Despite lower returns since its inception, the crypto coin’s price has more than doubled this year. The momentum is due to a combination of politics and marketing that feed cognitive biases. This is the recipe for a bubble market.
On January 1, 2024, the price of bitcoin was approximately $44,200, which was 34% lower than its peak in October 2021. By September of this year, the price was about $60,000. At that point, it became clear that a political shift would favor cryptocurrencies, or at least assert its support for them. Then, the rally toward $100,000 began.
However, one of the many issues with bitcoin is its strong correlation with the stock market.
Bitcoin and S&P 500 E-mini futures have had a positive correlation since 2020 (0-lag, 120-day first differences), which by the end of 2022 reached as high as 0.59. This indicates that bitcoin does not contribute positively to a diversified portfolio and may potentially negatively impact performance in bear markets. Will this positive correlation change in the future? We believe such a regime change has low odds.
More importantly, yearly bitcoin returns have decreased parabolically over the years.
Those who invest $10,000 in bitcoin with the hope of becoming millionaires soon should review the above chart. Large returns belong to the past and are unlikely to occur again. While it is possible to achieve returns in the range of 1000%, it is not a realistic expectation.
Politics and past performance have given rise to a few cognitive biases that are driving bitcoin higher.
Status quo cognitive bias: The future will continue to reflect the past.
The conservatism bias refers to the slow change of beliefs in response to new evidence.
Endowment cognitive bias: People value bitcoin more because they own it.
Optimism cognitive bias: Desires and expectations influence bitcoin’s price.
As long as politics and marketing feed the cognitive biases, bitcoin’s price could increase. However, a bear market has high odds. Furthermore, a declaration of cryptocurrencies as illegal instruments could potentially trigger a left-tail event and an absorbing barrier (total loss).
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Specific disclaimer: This report includes charts that may reference price levels determined by technical and/or quantitative analysis. If market conditions change the price levels or any analysis based on them, we will not update any charts. All charts in this report are for informational purposes only. See the disclaimer for more information.
Disclaimer: No part of the analysis in this blog constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results. Read the full disclaimer here.
Charting and backtesting program: Amibroker. Data provider: Norgate Data
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