1 Introduction
For last decades, cryptocurrencies have been increasingly playing a leading role in the worldwide economic and financial scenario. Among the various cryptocurrencies currently available to potential buyers,
Bitcoin (BTC, henceforth) is certainly the most famous and most interesting example. As proof of this, it is sufficient to note that the 2019 BTC market capitalization was equal to about $bn 170, representing the
\(53\%\) of the leading cryptocurrencies market capitalization.
1
Focusing on BTC, the literature has highlighted its peculiar structure. In some respects, BTC can be likened to a standard currency, because of its limited intrinsic value. In this perspective, the US dollar seems to represent to best touchstone, even though, by definition, BTC is not issued by any central bank. Meanwhile, BTC shares several interesting properties with some safe-haven assets, such as gold. However, BTC cannot be considered a commodity, due to its inability to perform financial hedging, see e.g., Byström and Kryger (
2018) for further details.
There is at least a couple of conceivable reasons why both academics and practitioners are currently participating in such a large development of the cryptocurrencies’ phenomenon.
The first motivation is related to their original task. It is worth recalling that the cryptocurrencies were born as an alternative form of payment to the traditional ones, see e.g., Nakamoto (
2008) in reference to BTC, which can rightly be considered the most famous issued cryptocurrency. More precisely, they represent a form of digital payment, like the well-known bank transfers or, more generally, online money transfers, such that the presence of intermediaries is not allowed, as in the case of cash payments, see e.g., Ametrano (
2016) and references therein.
The second rationale behind the aforementioned success for the family of cryptocurrencies is probably to be found in the ever-growing willingness on the part of financial operators to find new forms of investment that guarantee large profit margins, without taking into suitable account the level of risk associated with these financial transactions. In other words, cryptocurrencies can be considered a new form of speculative investment.
Compared to classical investment products (such as equity indices, or standard currencies), the cryptocurrencies are characterized by a significant volatility level, see e.g., Bucko et al. (
2015) and Kyriazis et al. (
2019). As a consequence, these kinds of products turn out to be highly palatable for
risk-seeking investors, while remaining less attractive to
risk-averse investors. Thanks to the aforementioned remarks about the BTC nature, and taking into account the crucial role played by volatility, recently many authors have started to look at BTC (and, more generally, all the cryptocurrencies traded on the main platforms) as an example of pure risky securities. Roughly speaking, BTC can be used as a
classic financial tool, on which investors might act in different ways. For example, an agent may directly focus on the security, namely by betting on potential prices’ upturns or dips. Alternatively, the same agent can build any appropriate investment strategies involving derivative instruments, see e.g., Bistarelli et al. (
2019) for an in-depth analysis.
It is worth highlighting that the growing interest in cryptocurrencies is revealing under several aspects. Many authors have been focusing on the study of appropriate trading software systems, trying to identify both their strengths and weaknesses, insisting on the transparency of the procedures, as well as the absence of fraud and data manipulation, see e.g., Bauriya et al. (
2019).
The demand to provide effective tools for weighing up cryptocurrencies’ trading strategies has led to a recent albeit substantial increase in statistical-econometric papers to estimate and predict specific economic variables, see e.g., Katsiampa (
2017). Moreover, the key role played by cryptocurrencies as risky assets has sparked the interest of academics toward potential (in)efficiency market issues, see e.g., Le Tran and Leirvik (
2020) and Brandvold et al. (
2015). Finally, the research lines dedicated to the explanation of cryptocurrencies’ pricing through behavioral economics is becoming increasingly popular, especially thanks to social networks, see e.g., Kim et al. (
2016).
Within such a broad literature, the present paper aims at enriching the recent strand of the literature that studies technical trading rules in cryptocurrency markets, see e.g., Detzel et al. (
2018), Hudson and Urquhart (
2019), Vo and Yost-Bremm (
2018), Cohen (
2020), using statistical techniques of supervised learning for estimation and inference.
More precisely, we would like to provide innovative trading strategies on BTC. Our proposal can be seen as an appropriate compromise between gambling and building a suitable hedging portfolio. In this way, the strategy affords to mitigate the extremely speculative vocation of the former through an injection of risk aversion of the latter. The idea behind our strategy is the following. Starting from the BTC time series, we set up a predictive strategy over short time horizons. Given the number N of time buckets where it is possible to trade over such a forecasting, at the fixed initial time \(t_0\) the trader establishes to enter into as many N Contract for Difference agreements (CfDs), either with short or long position, depending on the value that BTC is expected to reach with respect to a fixed threshold. The gain is achieved by exploiting the definition of CfD, viz. it is given by the difference between the BTC price and the threshold value, assessed at each time bucket. In addition, the trader can also opt for a wait-and-see strategy, which consists of selling or buying CfD only at the instant when the maximum profit is expected to be produced.
