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Yale economists conduct a comprehensive economic analysis of cryptocurrencies

Whether it’s financial service providers, educational institutions or governments- cryptocurrencies have not left anyone unaffected. One apparent field that witnesses an unparalleled impact of these decentralised digital assets is Economics. In the same light, Aleh Tsyvinski, a Yale economist and Yukun Liu, a PhD scholar in the Department of Economics have provided a comprehensive analysis of cryptocurrencies and the underlying technology of blockchain.

Tsyvinski, the Arthur M. Okun Professor of Economics spoke to YaleNews about their contribution, experience and assessments of the markets as described. The duo’s paper titled ‘Risks and Returns of Cryptocurrency’ recently got published and established that the “risk-return tradeoff of cryptocurrencies (Bitcoin, Ripple, and Ethereum) is distinct from those of stocks, currencies, and precious metals.”

This is the first time since cryptocurrencies came into being that detailed economic analysis has been conducted and published. The paper describes that cryptocurrencies don’t have exposure to the most common macroeconomic and stock market factors or the returns of commodities and currencies. It further talks about factors specific to the cryptocurrency markets that can predict crypto returns.

Tsyvinski got interested in the field of cryptocurrencies as “everybody from your local bartender to Goldman Sachs executives is talking about it, but most of the research on cryptocurrency comes from a computer-science perspective.” He feels that the crypto space has been lacking a detailed economic analysis.

Their analysis has revealed “a high return but with a lot of volatility.” However, the important question is if the high volatility gets compensated by the high returns. “This is called the Sharpe ratio, which measures the performance of an asset by adjusting for risk. Surprisingly, we found that cryptocurrency’s Sharpe ratio shows that the return is higher than the risk implied by its volatility. It’s higher than the Sharpe ratio for stocks and bonds, but not drastically so,” said Tsyvinski.

The duo has also tried to gauge the similarities that cryptocurrencies have with traditional assets. After analysing 155 potential risk factors in the financial literature, they found that almost none of the factors existed for cryptocurrencies and concluded that they are not like stocks. Neither did they see a link between how cryptocurrencies and gold, platinum or silver behave. However, they noticed similarities between cryptocurrencies and five traditional currencies (the Euro, Australian dollar, Canadian dollar, Singaporean dollar, and the British pound).  

Even though their examination renders that cryptocurrencies are not like traditional assets, common asset pricing tools can still be used by investors to understand the returns better. Momentum effect and investor attention are the two critical tools that crypto investors can leverage for more accurate predictions. On the contrary, while the cost of mining would seem to be a prominent factor behind cryptocurrency behaviour, the duo was surprised “to see that it does not predict cryptocurrency returns.”

Further, as per their calculations, the probability that the value of Bitcoin will fall to zero and render it useless is 0.3%, as compared to 0.009% of the Euro or 0.003% of the Australian dollar. On talking about the possible impact the cryptocurrencies could have across industries, Tsyvinski said that-

“…we found that the healthcare and consumer goods industries have significant and positive exposures to Bitcoin returns, while the finance, retail, and wholesale industries have no exposure to Bitcoin at all. Most surprisingly, we found evidence that the market perceives Ethereum technology as a potential disruptor in the financial industry.” They did not, however, give any explanations for these trends but just documented their findings.

As for the most asked question- what is the quantity of Bitcoin that an investor should hold, Tsyvinski shared that “if you as an investor believe that Bitcoin will perform as well as it has historically, then you should hold 6% of your portfolio in Bitcoin. If you believe that it will do half as well, you should hold 4%. In all other circumstances, if you think it will do much worse, then you should still hold 1%.”

The analysis that they conducted was based on an index of exposure to cryptocurrencies that the duo created across 354 industries in the U.S. and 137 in China.

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