Are there rational ways to decide whether cryptocurrencies such as Bitcoin are in bubbles? In their December 2017 paper entitled “Datestamping the Bitcoin and Ethereum Bubbles”, Shaen Corbet, Brian Lucey and Larisa Yarovaya test for bubbles in Bitcoin and Ethereum price series. For valuation, they consider three potential cyrptocurrency price drivers:
- Blockchain length, reflecting difficulty of finding a new block and receiving payment relative to past difficulty. As more miners engage, the rate of block creation increases, raising the level of difficulty.
- Hash rate, indicating speed of blockchain code execution during mining. A higher hash rate increases probability of finding the next block and receiving payment.
- Liquidity, measuring the relationship between cryptocurrency daily returns and volatilities.
They then apply ratios constructed from these variables to detect times when price series are substantially disconnected from fundamental drivers. Using Bitcoin data since July 18, 2010 and Ethereum data since July 30, 2015, both through November 9, 2017, they find that:
- Bitcoin exhibits some bubble behavior around the 2013-2014 turn-of-the-year, following declarations by a U.S. federal Judge and German tax authorities that Bitcoin has characteristics of currencies.
- Since Bitcoin breached $1,000 in early 2017, it exhibits clear, but not continuous, bubble behavior. At the end of the sample period, Bitcoin is in a bubble.
- Ethereum exhibits slight bubble behavior concentrated in early 2016 and mid-2017. Fundamentals drive its most recent phase of appreciation. In the latter part of the available sample period, Ethereum seems resistant to explosive bubbles.
In summary, evidence largely supports the view that Bitcoin is in a bubble as of the end of the sample period in November 2017.
Cautions regarding findings include:
- The study does not address exploitation of cryptocurrency bubbles.
- Introduction of Bitcoin futures may materially affect Bitcoin pricing and work against bubble persistence.
