Bitcoin Valuation: An Empirical Enquiry

Connor Kispert
Abstract
This paper develops a standard model for valuation of bitcoin using
supply and demand fundamentals. We will also analyze the relationship of
dollar and gold alternatives relative to bitcoin price and how this these assets
may affect its value. The period we analyze will run from 2011 to 2016
including three sub-samples before, during and after the alleged bitcoin
bubble of 2013. The changes in estimated coefficients across these samples
give some indication of how the market for bitcoins has structurally changed
since its beginning. Our estimates support a significant substitution effect
between bitcoin and the value of both gold and the dollar. We also find that
variables measuring market thickness are highly correlated with the price of
bitcoin and as market activity increases the value of bitcoin is driven up by a
demand side shock. These findings extend to moving average estimations as
well as results in the most recent sub-sample and also show that the model
developed for bitcoin price is both robust and significant in the post-crash
timeframe.

Introduction

To understand the Bitcoin market, it helps to have a good understanding of the

Bitcoin system and what makes Bitcoin transactions so unique. Bitcoin is an
electronic currency based upon a vast peer to peer network. One quality which
makes Bitcoin a very distinctive financial innovation is its inherent
decentralization, which is a byproduct of the separation between the pseudocurrency and financial institutions or central banks. There is no controlling entity
or central bank for Bitcoin which is able to directly drive or manipulate the
market. The system was created to be self-sufficient once set into motion.
Throughout this paper we will use the term bitcoin when referring to a single
unit of currency or the specific value of the currency and Bitcoin when referring
to the market or system as a whole, as is standard in describing the Bitcoin market.
The supply of bitcoins to the market is one very unique feature of the market
in that is almost entirely predictable over time. New bitcoins are introduced to the
market via a process called mining, in which a very large amount of CPU is used
to create new bitcoin units. The rate of creation of bitcoins in known at any given
time and it is the relative contribution of CPU power to the network as a whole
which determines the amount of bitcoin generated by each miner. This process is
important not only in establishing a supply of money, but also as an incentivebased system for security of each transaction against double spending. The system
can, in effect, reduce financial friction on even an international level, by cutting
out any financial third party involved in transactions. It manages this while
keeping identities linked to accounts private (to a certain extent) and all
transactions public. The publicly available ledger of all such transactions, known
as the Blockchain, serves as a guarantee that each transaction becomes final.
However, along with the financial independence of this system comes a loss of
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control over the money market as well as a slew of new restrictions on bitcoin
usage. This contributes to the extremely volatile value of bitcoin as well as it often
not being valued or used as a typical currency.
Over the lifetime of the Bitcoin network, the cryptocurrency system has gone
through some very different periods of behavior and activity surrounding the
cryptocurrency. In the early days, it was worth only fractions of a penny per
bitcoin and the market was dominated by what were considered to be tech-savvy
speculators. In 2013 the value of Bitcoin grew almost exponentially reaching a
peak of about $1300 U.S. dollars per bitcoin. In December this bitcoin bubble burst
resulting in a plummet in price to a value of around $200 to $400 dollars in months
following. In recent years, the value of bitcoin has experienced only minor trends
both positive and negative with a great deal of volatility. There is much
speculation about the future of the currency, as well as for the potential increase
in usage of the cryptocurrency if the market were to stabilize. Recent literature
would suggest that investors have shown interest in Bitcoin for a variety of
reasons since it burst onto the scene in 2013.
Another interesting feature of Bitcoin is that is generally perceived to be free
of regulatory oversight. However, as popularity of bitcoin grew, so did interest
from regulatory agencies and government bodies attempting to find new ways to
curb its usage. This can be traced back to the prominence of black market
transactions in Bitcoins history. Since the network provided a certain level of
anonymity behind a registered Bitcoin address and was able to transcend the need
for a third party intermediary in transactions, it was seen as a sort of safe haven
for black market commerce. The perceived anonymity of the network eventually
broke down as the Blockchain provides a public ledger of every transaction. This
feature prevented any sort of money laundering using the currency and once an
address was connected with a user, illegal activity became clear as day. Some large
scale black-market busts lead to the shutdown of very large Bitcoin exchanges, the
most significant which was the MtGox shutdown. This single exchange harbored
around 70% of all bitcoin trade up until its sudden closure in the beginning of
2014, resulting in the loss of over 850,000 bitcoins.1 This example gives a good
idea of the types of uncertainty which is often present for bitcoin users, leading to
the massive volatility.
Looking at the current, instable state of the Bitcoin market, we bring up the
question of how we can model determination of bitcoins value. If we were able to
break down the many drastic, seemingly inexplicable shifts in bitcoins price into
a basic model explaining bitcoins price variation, it could give insight into both
the nature of Bitcoin as a currency, and what we could expect out of the
cryptocurrency looking forward. In trying to build a model for Bitcoin price
determination, we have to take into account that historical data is very limited.
Bitcoin has been around since 2009 but the market did not have any significant
activity or value until around 2013. This study will attempt to analyze price
We will not consider this event as a major supply shock since the lost bitcoins were simply transferred
to another wallet (in a sense they were stolen)
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determination both in the early years of the Bitcoin network, and during the
volatile period since. Another concern is how to deal with the price bubble in 2013
and whether or not we can consider this time period along with the rest of the
time series. On one hand, it is important to understand the driving factors of such
a price bubble and why it became unstable towards the end of 2013. However, if
there is a significant structural break in the market during the price bubble, it
could lead to inconclusive or misleading empirical results when testing a model of
bitcoin price determination.
To account for the possibility of a structural break we will perform a
subsample analysis of time periods before, during, and after the 2013 price
bubble. It is apparent, looking at any set of market data related to Bitcoin that the
market has changed a great deal since its early years. Understanding this
structural change in bitcoins price determination will allow us to comment on
market equilibrium for bitcoin price, as well as what can be expected in the future
out of Bitcoin or similar cryptocurrency systems. Findings can be compared with
current news regarding increased usage of bitcoin for purchase of goods and
services along with the potential investment opportunity in the Bitcoin market.
The next section of this paper will be a survey of existing literature related to
Bitcoin and some of the previous ways in which bitcoin price has been modeled.
This will lead into the data and methodology section which breaks down each of
the variables included in our model with commentary on some of the assumptions
and predictions being made in our base model. This section breaks down testing
both a linear (level) model for price determination and a multiplicative model
which uses a log transform to estimate the true relationship between market
variables. It further expands into how a moving average is used as a check for
robustness of our findings, as well as how a sub-sample analysis will be used to
further support findings or show evidence of a structural break in the bitcoin
model over three time periods. The fourth section gives an analysis of the
empirical findings corresponding to each model outlined in the data and
methodology section. Included will be comparisons of results with our model
predictions as well as determination of the specification which best represents the
underlying structure of bitcoin price determination. There will also be an analysis
of differences shown between each sub-sample and what can be said about
potential structural changes in the Bitcoin market since its inception. The last
section gives a summary of findings as well as concluding remarks on how this
paper contributes to the full scope of literature related to Bitcoin markets. The
conclusion section will also give descriptions of some of the limitations of this
paper, along with potential routes for expansion upon this work.

