Introduction

Background of the study

Digital currencies have attracted increasing attention in recent years, steadily gaining the
attention of public and investors in the regard of digitalization. Cryptocurrencies were
formerly criticized for being used to make illegitimate transactions over the internet, but they
have now grown into a multi-billion dollar business and an acceptable payment mechanism at
corporations like Amazon, Tesla, Microsoft, Reddit. Cryptocurrencies picked up steam in
2017 as one of the most searched topics on the internet, and they made their way into the
mainstream media. (Niaz Chowdhury, 2020).

Cryptocurrency is a type of virtual currency that is intended to be used as a medium of

exchange but has a number of unique properties. Encryption algorithm is used to validate and
verify transactions, as well as to govern the creation of new units and to make restricted
entries in a database called Blockchain. Blockchain is a system that uses an open distributed
ledger to keep track of all transactions. It eliminates the requirement for a trusted third party
and resolves the issue of double-spending. (Nakamoto) .

Moreover, the peer-to-peer network mechanism and decentralization enable faster settlement,
lower transaction fees, increased capacity, and improved security for blockchain technology.
As a result, cryptocurrency has become one of the most hotly debated financial topics. (Baur
et al., 2018) Various academic studies have attempted to explain the price volatility and
exchange rate of bitcoin, such as Kristoufek (2013) and Yermack(2013).

Meanwhile, Kristoufek (2015) conduct a comprehensive analysis of price drivers using the
classical economic theories on currency creation and concludes that public interest in the form
of Google and Wikipedia searches is critical for price determination of bitcoin. (Kristoufek,
2015, p. 14). Bitcoin's average monthly volatility is greater than gold and the currency,
according to Dwyer (2015), but its lowest monthly volatility is lower than gold and the dollar.
The majority of the study focuses on the level of volatility or how it compares to gold or the
dollar. (Dwyer, 2015, p. 15) .

Dyhrberg (2016) used a GARCH model to explain Bitcoin, gold, and the dollar,
demonstrating that Bitcoin and gold shared key characteristics based on their GARCH
simulation results. Risk hedging and symmetrical market data reactions are both possible.
Bitcoin's transaction frequency may be greater than gold's since both the transaction and the
reaction to market sentiment occur at the same time. According to his conclusion, Bitcoin will
be classified as a hybrid between a fiat currency and a commodity due to its decentralization
and limited set of functions (Dyhrberg, 2016, p. 92).

As of July 2021, there are 6,044 coins that have been established using blockchain
technology. Bitcoin was created as a currency that people traded for transactions, despite the
fact that it was not intended as such. It was created to replace the fiat currency and the
dominance of the dollar. Meanwhile, there are those who dispute Bitcoin's monetary role.

Volatility has been a source of criticism for cryptocurrencies since their inception. The
Bitcoin market is highly volatile and speculative when compared to other currencies.
Additionally, the surge in virtual currency prices, which was not accompanied by a
comparable increase in transactions or real-world use, sparked concerns about their pricing.
The enthusiasm around the fast spike in bitcoin values turned it into a financial phenomenon,
and market participants began to see it as a digital money. Many scholars, on the other hand,
see bitcoin as a speculative asset susceptible to bubble-like events. (Cheah and Fry, 2015).

Similarly, Cermack (2017), who looked at bitcoin from an economic standpoint, said that it
does not meet the requirements of currency. It does not fulifill the criteria as a medium of
exchange, a unit of account, and a store of value. He claims these are its basic characteristics.
On the one hand, he claims that bitcoin meets the first criterion, but not on a global scale, and
it fails to meet the second criterion because it is impractical to quote prices up to the fourth or
fifth decimal place, which will make it difficult for consumers to use it as a medium of
exchange because comparing prices in decimals is confusing and difficult. In regards to the
third criteria, he points out that cryptocurrencies have difficulty as a store of wealth as a result
of the dangers of frequent hacking and thefts.

