Why cryptocurrency markets defy the laws of economics

Peter Zimmerman

Speculative buying can drive cryptocurrency prices down. This is contrary to the usual laws of economics. Blockchain technology limits how quickly transactions can be settled. This constraint creates competition for priority between different users. The more speculative activity there is, the longer it takes to make a payment. But the future value of cryptocurrency depends on its usefulness as a means of payment. Speculation therefore affects price formation through a channel that does not exist for other asset classes. This can explain the high price volatility of cryptocurrencies, and is consistent with the low adoption rate so far.

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Bitesize: How volatile is Bitcoin?

Giulio Malberti and Thom Adcock

In late 2017, Bitcoin was in the spotlight for its extraordinary return. But how volatile is it?

To consider Bitcoin volatility, we look at 10-day returns (capital standards typically estimate market risk over a 10-day period) since 19 July 2010, when Bloomberg’s Bitcoin data start. We compare Bitcoin with assets in three categories – currency pairs, commodities and equities – and for each we have picked one low-volatility asset and one more volatile asset. For currency pairs and commodities, we chose the most and least volatile ones (in terms of standard deviation of 10-day returns) out of the most liquid in each category. And we chose the most and least volatile FTSE 100 equities (again, in terms of standard deviation of 10-day returns).

For stable assets we expect a peaked distribution with short tails, as returns cluster near 0%. Figure 1 shows that Bitcoin has been more volatile than any other asset in our sample.

Figure 1

But people are often interested in the downside risk of assets. We therefore consider how Bitcoin’s Value at Risk (VaR) compares to other assets. VaR is the maximum loss over a given time interval under normal market conditions at a given confidence interval (eg 99%). A 10-day 99% VaR of -10% tells you that 99% of the time your 10-day return on the asset would be no worse than a 10% loss.

Figure 2 shows Bitcoin’s VaR is high, but the VaR of the other most liquid crypto-assets is higher. TRON’s VaR to date (-84%) is almost twice Bitcoin’s (-44%).

Figure 2

Giulio Malberti and Thom Adcock work in the Bank’s Banking Policy Division.

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Comments will only appear once approved by a moderator, and are only published where a full name is supplied.Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.

Can ‘stablecoins’ be stable?

Ben Dyson

Cryptoassets (or ‘cryptocurrencies’) are notoriously volatile. For example, in November 2018, Bitcoin – one of the more stable cryptoassets – lost 43% of its value in just 11 days. This kind of volatility makes it difficult for cryptoassets to function as money: they’re too unstable to be a good store of value, means of exchange or unit of account. But could so-called ‘stablecoins’ solve this problem and finally provide a price-stable cryptoasset?

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