Literature Survey

The current collection of literature related to the Bitcoin market is relatively

sparse as the market has only existed for just over seven years. On top of that, it
was not until the price bubble of 2013 that Bitcoin had much significant value or
activity. In looking at the literature related to Bitcoin it is important to recognize

the time period of publication relative to the Bitcoin bubble and when it burst
towards the end of 2013. Bohme et al. (2015) give a good general survey of the
intricacies of the Bitcoin system with its many of its unique qualities along with
an overview of the current state of academic work surrounding the
cryptocurrency.
Buchholz et al. (2012) explored developing a standard model to determine the
price of bitcoin. They were convinced that speculative interest represented a
driving force in modeling both the value and volatility of bitcoin. However, levels
of speculation regarding the cryptocurrency in 2012 seem insignificant in
comparison to speculative interest generated by the surging growth which lead
into a price bubble in 2013. Thus a similar analysis to that which was done in this
paper could give insight into whether the bitcoin market has changed
fundamentally since the cryptocurrencies popularity exploded in 2013. This will
lead to our exploration of some sub-sample analysis of some similar models as
were developed by Buchholz.
A study by Ciaian et al. (2014), which looks at the time period up until and
immediately following the Bitcoin bubbles burst analyzes the effect of supplydemand fundamentals, global macro indicators, and attractiveness to investors.
Ciaian et al. found that traditional macroeconomic indicators such as Dow Jones
stock market index and the price of oil had very little correlation with the price of
Bitcoin. However, it was found that traditional monetary variables such as size of
the Bitcoin economy and velocity of circulation had a significant effect on the price
of a bitcoin. It was also determined that speculative investors were, in part, driving
the price of bitcoin as well. A similar analysis by Polasik et al. (2015) focused on
the role of Bitcoin as a medium of exchange as opposed to its usage as an
investment. The determination was that popularity, although difficult to measure
in this case, was closely related to bitcoin value. This simple demand-side
relationship should not come as much of a surprise. A more interesting result of
this study, which used a survey of bitcoin usage by merchants around the world,
was that high bitcoin usage was correlated with large shadow economies as well
as with low GDP areas. This may suggest that certain government restrictions or
lack of faith in a domestic economy would lead to an increased demand for bitcoin
in any given country.
A common theme of Bitcoin-related studies is searching for what role Bitcoin
really plays as a cryptocurrency. This balancing act between being purely a
medium of exchange and an opportunity for investment is a central question in
much of the literature on Bitcoin markets. An article by Baur et al. (2015) focuses
on this balancing act between acting as a currency and investment. Baur et al.
determine that bitcoin is uncorrelated with traditional investments and has little
to no correlation with other asset classes such as stocks or bonds. This gives it
some serious benefits as an investment opportunity. Bitcoin is described in this
article as a hybrid between commodity backed assets and fiat currency backed by
monetary authority, and they believe its usage as a currency holds more potential
than as an investment. Briere et al. (2013) hold a much different belief as their
paper touts the potential for diversification and higher returns when including
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bitcoin in a diversified portfolio. However, it should be noted this study was