(Cermak, 2017). This research paper will contribute to the rapidly growing literature on
Bitcoin and its characteristics. The goal of this research is to examine Bitcoin prices,
primarily in terms of volatility, and to determine if Bitcoin's price behavior is comparable to
that of a currency or a commodity. As a result, we attempt to examine the relationship
between Bitcoin and currencies as well as between Bitcoin and commodities in the empirical
section. This thesis also studies the opportunities and challenges for the growth of bitcoins. A
literature study based on theoretical frameworks and empirical research is undertaken to
determine which variables are key elements for price formations in other financial markets as
well as the cryptocurrency market. As a result, we compare Bitcoin to the major currencies,
such as the USD, EUR, GBP, and JPY, as well as main commodities, such as Gold and Oil,
on a daily basis from January 1, 2016 to December 31, 2021.

This study also aims to identify the specific variables that affect bitcoin's return volatility after
thoroughly examining the variables. Following the identification of these variables, statistical
and economic tools are used to hypothesize their explanatory power. Existing theories and
models are given careful consideration. Finally, we apply our empirical technique to provide
evidence for our findings and conclusions.

Research Objective

The research paper has the following objectives:

 To give an in-depth analysis of Bitcoin as a financial instrument or a form of
alternative payment.

 To identify the impediments to the growth of Bitcoin and other cryptocurrencies.

 To provide in-depth understanding of cryptocurrency, blockchain technology, and

Bitcoin's future opportunities and difficulties.

 The impact of central bank digital currencies and European Union legislation on
digital currencies.

Research Question
Bitcoin is created to be an alternative to government issued currency, but the very volatile
exchange rate of Bitcoin has made this difficult. The volatile exchange rate, and the behaviour
in the market raises the questions about Bitcoin’s classification as a currency. This thesis
intends to determine whether Bitcoin is a currency or an asset. The research question is as
follows;

RQ: 1 “Does Bitcoin have the potential to be an alternative currency or an asset?” will be
answered by examining two specific hypotheses.

H1: To be an actual alternative for conventional currencies, Bitcoin needs to further

improve its common acceptance.

H2: Bitcoin fulfills a major part of the necessary criteria to become a long-term

successful currency.

RQ:2 How will Bitcoin’s underlying Blockchain technology impact the banking sector.
Limitation of the Study
The researcher relied upon currently available official statements and public charts, notably
from the individual exchange markets. Not all virtual digital currencies will be examined;
instead, the emphasis will be on Bitcoin, which is the most well-known and widely
recognized of this kind of digital currency. The 50 questionnaire will be sent out to the afore-
mentioned population particularly in Germany. Therefore, the feedback will be limited due to
the limitations of that population and answers. The majority of research materials are
accessible online, with just a few paper copies available. Due to the time constraints of this
master's thesis, the study will only give a glimpse of current attitudes.

Thesis Structure
Blockchain Technology and Bitcoin
This chapter discusses the theoretical background of Blockchain and introduces the major
elements that define this technology. In addition, I provide an overview of the Blockchain
evolution as well as a category of cryptocurrencies that will serve as the foundation for future
research.

Overview of Blockchain
Cryptocurrencies are digital assets that are protected by cryptography in decentralized
networks.Cryptography governs the flow of transactions, preventing fraud and controlling the
supply of these assets. Unlike bank account balances, these assets are not under the control of
a third party. (Narayanan et al., 2016) All validated transactions are digitally kept on a
"blockchain," which acts as a public ledger or accounting system and is visible to all network
users. (Niaz Chowdhury, 2020, p. 7) Transactions are not controlled by any financial
institutions or authorities in the system. They function on a global scale and may be used to
buy virtual or physical goods, making them a competitor to fiat currencies. Lower transaction
fees, faster transactions (relative to typical bank services), confidentiality, transparency, and
no limits on transfer amounts or recipients are all features of cryptocurrency transactions (Lee
Kuo Chuen)

