Sources and Threats of Bitcoin’s Recent Crisis

Abstract:

Bitcoin has long-termly been taken as a hedge in investment portfolios given its negative correlations with the stock market. This counter-cyclicality has boosted its market during the current pandemic period when the global economy has been sluggish. However, this "hedge" illusion has been broken by the Bitcoin's recent consecutive slumps. To help a better understanding to Bitcoin market, as well as to facilitate a better investment decision and crisis prevention, the sources of Bitcoin's recent crisis and its threat to the financial stability are examined by this paper. Through the quantitative analysis combined with the case studies, this paper finds that on correlation side, Bitcoin's crisis is related to its pseudo counter-cyclicity that is highly susceptible to external variations; on volatility side, it is associated with Bitcoin's uncertainty of intrinsic value, high competition, new centralization problem and moral hazards. Although Bitcoin has followed certain risk spillover paths to influence the financial market, its current influence is limited due to its strong rebounding ability, small market scale, and low correlation with other sectors. This paper provides some valuable insights into the Bitcoin by focusing on a timely issue and being first to specifically analyze the sources and threats of Bitcoin's crisis in 2021. With a high timeliness and originality, this paper can help a better understanding to the Bitcoin's current risk status, which is useful to the investment decision making and financial risk control.