carried out over a period of surging growth in the bitcoin bubble of 2013 and it
would be of interest to see if these results hold true for 2014 and beyond as the
value is still volatile yet showing no consistent positive trends.
Additional recent literature of interest related to bitcoin markets includes a
paper by Dyhrberg (2015) which uses a GARCH model to compare qualities of the
Bitcoin market to the more well understood gold and US Dollar markets. This ties
into the question of bitcoin being primarily used as currency or investment, but
the focus is instead on how it behaves relative to each extreme. The conclusion
that bitcoins behavior was very similar to that of gold, specifically in that is reacts
symmetrically to good and bad news and can be used to hedge against
expectations of economic downturn. However, Dyhrberg is clear that Bitcoin also
retains many qualities of the dollar in its significant response to changes in the
federal funds rate and usage as a medium of exchange by many.
It is speculated that Bitcoin could hold an advantage over both in having
certain qualities of both gold and the dollar, with potential for use of the
cryptocurrency in portfolio management, risk analysis and market sentiment
analysis. This is closely tied to the choice of rules over discretion in monetary
policy which is discussed by Barro and Gordon (1983). Their paper initially
explored the possibility of ideal equilibria in only using rules or only using
discretion in monetary policy, and came to the conclusion that a combination of
the two is preferable to either extreme. However, the Bitcoin system does not
allow for discretion in monetary policy which could be indicative of inflexibility of
the system relative to traditional currency.

Methodology & Data

With a goal of determining what factors into price determination of bitcoin, we

use a dependent variable of the price of bitcoin (Pbtct) as represented by its 24
hour average rate of exchange with the US dollar. Daily data on this value was
obtained for a time period from 2011 to 2016 as this was determined to be the
time period of interest for Bitcoin. The initial relationship we analyze is some
measure of thickness of the Bitcoin market as it can be related to both demand for
and supply of the cryptocurrency. This will be represented by the number of
transactions per day (transt). The next dependent variable which we will include
is the total number of bitcoins on the market. It should be noted that the supply of
bitcoins is unique in that it increases at a known rate and thus is always, in a sense,
completely predictable. We denote the total number of bitcoins on the market as
Bt. We also include the price of gold in US dollars (Pgt) to represent the
relationship between investment in gold and in bitcoin. To control for nominal
fluctuations in the value of the US dollar relative to world currencies we include a
trade weighted dollar index (twdit). Other variables which are considered in the
baseline model are the number of unique bitcoin addresses used (userst), which is
a different way to think about thickness of the Bitcoin market and demand for
bitcoin, and a single day lagged value of the price of bitcoin (Pbtct1). We will only

include the one day lag with the assumption that a market such as bitcoin can be
accurately modeled based on the most recent pricing information. We can justify
the inclusion of real and nominal variables together in this study since the data
has very high frequency (daily) which allows us to assume the expected inflation
is nearly zero in the short-run setting. A detailed description of these datasets and
their sources can be found in the appendix. Including each of these variables leads
to our first baseline specification for the price of bitcoin gives the equation:
Pbtct = 0 + 1transt + 2Bt + 3Pgt + 4twdit + 5userst + 6Pbtct1 (1)
We expect to find 1 > 0, representing a positive relationship between the price
of bitcoin and the number of transactions per day. This is because the increase in
market thickness is expected to be most closely related to an increase in demand
for the cryptocurrency and thus be accompanied by an increase in the price of
bitcoin. For the same reason, we also expect the same positive sign for 5, since
this variable is measuring a similar effect. We will have to take into consideration
the possibility that these two values are measuring the same effect as both can be
understood as measuring the level activity on the market for any given day.
However, it is possible that given no change in number of transactions on the
market, number of addresses used in a given day is a proxy for something else
entirely. The total number of bitcoins should have a negative effect on price (2 <
0) by simple dynamics of positive supply shocks lowering price. As bitcoin
becomes more abundant it should become less expensive (assuming cetris
paribus). Looking at the trade weighted dollar index we will predict a negative
relationship since as the dollar becomes stronger the exchange rate of bitcoins to
dollars should fall 4 < 0. We will certainly expect a strong positive coefficient for
6 as prices are expected to remain unpredictable from day to day, all other things
equal. 2 The variable representing the price of gold is interesting since there are
two possible predicted effects which could drive opposing predictions of
correlation between prices of gold and bitcoin. The first effect we will consider is
a substitution effect which would be the case if bitcoins were treated much the
same as gold is in hedging against economic downturn as an investment
opportunity. This would result in a negative relationship between the two and
thus a negative coefficient on 3. However, there is also a potential complementary
effect which occurs when the same types of users desire to hold both bitcoin and
gold against other types of asset leading to a competing positive correlation. This
leaves the true relationship between gold and bitcoin prices as an empirical
question which could tell us if either relationship has a dominating effect on
bitcoin pricing.
Equation (1) adopts a linear equation of the relationship between bitcoins
price and a variety of potential explanatory variables. However, if this were the
true relationship we would have to consider that this form assumes the possibility
of price being dependent on any single explanatory variable. A second form which
accounts for imperfect substitution between variables is a multiplicative form
If this lag-1 coefficient is very close to 1 we acknowledge that this is consistent with the random walk
hypothesis and thus supports the efficient market hypothesis.
2

