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Mar 26, 2021 in Economics

Free Essay: Digital Currency - Bitcoin

One of the factors that have created controversial theories and speculation in the finance industry is the issue of cryptocurrency. Difficulties in selling and buying with this type of currency have led to the whole matter being subjective since most of the people regard it as unstable. Currently, one of the leading cryptocurrencies available is bitcoin. It has increased its value by more than 100% since the time it was introduced. Among the reasons that have led to the rise in the value of this cryptocurrency are the issues of transparency and popularity, as bitcoin gains attention on a daily basis. However, some of the leading economists and research models have argued it is not stable attributed to many circumstance. By evaluating one of the economic letters written by Andrew Urquhart, it is much easier to understand some of the factors that make bitcoin inefficient as a form of currency.

Efficient Market Hypothesis (EHM)

Usually, one of the theories used to evaluate the effectiveness of a currency relates to an efficient market hypothesis. This theory stipulates that the presented information of a given currency should show the degree of effectiveness of a currency in the future. Most of the investors use such information to know the upcoming performance of the currency. According to Andrew Urquhart in his letter, one of the factors that make bitcoin ineffective is the lack of information surrounding the given currency. Moreover, the school of thought presented by this specialist stipulates that it will be challenging to speculate the currency performance, thus making it ineffective to any investors. However, one has to consider that the new currency known as bitcoin was introduced compared to the already existing ones.. Thus, it is due to the introduction of the cryptocurrency to the economy of the 21 century through the comparison with other forms of currencies that currently, there is the lack of information regarding it.

Volatility

Among the factors that usually determine the stability is the issue of volatility, which is related to the risk of the given currency. The fact that bitcoin has a higher volatility compared to that of the common currencies makes it even more inefficient in the market. In the commodities market and derivative trading, one of the most volatile units is gold. However, bitcoin is more volatile and unstable compared to gold as currency, making it very inefficient. This fact means that trading with this cryptocurrency is quite inefficient due to the aspect of volatility, as states Andrew Urquhart. Such disadvantageous circumstances are caused by the immense number of asset bubbles and crashes that exist in the market. On the average, bitcoin experiences more economic bubbles and crashes compared to gold according to the review in the economic letter. The fact that the bitcoin bubbles happen within a short limit of time makes it even more volatile than any other form of currency or commodity in the market.

Furthermore, one of the ways of confirming the discussed study is to define the regression using the hypothesis and the p-value. The latter shows the hypothesis of the given data in the economic letter. Andrew Urquhart has divided the sample space in two in order to define the parameters and the strength of bitcoin. According to the analysis, this cryptocurrency is considered inefficient since the p-value is not corresponding with the hypothesis. The reason is the instability in prices. Urquhart's assertion from the research is that the available data is not supportive in the given analysis to affirm the hypothesis. According to the economic letter, such situation may be contributed to the lack of information surrounding the currency, thus making it volatile.

Since the research under discussion has been separated into two clusters according to the time frame, the second part of the analysis still does not conform with the p-value of the hypothesis. However, after using the Ljung Box and the AVR test, the results confirm the hypothesis, thus showing that the cryptocurrency such as bitcoin has the ability to be efficient in the future. However, currently, due to existing price instability of this currency, it is inefficient in the given market condition. As a result, the issue of inefficiency of bitcoin is quite unstable.

Price Clustering

According to Urquhart's hypothesis, there is little information on the behavior of bitcoin prices. He also states that bitcoin prices are not random compared to other securities in the stock exchange around the world. Bitcoin forms a certain behavioral phenomenon known as price clustering. It is a process whereby prices are congregating around specific certain values and preferably whole numbers. Moreover, Urquhart's research on the daily closing prices from Bitstamp reveals that bitcoin had a high standard deviation on its price before 2013. He also notes that it had negative skewness and leptokurtic distribution, even though it was positive from a minimum of $4 to a maximum of $1350 as of 2014, and currently, it is at $6000. Bitcoin price appreciation is due to the hypothesis that investors are attracted to integers in order to reduce the negotiation process. Price clustering and kurtosis tests reveal there are conditional implications related to whole or round numbers as well as price clustering of over 10% around decimal digits of 00. However, it has no trading implications. Finally, bitcoin inefficiency has no predictable pattern due to the lack of information; therefore, investors cannot consider it as an investment strategy.

References

Urquhart, A. (2016). The inefficiency of Bitcoin. Economics Letters, 148, 80-82.

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