The economics of BitCoin price formation

Price Fluctuations and the Use of Bitcoin

Introduction:

Bitcoin is an innovation that has the potential to play an important role in e-commerce. It is characterized by a peer-to-peer network-based mechanism that could eliminate financial intermediaries and allows users to make anonymous transactions online without transaction fees. 

In this article, Polasik and others researchers study both the adoption and price formation of Bitcoin. They discover that its returns are affected, mainly, by its popularity, user sentiment, and the total number of Bitcoin transactions on the market.

 Thus, Polasik adopt both ordinary and Tobit regressions to model the share of paid sales of Bitcoin. Next, they examine how country, customer and company-specific characteristics interact with the proportion of sales attributed to Bitcoin. They note that the characteristics of the company, the use of other means of payment, the knowledge of customers about Bitcoin and the size of the economy are important determinants affecting the formation of Bitcoin prices. 

The results of this article are fundamental for traders who seek to understand the factors affecting the prices of this new cryptocurrency, thus, make it possible to inform sellers about the most favorable circumstances for the adoption of the currency for online transactions.

Objective:

The Goal of this article is:

•  To provide a comprehensive empirical study on the characteristics of Bitcoin payment and investment 
•  To study the implications of Bitcoin for the conduct of electronic commerce.

Problem: 

To solve this problem there are several fundamental questions you need to ask:

1. What can vendors who are considering adopting Bitcoin expect, given their profile and the characteristics of the country in which they are based?
2. For which payment methods is Bitcoin a complement and for which is it a substitute?
3. How does media reporting on Bitcoin, whether it is enthusiastic or alarmist, affect the value of this cryptocurrency?
4. What kind of fluctuations in Bitcoin prices can vendors expect, and what drives those fluctuations?
5. How should merchants organize their acceptance of Bitcoin when selling online?

Literature review :

Bitcoin has implications in various fields, which requires a broad multidisciplinary framework to understand this phenomenon. Bitcoin research is characterized by four main ways :

• Among the technological problems: system security and vulnerability to attacks.
•  A second part examines public and legal issues: the treatment of tax obligations arising from transactions and investments related to Bitcoin, as well as anti-money laundering regulations .These issues reveal considerable practical importance for companies and individuals, and also attract the attention of central banks and other public institutions . In addition, Bitcoin, with its pseudo-anonymous and decentralized nature, raises concerns such as: tax evasion and the financing of illegal activities .
• But the third area is based on the political, sociological and ethical implications related to the emergence of Bitcoin and subsequent cryptocurrencies.
• The last area of research related to economic issues. In other words, whether Bitcoin can fulfill all three functions of currency .

Methodology : 

Data :

In this part, Polasik collect data on Bitcoin prices from CoinDesk and then convert them into monthly returns in order to answer the question of what influences the value of Bitcoin. In addition, they assume that Bitcoin's returns can be influenced by its popularity. In this case, Polasik collect the number of articles that mention the word "Bitcoin" from Nexis, as well as the number of searches for the keyword "Bitcoin" compared to all Google searches. 

These two measures were expressed as percentages rather than an initial series in order to avoid problems of non-stationarity. In order to conduct a comprehensive analysis of the formation of Bitcoin prices, it is necessary to measure the volume of information related to this new cryptocurrency. 
Polasik et al. (2016) analyze the sentiment of articles that mention the keyword "Bitcoin" in newspapers. In other words, they collect all the news mentioning Bitcoin available in the Nexis database in a single file. 

Subsequently, Polasik use word dictionaries to distinguish between positive and negative words developed by Henry (2008) to determine the feeling of users. Henry's dictionary of positive words (2008) includes 105 words, while the list of negative words is equal to 85. 

Subsequently, Polasik program these dictionaries in text analysis software. This software makes it possible to measure the frequency of positive and negative words in files according to an average segment of 500 words. Finally, they construct a tone score for each document based on these frequencies :

Ton = (Positif – Négatif)/ (Positif + Négatif)

This index produces values between (-1, +1). 

Also, Polasik are trying to assess whether Bitcoin's performance depends on liquidity. They collect data on the evolution of the total number of transactions in the blockchain which can be treated as an indicator of the number of users. In addition, to capture the influence of the evolution of the money supply on Bitcoin prices, Polasik include the total number of Bitcoin in circulation. In addition, they examine the relationship of Bitcoin with other exchange rates. The authors focus on two most important currencies, namely the US dollar and the euro. In order to present adequate results, Polasik analyze the changes in trade-weighted indices as a percentage because trade between the United States and the eurozone is crucial. Finally, the authors examine macroeconomic factors. Polasik select aggregates that are available with a monthly frequency and use the figures of the Organization for Economic Cooperation and Development (OECD) as indicators of the world economy: the growth of industrial production, the unemployment rate and inflation. 

The empirical results :

Polasik find that popularity and investor sentiment lead to Bitcoin price changes. That is to say, a 1% increase in the number of articles mentioning e Bitcoin leads to an increase in its returns. They find, thus, that the tone is statistically significant and displays a positive coefficient indicating that news articles decrease Bitcoin prices. Polasik indicate that the increase in transaction volume is significant. This implies that the factors related to the demand for Bitcoin have a significant effect on its prices. However, the supply of this cryptocurrency is not significant. This can be explained by the fact that the offer of Bitcoin is fixed as soon as it is introduced. 