similar to the Cobb-Douglas function. This will generate a multiple linear

regression in taking the natural logarithmic transform of each variable
(independent and dependent), allowing us to interpret coefficients as elasticities
of bitcoin price with respect to different factors. We define this specification form
in equation 2 as:
(2)
From these two base equations we could describe a good number of relationships
and run ordinary least squares regressions using subsets of variables. Exclusion
of a given variable may be considered when it is highly correlated to another
explanatory variable, and thus leads to a multicollinearity problem. Specification
choice should take into account empirical support as well as sound justification of
the theory behind exclusion and inclusion of each potential variable.
To check the robustness of the explanatory power of the regression equation,
we take a moving average of each variable and repeat the empirical analysis done
on the base equation. The advantage of this is that it would smooth out some of
the excessive noise and volatility which characterizes the bitcoin market over
most of the time series for variables such as users per day, transactions per day,
and price. This could provide additional information as to what the longer term
trends changes in explanatory variables have on the price of bitcoin rather than
the single day response. If we find similar empirical findings both with and
without the moving average, it will serve as a test of robustness of our findings.
We will apply a seven day moving average to the data, as weekly changes are a
common frequency and are the shortest such frequency over which a noticeable
smoothing effect can be seen on the value of highly volatile variables (Pt, userst,
transt). This moving average approach will be applied to empirical testing for both
equation (1) and equation (2).
Upon testing the significance of these specifications over the entire relevant
history of bitcoin markets, the next step would be to analyze different subsamples to see how the model may have changed over time and if the more recent
behavior of the Bitcoin market should be modeled differently. This would also be
a way to build upon results from Buchholz et al. (2012) since market activity
related to Bitcoin has changed drastically since 2012. To perform our sub-sample
analysis we will break up our time series into three different subsamples. A
breakdown of these sub-samples over a plot of bitcoins value since 2011 is given
in Figure 1. One interesting result is the continued upward trend in market activity
even as the value took a dive at the end of 2013 and has fluctuated greatly since.
This could indicate that our market activity measures such as transactions per day
may have a different relationship with price in the most recent sub-sample.
Although no formal structural break testing has been done, these sub-samples
divide time series based on visible changes in trend as well as shifts in level of
public interest in the cryptocurrency. The first of these would be the period from
2011 to the end of 2012 which represents the market before the exponential
growth in price in 2013. This period characterizes a time in which Bitcoin and the
Blockchain were not a mainstream concept and not heavily utilized. The second
sub-sample would run from the beginning of 2013 through November of 2013,

just before the crash began. This period can be defined as the Bitcoin bubble and
is very unique in that exponential growth persisted which gave rise to a large
increase in speculative interest in Bitcoin. In this sub-sample many investors
believed that purchasing bitcoin could be an easy market to turn over large shortrun profits.

Empirical results from this sample give some insight into what sorts of
behavior was driving the bubble up until it burst in December of 2013. Differences
in the model over this period are likely to be found empirically as pricing trends
do not resemble any other portion of the time series. The third period runs from
the beginning of 2014 through the beginning of 2016. This period should be the
most important and most interesting in that is the current state of the Bitcoin
market and seems to be a volatile state at which the market is searching for some
equilibrium price level. A comparison of this sub-sample to the entire time series
could give insight into what is currently driving the Bitcoin market and how it has
changed since the bubble. Significant empirical support of a model from the most
recent sub-sample would be a critical finding in determining the state of the
Bitcoin market and how pricing determination can be modeled in the absence of
a bubble.

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4.1

Results
Full Time Series Analysis

The two base model specifications, both linear and log-transformed, along
with sub-specifications are summarized in Table 1. For the linear-level equation
(1) we estimate the model using all variables and find that all coefficients are
statistically significant. We will compare and contrast this level specification to
the log-linear equation representing the multiplicative underlying structure. In
(1), the coefficient of 1 is negative and significantly different from zero which is
contrary to our model prediction. This would indicate that increases in number of
transactions per day are met with decreases in price. On the other hand our loglinear regression predicts a statistically different positive coefficient. The value of
1 in the log-linear equation indicates a 100% increase in number of daily
transactions, all things equal, would be met with a 2% increase in price. Another
contrasting result is that equation (1) estimates a 2 as a statistically significant
positive value. This would be contradictory to traditional theory that increased
supply of bitcoins should be accompanied by a fall in price. On the other hand,
equation (2)s specification predicts an indirect relationship between our supply
variable and price (although this result is not statistically significant in the daily
data). These two differences in our empirical findings give the first indication that
the underlying structure of a multiplicative model is likely a better candidate for
modeling the true relationship.
Continuing through Table 1 we find strong support of negative 3 coefficients
in each specification. This would be an indication that the substitution effect is a
strong force relating the price of gold to bitcoins value. In fact, the value of 3
indicates that we could expect an increase of greater than 1% in the price of gold
with every 10% increase in the price of gold. This lends support to argument made
by Dhyrberg (2015) that bitcoin, as an investment, is similar to gold in that it can
be used to hedge against the same type of market risk. Looking next at the
coefficient relating the dollar index to bitcoin price we see our model prediction
is supported by both the level and log-transformed regression forms. This could
indicate that bitcoins value is in part the result of loss of confidence in a local
currency unit. It could also simply relate the U.S. dollar only being one of many
currencies which is traded for bitcoin and thus the dollar appreciate relative to
bitcoin as it appreciates relative to the basket of currencies in the index. In our
baseline log-linear model (2a), the elasticity coefficient predicts about a 2%
change in the dollar value of bitcoin for every 10% rise in the dollar index.
Moving onto our next coefficient, our initial prediction was that the number of
users per day (userst) is closely related to number of transactions per day (transt)
and that each should be positive. However, contrary to this intuition, the two
variables generate significant coefficients of opposite sign in our level regression
specification (1). In this additive specification, 1 does not have its predicted
positive coefficient (transactions per day having a negative effect on price) while
the multiplicative specification indicates an elasticity coefficient almost exactly
equal to zero for 5 (no effect of users per day on price). This could have something

