An Econometric Approach to the Key Drivers of Bitcoin Price

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Technical drivers

The supply of new Bitcoin is regulated by the difficulty that reflects in the computational power of Bitcoin miners which is called the hash rate. According to Bitcoin.org, hash rate is the speed at which a compute is completing an operation in the Blockchain. A higher hash rate is better when mining as it increases your opportunity of finding the next block and receiving the reward. Miners verify ongoing transactions and the uniqueness of Bitcoin by solving computational problems, and they obtain new Bitcoin as the reward. Rewards and difficulties are given by a known formula. More importantly, to keep the creation of new bitcoins in balance, the difficulty of solving the computational problems increases according to the hash rate of the current miners. Thus, in this case, the hash rate then becomes another measure of system productivity, which is reflected in the system difficulty. In this manner, the bitcoin supply remains balanced and the system is not flooded with bitcoins (Kristoufek, 2015).

When it comes to mining Bitcoin, investors often see mining as an investment opportunity since the more money they invest in the hardware, the faster their computational power is in return for the rewards. There are two possible effects between Bitcoin price and mining difficulty as well as hash rate. Firstly, instead of purchasing Bitcoins directly in the Bitcoin exchanges, investors invest in the hardware and start mining which causes the increase in hash rate, and, in return, pushes the mining difficulty level higher. On the other hand, increasing in hash rate and difficulty leads to increase in the cost of electricity and hardware drive more amateur miners out of the competition. And if these miners invested mining hardware instead of direct investment, now, they have to purchase Bitcoins through Bitcoin exchanges. The more amateur miners are driven out of the market, the higher the demand for Bitcoin is, and, the higher its price is. So we expect a positive relationship between Bitcoin price and hash rate as well as mining difficulty.

Investors’ interest

One of the possible key drivers of Bitcoin price is its attractiveness as an investment opportunity under particular news coverage for investors. Search queries provided by Google Trends has proved to be a useful source of information in financial applications ranging from the home bias and the traded volume explanations through the earnings announcements to the portfolio diversification and trading strategies. The frequency of searches of terms related to the digital currency can be a good measure of interest in the currency and it can have a good explanatory power (2013). The more interested investors are in investing in Bitcoin, the higher the demand is, thus, the higher Bitcoin price is. To quantify this relationship, we use weekly data on Google Trends to measure the popularity of the word “Bitcoin” in Google engine search queries. When interest in Bitcoin rises, the use of the digital currency might get a positive boost, presumably resulting in a higher price. Thus, we expect the impact is assumed to be positive.

Safe haven

We want to quantitatively analyze the possibility of the Bitcoin being a safe haven. Specifically, we examine the relationship of Bitcoin price with the Financial Stress Index (FSI) and gold price. The former is an index of financial uncertainty of the US market provided by St. Louis Federal Reserve. The latter is chosen because gold is considered as a long-term storage of value asset which is resistant to inflation or collapsing financial market. Another reason is the fact that gold, like digital currency, is not controlled by any centralized organization (e.g. government) which means no monetary or fiscal policies can influence its value. We expect a positive relationship with the gold price. Periods of economic distress tend to move people towards alternatives such as Bitcoin; therefore, more ambiguity in financial markets can be a price stimulant, as the alternative currency can be seen as a safe haven (Kristoufek, 2015). So higher financial uncertainty, or declining stock market indices, should move the Bitcoin price up.

Historical Bitcoin-related events

There were a numerous historical Bitcoin-related events happened since the beginning of Bitcoin in 2009 which has a serious effect on Bitcoin price such as the Chinese government bans financial institutions from using Bitcoin - December 5, 2013 – when Bitcoin value is at $1022 and dropped to $840 ten days later: or the close of the Bitcoin exchange Japan-based Mt. Gox, by 2013 was handling 70% of all bitcoin transactions, due to hacker’s exploitation which results in around 850,000 Bitcoin were lost by the company, an amount valued at more than $450 million at the time. Therefore, we want to capture the effect of positive and negative Bitcoin-related events on Bitcoin price. We expect the positive events are positively correlated to the Bitcoin price and negative events are negatively correlated to the Bitcoin price.

Data

We collect the time-series data of Bitcoin market price in US dollars, total number of Bitcoins in the network, Bitcoin trade volume versus transaction volume ratio, hash rate, and Bitcoin network deficit on Quandl.com, a marketplace for financial and economic data delivered in modern formats for today's analysts. Below are the graph of weekly data for Bitcoin drivers.

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To capture the public interest of Bitcoin, we use the weekly data of user search for the term “Bitcoin” on Google Trends. Numbers represent search interest relative to the highest point on the chart for the given time. A value of 100 is the peak popularity for the term. A value of 50 means that the term is half as popular. Likewise, a score of 0 means the term was less than 1% as popular as the peak.

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For the safe haven drivers, weekly data of gold price and Financial Stress Index were obtained from Federal Reserve Bank of St. Louis, a wealth of economic data and information to promote economic education and enhance economic research.

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We found the historical Bitcoin-related events that influenced Bitcoin price significantly at https://99bitcoins.com/price-chart-history/ which represents 61 historical events that seemingly effected Bitcoin’s value at that time. For this particular

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