Not surprisingly, Bitcoin prices are well described by the log periodic power laws describing the dynamics of bubbles. A reminder of what a LPPL model looks like; here is a simple one:
I didn’t profit from this. I thought of applying LPPL to the BTC bubble well before the crash during a bullshit session with a friend, but I didn’t run the analysis until after. I have better things to do with my time than play with weird monopoly money, and the “exchanges” presently offering shorts are not even close to useful. I also think anyone who trades on LPPL is basically gambling. The most interesting parameter, is hardest to fit, and, well, with all those parameters I could fit a whole lot of elephants. Just the same it is a useful enough concept to justify further research. No, I won’t be telling the world about that research on my blog. A man’s got to eat, after all. Doing bubble physics costs money.
If you don’t know about LPPL models, click on these two helpful links. The “hand wavey” idea is, if the price is formed by market participants looking at what other market participants are doing, as with Dutch tulips, pets.com, and market prices in various eras, the price is an irrational bubble which will eventually burst. This isn’t an original idea: Charles Mackay was talking about it 180 years ago. The original idea is mapping this behavior onto an Ising model, running some renormalization group theory on it, and fitting to the result to get a forecast of bubble burstings. Sornette, Ledoit, Johanson, Bouchaud and Freund did it and told the world about it; may the eternal void bless them with healthy returns for being kind enough to share this interesting idea with us.
Here’s a plot of BTC close prices from MtGox (via quandl), with the LPPL model fit 10 days before the bubble pop. I wasn’t real careful with the fit; no unit root tests were done, no probabilistic estimates were made and no Ornstein Uhlenbeck processes were taken into account. This is just curve fitting. The result is compelling enough to talk about. As you can see, with these parameters, the out of sample top is fit fairly well. Amusingly, so is the decline.
What can we learn from this? You can see a “fair value” of around $20/BTC due to be hit in a few weeks, with perhaps a full mean reversion to $10/BTC. BTC doesn’t seem to have a helpful “anti-bubble” decay; if anything, it is decaying faster than expected so far (it is possible I mis-fit the ). The fit parameters for this version of the model tell us a few interesting things about the herding behavior which you can read about in Sornette’s book.
I don’t have any strong opinions about using BTC as a currency. I think most of its enthusiasts are naive and do not understand the nature of money and what it is good for. I do think BTC would work a lot better as a store of value with a properly functioning foreign exchange futures market. There are no properly functioning BTC futures exchanges at present; just an assortment of dreamers and borderline crooks cashing in on hype. This is more of an engineering and legal problem than it is an inherent problem with using BTC as a currency. The way things are presently set up, without shorts, any extra media attention will result only in people buying the damn things. Without the ability to easily short them, price discovery is impossible, and herding behavior is the rule. It ain’t a market without shorts. It’s a bubble maker. Shorts don’t guarantee there will be no bubbles; we see plenty in shortable markets, but a lack of shorts will virtually guarantee future BTC bubbles.