to do with the possibility of multicollinearity between variables representing the

transactions and users per day. Investigating this possibility we calculated a
Pearson correlation coefficient between the base data sets and found it equal to
.95. This leads us to the two sub-specifications of the log-linear equation denoted
as (2b) and (2c) which exclude userst and transt respectively. This successfully
improves our results as we find that each variable exhibits a positive elasticity
which is statistically different from zero when included alone. These results
further support our claim that the log-linear regression represents the more
accurate functional form. As expected, our last coefficient, 6 variable is both
positive and close to unity. Altogether, we find the level equation specification
(equation 1) has an explanatory power of 97.1% and each variable is significantly
different from zero at even a 1% level. However, both theory and the empirical
results seem to indicate the log-linear specification, which has explanatory power
of about 99.9% is the more probable underlying functional form and thus we will
focus on this regression moving forward.
Having now narrowed the focus onto the log-linear specification in our
regressions, we can now take a closer look in comparing the base subspecifications (2a), (2b), and (2c) in Table 1. We already mentioned that 5 was
drastically different when dropping the transactions variable going from very
near zero to statistically significant at the 5% level with a positive elasticity of
.017. However, there is also some differences in our other variables between the
three specification options. As the userst variable had almost zero effect in the
initial regression (2a), we find that there is almost no difference in the other
coefficients in (2b) when dropping it entirely. However, when instead leaving out
the transactions variable, both the price of gold and the trade weighted dollar
index are shown to have a larger effect upon value. The other difference which
stands out in (2c) is that the supply variable (total number of bitcoins) switches
signs form negative to positive. Although, it is still not statistically significant at
even the 10% level, this change as well as the other deviations from (2a) would
lead us to believe that dropping the users variable from our specification may
more accurately represent the underlying structure of price determination as it
seems it is only related to price through its correlation with the number of
transactions per day. However, as this is not shown conclusively, we will continue
to compare all three specifications going forward in both moving average and subsample analysis.
To account for the large volatility in the daily data for our bitcoin related data,
we will now analyze the effect of using a seven-day moving averages on data in
Table 2. This should have a general smoothing effect and take into account some
of the effect of a change in independent variable on bitcoin price over a weeklong
time frame. We can compare results from these moving average equations in
Table 2 to those of Table 1 to check for both robustness and the potential
differences in longer-term relationships between bitcoins value and its
explanatory variables. Looking at only the (2a) specification, we see the moving
average gives some substantial differences in coefficients estimated. Although
there is nearly no change in the elasticity coefficient 1, 5 becomes a negative
value significantly different form zero at even the 1% level, similarly to the
10

relationship we found in equation (1). We can see in the moving average

regression for (2c) that this negative coefficient of 5 persists despite dropping the
transactions variable. This further supports a preference of sub-specification (2b)
since it retains a significant value of 1. Another difference worth noting is that we
find our first statistically negative coefficient on 2 (at 5% level) which finally gives
us some statistical evidence that the relationship between bitcoin supply and the
value of bitcoin does in fact exhibit the indirect relationship we predicted. The
results of Table 2 strongly support our model prediction as well as the empirical
findings in Table 1, which serves to indicate that our findings are in fact robust.
We will proceed using the daily data (as in Table 1), as the moving average
transformation has served its purpose in helping to confirm its validity.