Despite not being the main focus of the present paper, BTC price prediction is not a mere byproduct. Flexible models skilful to detect hidden features driving prices are desirable to carry out predictions over time, avoiding pitfalls stemming from structural predictive models. Thanks to their capacity to process data, catching fundamental patterns within them, machine and deep learning models are suitable tools. Probing empirical BTC price demeanor, data-driven models represent prominent prototypes to reach either accuracy and reliability in predicting chaotic behavior.
Among the various machine and deep learning models existing in the literature, in this paper, we resort to the
Neural Networks (NNs) framework. More properly, we select a
Recurrent Neural Network (RNN) model with a
Long Short-Term Memory architecture (LSTM, from now on), see e.g., Hochreiter and Schmidhuber (
1997), in order to elaborate the observed BTC price series and project it over a designed short term horizon. Our choice moves along the lines of Altan et al. (
2019), Lahmiri and Bekiros (
2019) and Lahmiri and Bekiros (
2020). The latter compares disparate machine learning models to anticipate BTC price for high-frequency trading intents. Lahmiri and Bekiros (
2019), firstly in the literature, proposes LSTM to foresee BTC price, bringing out RNN architecture proficiency to predict short and long fractal patterns. Finally, Altan et al. (
2019) designs a innovative forecasting system based on LSTM achieving high closeness to the observed cryptocurrency prices.
Whatever the strategy undertaken by the investor, it is pivotal to assign to BTC a mathematical model capable of capturing, and possibly replicating, the evolution in time of its main characteristics and properties. The literature proposes several approaches. Looking at volatility as an indicator of the evolution of the underlying process, quite recently many authors rely on
stochastic volatility models for BTC price dynamics, see e.g., Bohte and Rossini (
2019). Moreover, justified by the empirical evidence that demonstrates the presence of large but infrequent fluctuations in the cryptocurrencies’ prices, such models can be further generalized, assuming the presence of discontinuities in the dynamics, see e.g. Hou et al. (
2018). Besides, the literature proposes a classic approach, based on the use of diffusive models for the price dynamics, see e.g., Bistarelli et al. (
2019) and references therein. This is not a mere modeling simplification. Such a choice is justified by empirical evidence and supported by theoretical considerations. One of the techniques existing in the literature to verify whether a given phenomenon is driven by a (fractional) Brownian motion (fBM) consists in measuring the associated so-called
Hurst exponent H. In particular, it is possible to prove that
\(H = 0.5\) is equivalent to saying that the corresponding fBM is a Wiener process. For further details about fBM and its generalizations, we address the reader to Bianchi and Pianese (
2015) and Bianchi et al. (
2015).
From an operational point of view, the literature provides several standardized algorithms to calculate the Hurst index associated with a given time series; some examples are given by the
rescaled range analysis (R/S), the
Fourier spectral techniques (PSD), or
wavelet variance analysis, see e.g., Serinaldi (
2010) for further details. In this paper, following the intuition exploited in Bariviera et al. (
2017), we exploit the
Detrended Fluctuation Analysis introduced in Peng et al. (
1995) and Peng et al. (
1994). We refer to the BTC instantaneous returns financial time series, ranging between January 1, 2019, and December 31, 2019. The empirical analysis carried out on the dataset shows that
\(H = 0.5,\) which authorizes to assume a log-normal dynamics for the BTC prices on a short time horizon.
The novelty of our proposal resides in introducing a suitable boundary solely linked to the underlying diffusive price dynamics. To the best of our knowledge, this occurs for the first time in the literature. Such a comparison shows once again the potential of our proposal: the technical analysis performed highlights that our strategy is comparable with the others in terms of returns, but is more conservative, as it guarantees significantly lower losses.
The rest of the paper is organized as follows. In Section
2, we describe the methodology we use. In particular, we recall the financial model, as well as the main empirical results related to the data we are considering. Section
3 is devoted to the implementation of the trading strategy we present, while Sect.
4 shows numerical results that corroborate our proposal. Section
5 concludes the paper.
5 Conclusions
In this article, we exhibit an original profit-oriented trading strategy on BTC for risk-seeking investors.
The idea is simple, but compelling. We can set up the strategy, by taking into account a given number of suitable financial instruments (the so-called contracts for difference) that provide profit in terms of the spread between the underlying value and the optimal frontier of a synthetic American-style derivative.
One of the key points of this work is the possibility of evaluating the BTC price through a geometric Brownian motion over very short time horizons. This is empirically justified by the observation that, for such time frames, the log-returns show a Hurst index equal to \(H = 0.5\).
The results presented here, stemming from the comparison between the NNs BTC price prediction and a suitable model-based investment boundary, represent a first, albeit significant, attempt. The technical analysis pursued on the proposed Kim-barrier strategy, in comparison with other trading rules widely used by insiders, provides encouraging results about the appropriateness of our proposal. The latter can be legitimately deemed as a viable alternative for investors looking for a profitable-but-protective trading blueprint.
One further development, which is already subject of our ongoing research, is the extension of such a type of trading strategy when the underlying evolves according to more realistic models, such as the fractional geometric Brownian motion or stochastic volatility models with jumps.