History of Blockchain and Cryptocurrencies

The concept of sending untraceable payments via blind signature technology was first
proposed in the early 1980s, on a piece of paper signed by David Chaum. Chaum also
introduced one of the most important components of today's Bitcoin technology: a two-key
digital signature system, with a "private key" and a "public (crypted) key," which enables
users to remain anonymous. (Bambara and Allen, 2018, p. 15). Then, in 1990, Chaum took
his notion a step further, suggesting the construction of an Untraceable Electronic Cash
(eCash) system, as well as the concept of "double-spending prevention." The eCash system,
as the first cryptocurrency, was accessible via a variety of institutions and smart cards in
nations such as the United States and Canada. Despite its flaws, eCash survived and was
adopted and utilized by others, setting the foundation for a entire generation of cryptocurrency
developers. (Chaum et al., 1990, p. 319).

In 1998, Szabo designed a "basic" protocol that required participants to invest resources in
mining digital gold (or "bit gold") in order to be paid, as well as validating the public digital
record. It was proposed that "bit gold" might be mined and bits recorded on a digital register.
At the beginning of the global financial crisis in 2008, interest in cryptocurrencies increased.
Cryptocurrencies have the ability to address a number of issues that are often associated with
the fiat currency system. Consumers were drawn to cryptocurrencies as a method to hedge
their position with a limited amount of cash due to a loss of confidence in fiat money that
arose after the 2008 economic crisis. Cryptocurrencies were thought to be a debt-free
currency that grew at a consistent pace. (Vigna and Casey, 2015).

At the end of 2008, the idea of "Bitcoin" was created. Under the pseudonym Satoshi
Nakamoto, an unknown person (or group of people; there is an ongoing debate about this)
published a research paper labeled "white paper," which consists of nine pages. His objective
was to develop a decentralized payment system that was not reliant on any financial
institutions. Specific features of the present electronic payment system, such as reversibility
of payments and high transaction costs, are addressed by Nakamoto (2008). He claims that
reversible transactions, in which merchants cannot completely depend on payments, make
digital payments vulnerable to trust issues. Furthermore, he claims that financial
intermediaries increase transaction costs, thereby restricting the minimum payment amount.
(Vigna and Casey, 2015).

Bitcoin is a cryptocurrency created in early 2009 by Satoshi Nakamoto, an unidentified

programmer. People were not interested in the early days, and there were relatively few
transactions. This scenario is reflected in the fact that a pizza sold for 10,000 bitcoins was a
major issue. Beginning in 2011, however, we are reaching a 'tipping point.' In February of that
year, the value of one Bitcoin surpassed $1 for the first time, and in June, it exceeded $10.
Someone has spent '100,000 dollars' on a pizza in only one year. (Lee Kuo Chuen)

This rise in the price of Bitcoin is a classic example of a financial bubble. Bitcoin is a form of
"nominal money" that has no physical substance nor inherent value, unlike gold, which is
referred to as "eternal currency." Nonetheless, this currency has outperformed all other stocks
in terms of returns (Vigna and Casey, 2015). Furthermore, the price of Bitcoin exhibited a
very sensitive response to media exposure, which is a typical phenomenon in financial
speculation. In this sense, many individuals have drawn parallels between the current
happenings around bitcoin and the tulip frenzy, the world's greatest financial bubble. (Balcilar
et al., 2017)

On January 3, 2009, Nakamoto mined the first 50 bitcoins, which became known as the
"genesis block." Laszlo Hanyecz, a Florida programmer, paid 10,000 bitcoins for two pizzas
from Papa John's, which bitcoiners consider to be the first real-world bitcoin transaction.
(Cermak, 2017). Mt. Gox, the first bitcoin exchange, was founded as a result of the growing
interest in Bitcoin, particularly among computer enthusiasts. (Vigna and Casey, 2015)