4.2

Sub-Sample Analysis

The time series of daily data related to Bitcoin is broken down into three subsamples in Table 3. This can give us an idea of what types of structural change the
bitcoin market has gone through since its inception, as well as indicate where our
model specification may break down. We start with the most full inclusion
specification from equation (2), broken down into all three periods in Table 3a.
We will refer to our sub-samples as pre-bubble: the period from 2011 through the
end of 2012, Bitcoin bubble: the period running from the beginning of 2013
through November of 2013, and post-crash: the period running from 2014
through the present data (currently February 2016). The month of December
2013 is when the price of bitcoin was plummeting during the crash and rather
than analyze in alone or include it in either of the surrounding sub-samples, we
will exclude this period. This is done since that particular month is both unique
and distinct from the periods surrounding it and also too short a time frame to
give much information on its own. We can compare the elasticity coefficients
between each of the three sub-samples in Table 3a along with the original full
time-series data in Table 1. The first thing to notice is the clear differences
between the three time periods. Starting with the transactions variable, we find
that it remains positive yet statistically insignificant from zero in only the prebubble and post-crash periods. In the period during the bitcoin bubble, this
coefficient was actually negative. On the other hand the 5 coefficient remains
positive or near zero through all three samples with a much higher elasticity
predicted during the bubble. However, this coefficient is also not statistically
different form zero. We also notice that sub-sample 1 has much lower elasticity
coefficients for both of these variables which we will see is a common theme for
this period as price fluctuations were much less extreme before the bitcoin
bubble.
The next difference we pick up is that (2) has a positive sign (which is only
statistically different from zero at the 10% level in sub-sample 2) in the first two
sub-samples, with an elasticity as high as .65 during the price bubble. The third
sub-sample predicts an elasticity coefficient of nearly zero for the total bitcoins
variable (Bt). This indicates that prices grew directly with total number of bitcoins
in the earlier history of Bitcoin markets, violating our predicted supply-side shock
relationship. Another interesting result of this sub-sample breakdown is that our
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predictions regarding the relationship of price to both the dollar index and the
price of gold break down during the bitcoin bubble period. The most notable
feature of this second sub-sample is that it is noticeably dissimilar to the pooled
sample and the other two sub-samples. Another finding is that the prices of similar
alternative assets, such as gold, seemed to dominate price determination in the
early years of Bitcoin. A negative elasticity coefficient of .188 was estimated
relating bitcoins value to the price of gold which is significantly smaller than the
the -.068 elasticity coefficient estimated in the years since the crash. Looking at
Figure 1 it is apparent that these periods are dissimilar in general in both the
average value of bitcoin and the general volatility of the market. As the market is
much larger in recent years, it is less heavily influenced by the value of alternative
assets such as gold and the dollar.
In Table 3b we apply our two sub-specifications of the multiplicative model in
excluding either transactions per day or users per day. This is successful in
combining their effect into a single elasticity variable as we see that each has an
elasticity of greater than .03 in the most recent sub-sample. It is also an
improvement upon the (2a) base specification in that both users per day and
transactions per day generate coefficients which are significantly different from
zero at even a 1% level while the base specification was not even statistically
significant at the 10% level. Despite this general improvement, we find that
neither specification offers any additional evidence that our 2 coefficient could in
fact be negative. Given this, we would have to consider whether some alternative
specifications are required to reconcile this or if there is some other force relating
total number of bitcoins increasing with the value of the currency due to the
unique and predetermined nature of bitcoin supply.
Looking at each of these periods separately there is definitely some evidence
of significant change in the underlying structure of bitcoins price determination.
It is clear that our model predictions broke down during the period of rapid price
growth in 2013 which we refer to as the bitcoin bubble. This irrational explosion
of bitcoins value likely had a large degree of influence from variables not included
in this model which relate to the excessive speculation and surging popularity
surrounding the cryptocurrency. There is also a clear shift in variable weighting
before and after the bubble ran its course in 2013. A permanent shift in the value
of bitcoin and size of the market accounts for the transition from sub-sample 1 to
sub-sample 3. The significant influence of an alternative such as gold has become
much less prominent in price determination in the years since the crash while the
influence of real market variables such as transactions per day and number of
unique addresses used has become much more prominent as seen in Table 3b. The
userst variable in specification (2c) increases from .009 to .038 and becoming
statistically significant. The transactions variable in (2b) shows much the same
change becoming significant and increasing from .007 to .035. Once again the
lagged price of bitcoin (Pbtct1) is always close to unity and adds significantly to
the explanatory power of the regression. In addition, we include this
predetermined bitcoin price hoping to control for any potential price adjustment
process over time.

12

Conclusion

The market for and interest in Bitcoin is continuing to grow despite the
volatile and unpredictable swings in the value of the cryptocurrency. This paper
attempts to develop on a model for the price determination of bitcoin as well as a
sub-sample analysis to further shed light on the developing Bitcoin market.
Variables which were analyzed to capture both demand and supply side drivers
included measures of the market thickness as well as the relationship between
bitcoin and some currency alternatives such as the US Dollar and the value of gold.
The empirical results definitively support the multiplicative model, and a
regression on the moving averages of datasets showed that all results from the
base regression are robust. The model specifications support a positive
relationship between market thickness measures which indicates the predicted
demand-driven relationship between market activity and price. On the other
hand, the model also confirmed a negative relationship between the value of gold
and bitcoin price, as well as between the value of the US Dollar and bitcoins price.
This shows that our proposed substitution effect between bitcoin and gold seems
to have a dominant effect on price changes. It also confirms that bitcoins value is
not tied to the US Dollars and its US dollar price decreases as the US dollar
appreciates (much like any other competing currency). These demand-side
drivers are supported by the empirical results while the expected supply-side
relationships, such as the effect of total supply of bitcoins, do not seem to have a
significant effect on the Bitcoin market. This leads us to the conclusion that the
volatile shifts in price of bitcoin over the past few years can be largely attributed
to demand-side shocks. It should also be noted that the consistent coefficient near
one relating price with its single day lagged value is representative of the random
walk hypothesis which occurs with the assumption of efficient market. The
assumption that a single day lag was preferred is based upon the highest
frequency relationship being exemplary of the rapidly adjusting bitcoin market,
but a future contribution could be made in testing the optimal lag structure of the
bitcoin price variable to be sure that it is the preferred lag variable to be included
in the model. Furthermore, one can consider conducting a formal stationary test
on the bitcoin price.
Along with providing insight into the types of shocks driving bitcoin price
volatility, the results of this paper lead to new questions regarding the nature of
bitcoin supply variables and how it relates to price determination. As discussed in
the introduction to Bitcoin, the system of generating new bitcoins and injecting
currency into the market is very unique. We could conjecture that supply-side
shocks could rather be represented by speculative interest as well as the holding
of bitcoin for investment purposes. However, this paper only analyzes the
substitution effect related to investment driven usage of bitcoin. This allows for
further research to be done regarding the investment decision to hold bitcoin as
well as how it affects a portfolio when included.
The largest contribution made within this paper which differentiates it from
other work done in the area is the usage of a sub-sample analysis to approach the
effect of the bitcoin bubble. We can see from Figure 1 that there were noticeable

