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Game of Hashes

A study on the driving forces of the Bitcoin price

DECOM
DECOM
Jul 19, 2019 · 12 min read
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Executive Summary:

In the period between December 2017 and December 2018, the price of Bitcoin reached an all-time record of almost 20’000 USD and a minimum price of about 3’200 USD. In this short study, we analyze and explain some of the driving forces that negatively influenced the price of Bitcoin during the last quarter of 2018. Our purpose is to understand some of the mechanisms behind the price fluctuations of cryptocurrencies. Since many of the technical factors that alter the price of cryptocurrencies, such as forks or moves in the mining hash power, can be foreseen by observing social media and metrics in the network — like the fees paid to the miners, or the block time — we argue that active management of cryptocurrency portfolios might be able to anticipate some of the future (positive or negative) sharp moves in the price of cryptocurrencies.

Introduction

In order to analyze the development of the Bitcoin price, we first introduce and explain various technical concepts that are necessary to understand the explanation. We start introducing mining in “Proof of Work” protocols and the role of hash power in the probability of writing valid blocks. We continue by introducing forks, which are changes in the original protocol that yield new currencies. Only after introducing these concepts we analyze and explain the development of the Bitcoin price in the last quarter of 2018.

Understanding Proof of Work Mining

Bitcoin is a currency that is created by computers, which are commonly referred as “miners”. Miners follow the Bitcoin protocol, which is the set of rules that defines how new bitcoins are created and how bitcoin transactions are validated. New bitcoins are created whenever a miner writes a valid block. A block is a piece of information (that can be understood as an entry in an accounting ledger), which refers to the history of all previous valid transactions by means of a cryptographic hash and adds information about new transactions. A valid block confirms the new transactions made by bitcoin users. A valid block is a block that respects the rules of the Bitcoin protocol. Valid blocks are created in a random manner, such that miners need to write and test many versions of a block until they find one that is valid. Once a miner finds a valid version of a block, the block is added to the blockchain and the mining process starts again. [1]

Understanding Forks

The Bitcoin protocol is open and can be replicated and altered by any miner. When miners disagree about the mechanics of a currency (block size, block reward, average mining time, etc.) they can slightly alter the protocol and create a “fork” to accommodate the cryptocurrency to their needs. A fork is a change in the protocol of the original currency. Forks yield new currencies. [2]

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Figure 1: Illustration of hash power distribution and of a double-spending-attack (in red).

The Bitcoin Cash SV Fork and its Impact on the Bitcoin Price

On November 15th, 2018 Bitcoin Cash was forked in two currencies, namely Bitcoin Cash SV (“SV” standing for “Satoshi’s Version”), and Bitcoin Cash ABC (“ABC” standing for “Adjustable Blocksize Cap”). Both versions vary in the implementation of some attributes of the currency and their supporters have fought roughly in terms of price, hash power, and media statements to become the “original” Bitcoin Cash. Bitcoin Cash ABC has been backed by more hash power and is nowadays referred by miners and exchanges as “Bitcoin Cash”, whereas Bitcoin Cash SV has kept its versioned name and is currently traded at lower rates than Bitcoin Cash (ABC) [4].

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Figure 2: Daily average Bitcoin price and standard deviation between October 13th and November 14th.
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Figure 3: Total hash power of the Bitcoin network between October 25th and November 15th.
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Figure 4: Daily miner’s fees comparison.
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Conclusion

While understanding all the forces that drive the price of cryptocurrencies is a difficult if not impossible task, we have analyzed some of the key reasons for the decline in the price of bitcoin during November 14th and 15th. Our aim is to understand some of these fundamentals and in order to anticipate –or at least explain– sharp moves in the prices of cryptocurrencies.

Sources

[1] Andreas M. Antonopoulos, Mastering Bitcoin, Unlocking Digital Cryptocurrencies, O’Reilyy Media 2014. Average Block time before the fork Average Block time after the fork 584 seconds 703 seconds Blockchain Research Lab Chair of Quantitative Business Administration University of Zurich



About DECOM

Decom Switzerland LLC is an independent crypto asset management company based in Switzerland that facilitates access to the entire crypto universe for institutional and private investors. Its objective is to offer a diverse range of actively managed investment solutions. The company’s core goal is to create long-term wealth through crypto assets.

About Blockchain Research Lab

The Blockchain Research Lab is an initiative of the Chair of Quantitative Business Administration of the University of Zurich that combines economic analysis, information systems research, and blockchain technology to promote the sustainable and collaborative adoption of blockchain technology in society.

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