The first exchanges, such as "BitcoinMarket.com" and "Mt. Gox," appeared in 2010, allowing
individuals who had no strong connections to the cryptography community to purchase
Bitcoins in US dollars. The online marketplace "Silk Road," which made headlines for selling
illegal drugs over the internet, accepted Bitcoin as a payment mechanism and accounted for
over half of all Bitcoin transactions at one point. "Silk Road" was the first organization to
make commercial use of Bitcoin's anonymity, which served to boost its appeal and demand
while also raising concerns about its usage. (Lewis, 2018)

When WikiLeaks chose to accept contributions in Bitcoin after all other payment companies
declined to give their service in 2011, cryptocurrencies captured the first mainstream media
attention. WikiLeaks pushed other online service providers, like Baidu, the world's fifth most
popular website, to accept Bitcoin as a payment method. Several companies began to accept
Bitcoin as a new payment mechanism in the following years, and new exchanges in various
countries made it easier for people to acquire Bitcoins. (Cermak, 2017)

Mt. Gox, the world's largest Bitcoin exchange, filed for bankruptcy in 2014 when it became
known that 850,000 bitcoins ($480 million market cap) were leaked in a hack. The hacking
incident occurred not only at Mt. Gox but also at many other exchanges, and this series of
events led to a drop in trust in Bitcoin and raised concerns about its stability as a currency.
(Tapscott and Tapscott, 2016) The hacking of Mt. Gox in 2014 caused the Bitcoin price to
fall, and concerns have been raised that regulation is important since it is extremely prone to
being affected by cyber-attacks and illegal activities, and China has enforced a transaction
prohibition. The issue of what Bitcoin is, on the other hand, does not go away. With the
advancement of the Internet and the emergence of many forms of virtual money based on it,
this is no longer the case. The creation of virtual currency, such as Bitcoin, which seems to be
distinct from the current monetary system, is due to the fact that it continuously raises
concerns about the use of virtual currency, how to govern it, and, ultimately, what constitutes
money. (Cermak, 2017).

On a more positive note, the first Bitcoin ATM was launched in Vancouver in 2013 The ATM
let customers withdraw their bitcoins in Canadian dollars and it also let them deposit
Canadian dollars, which were quickly converted to their Bitcoin wallets. Furthermore, many
countries offer ATMs for Bitcoin, where people can withdraw money by selling their Bitcoin
(Cermak, 2017). Because of Bitcoin's open-source protocol, anybody may clone the original
code and build their own cryptocurrency, resulting in the creation of several other
cryptocurrencies. While some are simple clones and others provide answers to Bitcoin
network issues such as faster transactions, lower electricity use, more security, and ease of
use. The mechanics of cryptocurrency systems, as well as their particular variations, will be
discussed in the following sections. (Vigna and Casey, 2015).

Blockchain Technology

A blockchain is a distributed database in which each user has unlimited access to the data.
The fact that no single entity controls the data or information recorded on the blockchain is an
important feature. Furthermore, there is no requirement for a third party or intermediary to
validate peer-to-peer transactions. The ledger is copied to each node at the same time, thereby
necessitating consensus among a majority of nodes in order to validate the database's
contents. Individual users are represented as nodes in a peer-to-peer network linked by open-
source software. Data may be transmitted between network nodes using this application. The
three primary functions of nodes are to send transactions, update the blockchain with new
transaction blocks (consensus), and relay transaction blocks. Everyone in the network has
access to the data recorded on the blockchain, but only those possessing the hash-signature or
private key associated with that data have access to the data's real contents. (Narayanan et al.,
2016).

Anonymity is ensured by using a double hash signature technique to only identify participants
inside the network. Each network member has both a public and a private key. Participants
enjoy anonymity since only the public key is used to sign transactions, while the network has
total transparency into the transactions signed by the public keys. Each node on the ledger is
represented by a unique alphanumeric address instead of a name, providing each node the
option of confidentiality. (Vigna and Casey, 2015).