13

differences between the early years of the bitcoin market and the more recent
years since the bubble. Our sub-sample analysis provides evidence of a significant
difference in elasticity coefficients which indicates a shift in variables important
to price determination. Specifically it seems the relative weight of the substitution
effect from assets such as the US Dollar and gold has decreased and the relative
weight of the effect of changes in market activity as measured by transactions and
unique users per day has increased in the most recent subsample. These results
of the sub-sample analysis could further be improved upon in using a formal test
for structural break to give an idea of when exactly the period defined as the
Bitcoin bubble began and ended which could be used to both improve upon these
results as well as give some indication as to what events may have caused the
Bitcoin bubble and subsequent crash in 2013.
The conclusions drawn from this paper are another step towards
understanding the Bitcoin market and what the future may hold for the electronic
system of transaction. The question will continue to be asked if this
cryptocurrency is the future of money or even a sound investment opportunity.
What we do know is that the valuation of bitcoin happens to be very unique in its
differences with more commonly accepted forms of currency. In recent years its
usage in legitimate electronic transactions has increased and it seems to have
found its niche as an investment which differs significantly from traditional assets
in a portfolio. However, there are no signs that its volatility will diminish or its
value will follow any specific trend in the coming years. Investment behavior is
rather driven by speculative interest in the future of cryptocurrency and the belief
that the next Bitcoin bubble could be on the horizon. For now, it is important to
continue to study the usage of bitcoin and continue to develop an understanding
of the unique Bitcoin market in order to ponder what the future may hold for
cyrptocurrency.

References

Barro, Robert and David Gordon. Rules, Discretion and Reputation in a Model
of Monetary Policy. Journal of Monetary Economics 12 (1983): 101-21. Web.
Baur, Dirk, Lee, Adrian, and Hong, Kihoon, Bitcoin - Currency or Asset?.
Melbourne Business School, 2016 Financial Institutions, Regulation, and Corporate
Governance (FIRCG) Conference (2015). Web.
Bohme, Rainer, Nicolas Christin, Benjamin Edelman, and Tyler Moore.
Bitcoin: Economics, Technology, and Governance. The Journal of Economic
Perspectives 29.2 (2015): 213-238. Web.
Briere, Marie, Kim Oosterlinck, and Ariane Szafarz, Virtual Currency, Tangible
Return: Portfolio Diversification with Bitcoins. Working Papers CEB 13-031, ULB
Universite Libre de Bruxelles (2013). Web.
Buchholz, Martis, Jess Delaney, and Joseph Warren, Bits and Bets.
Information, Price Volatility, and Demand for Bitcoin. (2012). Web.

14

Ciaian, Pavel, Miroslava Rajcaniova, and dArtis Kancs. The Economics of

BitCoin Price Formation, Papers 1405.4498 accessed through arXiv.org (2014).
Web.
Dyhrberg, Anne Haubo. Bitcoin, gold and the dollar A GARCH volatility
analysis. University College Dublin Centre for Economic Research Working Paper
Series (2015). Web.
Polasik, Micha, Anna Piotrowska, Tomasz Piotr Wisniewski, Radoslaw Kotkowski ,
and Geoff Lightfoot. Price Fluctuations and the Use of Bitcoin: An Empirical Inquiry.
International Journal of Electronic Commerce 20.1 (2015). Web.
Table 1:
Baseline Equations
(1) Level
(2) Log
Variable
trans (1000s)

a
-.491
(-4.70)***

ln(trans)
B (1000s)

.018
(3.40)***

.018
(3.40)***

-.013
(-0.45)

-.013
(-0.46)

.0291
(1.27)

-.109
(-3.49)***

-.109
(-4.03)***

-.125
(-4.09)***

-.196
(-2.33)**

-.196
(-3.18)***

-.277
(-3.55)***

.007
(6.92)***

ln(B)
P Gold

-.055
(-5.32)***

ln(Pg)
twdi

-4.42
(-8.67)***

ln(twdi)
users (1000s)

