What drives the Bitcoin price? A factor augmented error correction mechanism investigation

ABSTRACT

This article aims to determine what drives the price of Bitcoin. To achieve this aim, a large set of data is analysed using VEC models augmented by factors representing unobservable economic forces. They have been obtained by means of principal component analysis. This method enables us to contribute to the existing literature on Bitcoin in two ways. First, we employ the dimension reduction technique to combine variables from several papers. Second, we estimate several unobservable economic concepts instead of utilizing proxy variables as is usually done. We find that the main factor driving the Bitcoin price is its popularity. Hence, our result not only confirms some previous findings but reinforces them by providing a better definition of popularity. Finally, we conclude that the Bitcoin price is not affected by supply and demand factors in the way that is natural for conventional currencies.

KEYWORDS:

• Bitcoin
• cryptocurrency
• FAVAR
• FECM
• financial investment

JEL CLASSIFICATION:

• E31
• E42
• G12

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ https://www.nexis.com/.

² https://stats.grok.se/.

³ https://tools.wmflabs.org/.

⁴ Bai and Perron (1998).

⁵ The Mt. Gox Bitcoin Exchange was hacked in this period.

⁶ In November 2012, the first halving of Bitcoin’s emission occurred.

⁷ The Bitstamp wallet was hacked in this period. Later in that month, Coinbase Inc. launched a US-licensed exchange.

Additional information

Funding

This work was supported by the Narodowe Centrum Nauki [2016/23/B/HS4/02357].