The most common method for encrypting private addresses on a blockchain is to use the
Secure Hashing-256 Algorithm (SHA-256), which is very difficult to reverse-engineer
without a lot of computational power. After transactions are placed in the network and the
nodes are synchronized to the Blockchain, it's difficult to edit the records unless you control
the majority of the network nodes. This is the case because each node in the blockchain
confirms the transaction while also linking it to all prior transactions in the chain. This is
accomplished via the use of algorithmic and cryptographic proofs. (Narayanan et al., 2016)
Like traditional double entry accounting, the Blockchain ledger stamps off transactions by
confirming them. To reverse a record, you'd have to change all prior transactions and numbers
in the account, similar to how double-entry accounting works. To make transactions
reversible, all nodes in the network would have to alter and verify every previous transaction,

resulting in a practically immutable record. (Franco, 2015, p. 45)

Reversing records would have to fulfill the motivations of the majority of nodes in the
network, given that a public ledger is backed by unconnected nodes all driven by individual
goals. If the majority of nodes in a network disagree with you, you have the option of either
not participating in the network or attempting to form a majority. By making records and
transactions irreversible, one loses a key component of trust, namely accountability. (Lee Kuo
Chuen). A private blockchain differs from a public blockchain in terms of who is allowed to
join the network. Unlike Bitcoin, which utilizes a public ledger that anybody can join,
organizations may want to create a private network where membership is restricted to those
who have been given permission. Private blockchains include read-only and write-only access
restrictions, implying that the private blockchain's owner may select who can view the chain's
transactions and transact with it. This allows businesses to become more transparent while
also ensuring that they are the exclusive users of the private blockchain. (Lewis, 2018)

Bitcoin Mining

To obtain Bitcoin, you must either download a digital wallet or create an account with an
online exchange. When purchasing bitcoins, you exchange money in your chosen currency for
bitcoin at one of the multiple online exchanges. When you buy bitcoins, a code is generated in
your digital wallet. You may get Bitcoins online or in person by obtaining the source codes of
the Bitcoins you have purchased. Bitcoin is designed on a peer-to-peer basis. The transactions
are ordered chronologically to avoid the use of the same Bitcoins in two transactions
simultaneously. Transfers of transactions between users are recorded in what are known as
"block chains." The uncompleted transactions are aggregated into blocks; each block has a
reference to the prior block, thus building a chain. (Vigna and Casey, 2015)

Someone must make their computer resources available on the network in order to broadcast
these chains and really transfer money peer-to-peer. This is called mining. Miners are
compensated for their efforts with a fixed amount of Bitcoin known as a "block reward."
When a computer mines, it employs specialized software to solve difficult mathematical
algorithms and proofs of work. Mining is a game of trial and error in which the goal is to
"find the next piece of the puzzle." The hash rate, or the pace at which a miner searches for
new puzzle pieces, is the number of tries and mistakes that each miner does. (Niaz
Chowdhury, 2020, p. 15)

The Bitcoin framework is expected to clear one block every ten minutes on average. This is
accomplished by making the mathematical algorithms that the miners must solve more
complex. Every two weeks, the degree of difficulty is examined. As a result, the number of
miners is inconsequential in terms of the speed with which blocks are cleared, resulting in
large variations in mining payouts. The speed at which blocks are cleared causes problems for
users who want to send Bitcoins. When users make a transaction, it must first be verified by
all of the Bitcoin network's available nodes, or computers. (Lee Kuo Chuen)

After that, the transactions are held in a mempool (memory pool) until a miner picks them up.
The blockchain's capacity is also restricted, forcing the mempool to grow at times when a
large number of users seek to conduct transactions. The nodes establish a minimum
transaction fee threshold when the mempool reaches capacity. Users who charge less than the
minimum transaction fee are removed from the mempool immediately. Transactions that have
already been committed to the mempool are included here. If transaction demand is strong,
miners may overlook transactions without a transaction fee, causing them to be ejected from
the mempool. (Antonopoulos, p. 184)

