Cryptocurrency Risk Analysis : A Factor Risk Analysis of the Cross-Section of Cryptocurrency Returns : A Unique Asset Class

Cryptocurrency Risk Analysis : A Factor Risk Analysis of the Cross-Section of Cryptocurrency Returns : A Unique Asset Class We compare the explainability of cryptocurrency returns from macro and microeconomic risk factors during stressed and normal market environments, in particular, analyzing the effects of the Covid-19 pandemic to cryptocurrency return explainability.

We find that risk-premiums are encapsulated within cryptocurrency-specific market factors in both
stressed and normal market conditions.

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Furthermore, cryptocurrency factors, particularly relating to liquidity, momentum, and counterparty risk, showed evidence of providing stronger predictability of cryptocurrency returns during the Covid-19 pandemic compared
to pre-pandemic levels.

We find that during the stressed market environment, Fama-French 5 factors continue to provide low explainability to cryptocurrency returns.

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Cryptocurrency Risk Analysis : A Factor Risk Analysis of the Cross-Section of Cryptocurrency Returns : A Unique Asset Class

Created as decentralized peer-to-peer electronic payment systems based on a distributed ledger protocol, blockchain,
cryptocurrencies have gained the attention of investors and speculators over the past few years. The public attention
towards cryptocurrencies as an individual investment asset class has grown and with it has come concerns.

The fundamentals of cryptocurrencies are still a mystery. By both the public and private sectors. In particular, the intrinsic value of cryptocurrencies is often the main target of critique’s ire.

Though some have pointed towards measurable properties. Such as the amount of electricity required to mine a unit of cryptocurrency (Hayes, 2018). Or the innate value of the information stored within each blockchain unit. The valuation is predominantly shrouded in uncertainty.

Cryptocurrencies have also become attractive as a potential diversification tool within an investment portfolio.
With empirical evidence of cryptocurrencies having little correlation with other financial assets such as bonds,
equities, real estate, and other currencies, from a modern portfolio theory perspective, there is an opportunity to
maximize risk-adjusted returns through appropriate diversification including cryptocurrencies within an investment portfolio.