.472
(7.49)***
.000
(0.01)

ln(users)
P lag-1

.017
(2.30)**

.881
(91.7)***

ln(Pbtc lag-1)
R2
N (observations)

.971
1246

.988
(200)***
.999

.988
(350)***
.999
1236

*** denotes significance at 1% level

(t-values in parenthesis)
** denotes significance at 5% level

15

.982
(223)***
.999

* denotes significance at 10% level

Table 2:
Moving Averages
(2)
Variable

ln(trans)

.020
(8.06)***

.009
(4.96)***

ln(B)

-.024
(-2.44)**

-.011
(-1.18)

.024
(3.11)***

ln(Pg)

-.030
(-2.68)***

-.070
(-7.39)***

-.049
(-4.46)***

ln(twdi)

-.020
(0.63)

-.129
(-6.09)***

-.078
(-3.55)***

ln(users)

-.024
(-6.52)***

ln(Pbtc lag-1)

-.005
(-1.63)

1.004
(556)***

.993
(1016)***

.997
(607)***

.9999

.9999
1839

.9999

R2
N (observations)

*** denotes significance at 1% level

(t-values in parenthesis)

Table 3a:

Variable
ln(trans)

** denotes significance at 5% level

* denotes significance at 10% level
Sub-Sample Analysis - Base Specification
(2)
Sub-sample 1 Jan
2011 - Dec 2012

Sub-sample 2 Jan
2013 - Nov 2013

Sub-sample 3 Jan
2014 - Feb 2016

.010
(0.78)

-.025
(-0.59)

.022
(0.23)

16

ln(B)

.039
(0.87)

.652
(1.90)*

-.007
(-0.06)

ln(Pg)

-.188
(-2.83)***

.283
(1.95)*

-.068
(-1.16)

ln(twdi)

-.36
(-1.68)*

1.48
(1.81)*

-.287
(-2.97)***

ln(users)

-.007
(-0.38)

.075
(1.63)

.020
(0.96)

.996
(112)***

.970
(50.4)***

.981
(134)***

.997

.993

.993

ln(Pbtc lag-1)
R2
N (observations)

496

(t-values in parenthesis)
Table 3b:

Variable

226
491
*** denotes significance at 1% level
** denotes significance at 5% level
* denotes significance at 10% level
Sub-Sample Analysis - Alternate Specifications
(2)

Sub-sample 1 Jan
2011 - Dec 2012
b

Sub-sample 2 Jan
2013 - Nov 2013
b

ln(trans)

.006
(0.77)

ln(B)

.043
(0.98)

.059
(1.57)

.624
(1.81)*

.629
(1.85)*

.028
(0.27)

-.002
(-0.02)

ln(Pg)

-.200
(-3.41)***

-.219
(-4.13)***

.260
(1.80)*

.245
(1.89)*

-.056
(-0.98)

-.078
(-1.34)

-.370
(-1.75)*

-.366
(-1.71)*

.980
(1.29)

1.384
(1.73)*

-.277
(-2.88)***

-.261
(-2.77)***

ln(twdi)

.007
(0.18)

Sub-sample 3 Jan
2014 - Feb 2016

17

.035
(2.69)***

.009
(1.10)

ln(users)

.062
(1.53)

.038
(2.59)***

ln(Pbtc lag-1)

.994
(156)***

.994
(116)***

.993
(75.8)***

.970
(50.5)***

.983
(144)***

.981
(135)***

R2

.999

.999

.993

.993

.993

.993

N
Variable

496
N

Mean

226
Min

Max

Description
This is the independent variable of the study,
it represents the 24 hour weighted average
Pbtc
1825 202.6
0.3
1132.26 233.5
of the price of 1 bitcoin in US dollars. Source:
Blockchain database through quandl.com
This explanatory variable measures the total
trans
number of unique bitcoin transactions per
1845 56.6
0.6
241.4
46.9
(1000s)
day which are verified on the Blockchain.
This data was also obtained from quandl.com.
This explanatory variable measures the
number of unique bitcoin addresses used on
users
1845 103.8
0.8
457.57
98.4
any given day which was also collected from
(1000s)
quandl.com with the original source being the
Blockchain database.
This explanatory variable measures the total
B
number of bitcoins which have been mined up
1845 10411 3437 15109
2813
(1000s)
to the current day obtained from quandl.com
and the Blockchain database.
This is the Trade Weighted U.S. Dollar Index:
Broad as obtained from the St Louis Fed
(fred2) database. It is a weighted average of
twdi
1265 102.9
93.7
125.6
7.6
foreign exchange value of the U.S. dollar
against the currencies of a broad group of
major U.S. trading partners.
This measures the U.S. dollar value per troy
ounce of gold as measured by market value.
Pg
1318 1411
1049 1895
216
obtained using quandl.com with the original
source being the World Gold Council database.
Pbtc (lag-1) This explanatory variable is the exact same as the P variable but with a 1 day lag.
*** denotes significance at 1% level
(t-values in parenthesis)
** denotes significance at 5% level
* denotes significance at 10% level
Appendix

18

StDev

491