitcoin, Ripple and Ethereum.
Cryptocurrency Investor Attention:
Ratio is constructed to analyze the deviation of Google searches for the words Bitcoin, Ripple, and Ethereum is constructed in a given week compared to the average of those in the preceding four weeks and strong interdependence is observed
Crypto Volatility Price-to-Dividend and Crypto
Obviously, there is no direct measure of dividend for the cryptocurrencies. However, in its essence, the price-to-dividend ratio is a measure of the gap between the market value and the fundamental value of an asset. The market value of cryptocurrency stands to be the observed price. The fundamental value is proxied by using the number of Bitcoin Wallet users. Overall, there is very weak relation between the future Bitcoin returns and the current price-to-dividend ratio and similar results align to volatility. For Ripple and Ethereum, the data on the number of users is not immediately available. The value weighted stock returns of the U.S listed electricity industries The value-weighted stock returns of the China-listed electricity industries The SINOPEC(SNP) stock returns (China is considered to have the largest coin mining operation among all countries).
For proxies of computer power, stock returns of the companies that are major manufacturers of either GPU mining chips (Nvidia, Inc) or ASIC mining chips (TSMC Inc) are considered.
Findings explain that supply factors such as mining costs, price-to-dividend ratio, or realized volatility are useful for predicting the behavior of crypto currency returns.
By Pankaj Yadav
The blockchain technology embodied in cryptocurrencies has a potential to affect a number of important industries. Cryptocurrency investors are more likely to trade penny-stocks and stocks featured in pump and dump schemes and also more likely to participate in other investment vehicles with high idiosyncratic risk, such as emerging market, biotech, and solar-related ETFs.
Comparing the portfolio return profiles of cryptocurrency and non-cryptocurrency investors, we show that crypto currency investors have higher portfolio betas but lower portfolio efficiency, as measured by relative Sharpe ratio losses (Calvet et al., 2007). While the previous literature suggests that cryptocurrency can be used as a diversification instrument (Bouri et al., 2017), the cryptocurrency investors in our sample might underperform due to investment biases. Despite their speculative nature, there is evidence that cryptocurrencies have positive portfolio returns, at least over their short period of existence.
It remains ambiguous whether cryptocurrency investors are also more likely to be blue-collar workers and less educated or whether they attract a higher wealth clientele. In addition, we presume that cryptocurrency investors have more trading experience, trade more frequently, especially in assets with high idiosyncratic risk and skewed return profiles and have riskier portfolios than the average individual investor.
DeFi draws inspiration from blockchain, which allows several entities to hold a copy of a history of transactions. DeFi is distinct because it expands the use of blockchain from simple value transfer to more complex financial use cases. Eliminating the middlemen from all kinds of transactions is one of the primary advantages of DeFi.
Popular types: Decentralized exchanges (DEXs), Stable coins, Wrapped bitcoins (WBTC), Yield farming, Liquidity mining, Composability, Money Legos.
The empirical analysis implies that Bitcoin improves the effectiveness of the portfolio in emerging markets of the selected EU countries. The best combination of risk and return are offered by Tangency portfolio offers it has the highest Sharpe ratio. Bitcoin would increase portfolio efficiency even more.
By Pankaj Yadav
From a consumer financial protection and normative point of view, it is imperative to understand these uptake patterns and shed light in coming years on how new technologies and investment strategies are adopted by different types of consumers over time such that researchers, policymakers, and financial institutions can accurately measure the associated welfare gains or losses been recorded that cryptocurrency investors have higher portfolio betas and experience higher relative Sharpe ratio losses. This finding might be partly driven by investment biases since their portfolio choice is to a larger extent driven by behavioral biases, such as trend chasing and lottery-stock preference.
CURRENT STEPPINGSTONES: A NEW
Some of the points that can be concluded from the synopsis are: WORLD BEING BUILT
With a focus on financial By Pankajprotection and Yadav vulnerability in terms of participation in initial coin offerings (ICOs) and the unexplored link between cryptocurrency and crime is the call of the coming decade. This focus is important since the regulation regimes differ widely across jurisdictions New trends have been surfacing up combining digital assets with traditional banking services managing an array of digital assets and fiat holdings in one simple-to-use platform. Recent example of being Deustche bank preparing a trading and token issuance platform.
Products must be classified along several risk classes, allowing for geographical (EU, ASIAN, US…) product comparison and ensuring that only customers with a measured risk preference are eligible to buy those structured products
Low correlation to other assets and resistance to economic shocks are just some of the reasons why investors want to include them in their portfolio Further queued by the likes Bank of New York Mellon and MasterCard announced plans for storing bitcoin and other cryptocurrencies for its clients. Services if not tokens are being sought to be integrated into business opportunities. Blockchain seems like it has some sort of potential to offer a different economic logic that structures society, and so a lot of artists are interested in decentralization and the buzz around digital money.