Finally, the relationship between Bitcoin returns and fluctuations in major currencies, as well as global macroeconomic aggregates, is weak and not significant.

The use of Bitcoin in e-commerce payments :

Data :

The analysis, of this part, is divided into two main groups : 

• The first group presents the characteristics of enterprises. In other words, a survey carried out by the authors in April 2013. The subjects of this survey were the acceptance of payments in Bitcoin for goods and services exchanged via the internet. The first phase of the study was the creation of a database of online sellers (671 companies accept Bitcoin). Then, Polasik delete the inactive entries by checking the e-mail addresses (the number of entities has decreased to 603). Indeed, the anonymous online questionnaire was sent to each entity. The authors collected 108 usable responses from 35 countries.

 This group consists of: Bitcoin_Sales, Size, Start_Up and Physical_Location and Bitcoin_Knowledge. 

•  The second group is based on the characteristics of the country. It consists of the following five variables: Payment_Card, PayPal, Pay_by_Link, Cash and Bank_Transfer (these are payment methods other than Bitcoin). this group describes the economic and business environment of the company.

 Results:

This research has yielded several results:

- The factor that has a stronger (positive and significant) impact on Bitcoin sales is related to start-ups. This implies that these start-ups are themselves innovative companies. Also, Polasik suggest that start-ups are adopting Bitcoin as a new form of advertising, as well as a way to access a new niche market. In addition, some companies are related to the development of the Bitcoin system. 

 - Increasing the level of knowledge of Bitcoin by customers has a positive and significant impact on the sales of this cryptocurrency. Since Bitcoin is an innovation that most people do not have sufficient knowledge about its ecosystem, this implies an obstacle to its development. According to Rogers (1983), the first step taken by an individual when faced with an innovation to adopt it is to search for information and knowledge related to his field. 

- The study demonstrates that the existence of alternative payment methods in parallel to Bitcoin has an influence on consumer choice (Jonker, 2007). Three payment methods have a negative impact on the formation of Bitcoin prices, the most notable of which was PayPal, which may be due to its popularity as a payment method among consumers. Many customers are faced with the choice between Bitcoin and PayPal. They choose the familiar technology, although PayPal integrates Bitcoin into its system (Mishkin, 2014). 

Similar reasons could explain the negative impact of payment cards. Payment via PayPal and credit cards is less risky for the customer because there is protection in the form of chargeback procedures (Zhang, 2006). Thus, cash on delivery is often used by individuals, who may not even have a bank account or a payment card, and by people who are suspicious or ignorant of new technologies (Allen et al, 2016). In this case, the level of customer trust decreases when using Bitcoin.

- The bank transfer does not have a significant influence, which suggests that it is neither a substitute nor a complement to Bitcoin. The researchers finds a positive relationship between Pay By Link and Bitcoin. Indeed, Pay By Link is a mechanism based on bank transfers that allows quick execution of transactions because it immediately informs the seller without waiting for confirmation of the transfer of funds via the interbank payment system. Thus, Pay By Link is mainly used in transactions for information technology services or online entertainment. Also, Bitcoin offers fast online payments.

 It can be used for the same type of transactions as Pay By Link, and both payments are irreversible (unlike PayPal and credit card transactions). In addition, Pay By Link can be cheaper compared to the high costs of PayPal and card payments. However, the use of Pay By Link is limited to domestic transactions, which means that this method is not a real substitute for Bitcoin when it comes to international trade. 

- The researchers show that the share of payments related to Bitcoin was significantly higher in countries with a lower GDP. The main reason is that developing countries have a general tendency to use very high liquidity (Denecker, 2009). Similarly, developing countries may pursue a less credible monetary policy, which encourages citizens to look for alternatives to the national currency.

 - Another important factor is the underground economy in many developing countries. Since GDP and the relative size of the shadow economy are strongly negatively correlated, the researchers do not include both variables in the same regression model in order to avoid multicollinearity problems. the results of this article indicate a positive association between the underground economy and Bitcoin payments in e-commerce.

Conclusion:

This research provides empirical evidence on the recent innovation "Bitcoin’, which can be considered as a new digital currency that is linked to a decentralized electronic payment system. the researchers examine the formation of Bitcoin prices and its factors of its success in e-Commerce. Thus, they indicate that the popularity of this cryptocurrency is one of the main factors determining the price of Bitcoin. 

They observe that returns tend to be high whenever articles published in newspapers that mention Bitcoin and whenever the number of people searching on Google increases.

 In addition, the tone of newspaper articles also influences the value of Bitcoin, while, adverse events can have negative consequences on its prices. they find a positive relationship between Bitcoin payment activity and the size of the underground economy. The authors note that PayPal, payment cards and cash on delivery are substitutes for Bitcoin, while Pay By Link seems to work as an add-on. The results suggest that the share of sales in Bitcoin was higher for start-ups and small businesses. A key factor is the knowledge of customers about this new cryptocurrency. However, there are still many obstacles related to Bitcoin. The most important thing is its legal status. On this premise, some countries prohibit its use. 

Polasik and other researchers point out the importance of the underground economy in the use of Bitcoin, which encourages the authorities to reduce illegal activities to facilitate transactions of this cryptocurrency.