Risk Analysis Of Cryptocurrency
Risk Analysis Of Cryptocurrency. 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.
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.
Moreover, we find that during the stressed market environment, Fama-French 5 factors continue to provide low explainability to cryptocurrency returns.
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 ofcryptocurrencies have been called into question.
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.
As the risks associated with this asset class are better understood.
The ability to ultimately determine the long-term investment value of this asset will be better realized.
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.
However, the cryptocurrency market is still young and has many market frictions. A multitude of
exchanges provide liquidity for a host of cryptocurrencies, but often provide different exchange
rates to the local currencies, leading to market inefficiencies and high transaction costs.
Besides, the total market capitalization of cryptocurrencies is far less than other traditional financial asset
classes, leading to limited availability for institutional investors. Furthermore, cryptocurrencies
and their associated exchanges have not truly undergone a consolidation period, thus exposing
the asset class to potentially unusual risk factors associated with the uncertainty around the
implementation and application of new technology