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Buy, sell, or hold? Since its launch in 2009 as the first cryptocurrency, the value of bitcoin has been a financial roller coaster ride with lofty peaks and precipitous drops. Given this history of volatility, is there any way that investors with bitcoin in their portfolios—or those who are considering adding it—can anticipate where this crypto is headed next?

Associate Professor of Finance Sang Baum Kang at Illinois Institute of Technology’s Stuart School of Business is co-author of a paper published in The Journal of Alternative Investments that provides new empirical evidence about bitcoin returns to guide investment professionals, economists, and academic researchers.

details research conducted by Kang and two of his former doctoral students—Yao Xie (M.S. Finance ’15, Ph.D. MSC ’21), an associate quantitative analyst at Morningstar Inc., and Jialin Zhao (Stuart Ph.D. MSC ’17), associate professor of quantitative management at St. Mary’s University in San Antonio.

According to Kang, Xie, and Zhao, bitcoin has straddled three different economic roles over time: as a type of currency, due to its use as a medium of payment; as a speculative security; and as a safe-haven commodity because of its scarcity and mining cost.

“In academia, there is a research methodology called the asset return predictability study,” says Kang. “An underlying principle is that variables predicting the future movement of an asset price may be important in the economic system. So understanding what those variables are is important not only to traders who want to take a position in bitcoin, but also to economists who want to understand the nature of bitcoin.”

Utilizing cutting-edge predictive analytics techniques and dimension-reduction models with a dataset covering January 2011 to January 2020, the research team focused on a comprehensive set of 25 information variables under five categories—macroeconomics, blockchain technology, other assets, stress level, and investor sentiment—to identify factors that impact bitcoin returns.

“We find that blockchain technology, investor sentiment, and stress level have predictive power for bitcoin returns,” Kang says. “Similar to traditional assets, bitcoin shows higher return predictability with longer return horizons. These findings support the dual nature of bitcoin as a technical artifact and speculative asset.”

Major results of the research include:
•    The difficulty of mining bitcoin positively predicts returns, which supports the theory that as blockchain technology requirements increase, the supply of bitcoin is reduced, which in turn increases the return on bitcoin.
•    Bitcoin returns are positively driven by investor sentiment—that is, the general attitude about bitcoin and the market. When investor sentiment goes up, so does bitcoin, indicating the speculative nature of bitcoin as an asset.
•    Future bitcoin returns decrease when there is an increased stress level, or financial turmoil in the economy, which points to the risks associated with holding bitcoin as an asset.

In addition, the research demonstrates that macroeconomic variables—such as measures of business conditions, monetary policy, and inflation—and returns on commodities, securities, and other assets do not predict bitcoin returns well. 

“Bitcoin returns are largely detached from economic fundamentals,” Kang says. “From this finding, we caution against using bitcoin as a diversifier or safe-haven asset within an investment portfolio.”

Photo: Associate Professor of Finance Sang Baum “Solomon” Kang