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