The Bitcoin protocol specifies a maximum number of Bitcoins of 21 million. In the early days
of Bitcoin, the block reward was highly profitable since you received a significant portion of
the overall quantity of Bitcoins. The system, on the other hand, is set up such that the block
reward is halved every 4 years, or every 210,000 Bitcoins mined. As a result, the quantity of
Bitcoins received by miners asymptotically approaches zero over time. This, along with the
clearing block constraints, causes consumers to add a fee to the miners in their transactions as
an incentive for the miners to include their transactions in the block. (Swammy et al., 2019,
p. 66)

file:///C:/Users/LENOVO/AppData/Local/Temp/Lee Kuo Chuen (Ed.) -

Handbook of digital currency.jpg (Lee Kuo Chuen)
Until now, the supply of mining power has remained constant, allowing the price to vary
mostly in response to demand. The price of a Bitcoin transaction is determined by market
demand.This makes it hard to utilize Bitcoins as intended, since the exchange rate, transaction
fees, and transaction durations are all subject to considerable volatility. As previously stated,
the purpose of Bitcoin's creation was for it to act as a money analogous to well-known fiat
currencies.This has been challenging due to large variations in exchange rates,making it
almost impossible for clients to utilize Bitcoin as their primary currency.Because of its
unpredictable exchange rate, it's unclear whether Bitcoin should be classified as an asset or a
currency. (Lee Kuo Chuen).

Alternative Cryptocurrencies

Alternative cryptocurrencies flourished as a consequence of low entry barriers, such as

publicly available algorithms and minimal capital requirements, along with a booming sector.
Most cryptocurrencies specialize in overcoming certain issues to distinguish themselves from
other coins. Regardless, they all operate in the same market and compete against each other.
(Vigna and Casey, 2015). Although there are many other types of cryptocurrencies, I’ll
concentrate on three of the most well-known and widely used. The attributes of three
alternative cryptocurrencies (commonly known as "altcoins"), as well as how they differ from
Bitcoin, are listed below:

Ethereum (ETH)
Ether is the fundamental cryptocurrency that is based on this network technology. Ether is the
most innovative cryptocurrency, apart from Bitcoin. Ethereum aspires to make more
sophisticated financial transactions, such as trade and bank settlements, easier than Bitcoin. It
enables the maintenance, initiation, and execution of decentralized contracts to be done
automatically. Certain enterprises are already using Ethereum's revolutionary technology,
known as "smart contracts," to govern their supply chains. The practical uses of
cryptocurrencies, on the other hand, are dependent on their network technology rather than the
cryptocurrency itself. (Lewis, 2018)

Ethereum and Bitcoin are analogous in that they both use the Proof-of-Work stake algorithm
to mine their currencies. The Ethereum network, on the other hand, has a main difference in
that blocks are created every 15 seconds, as opposed to every 10 minutes in Bitcoin, and its
token, ETH, does not have a predetermined supply limit in circulation. (Franco, 2015,
pp. 172–173)
Litecoin (LTC)

Litecoin allows users to send high-speed payments to anybody worldwide at a relatively lower
cost compared to standard payment methods (such as SWIFT). (Antonopoulos, p. 223) As
Bitcoin gained steam, concerns about block transaction processing time and verification
became an issue. The Proof-of-work consensus algorithm is also used by Litecoin to confirm
transactions. The main distinction between Bitcoin and Litecoin is that the former employs
the SHA-256 algorithm, which makes Bitcoin mining more costly and involves the use of
special tools known as ASICs (Application-Specific Integrated Circuits), which exceed
standard CPUs. (Narayanan et al., 2016)

Meanwhile Litecoin employs the Scrypt algorithm, which eliminates the need for ASIC-
equipped processors and enables mining to take place on normal CPUs. Each block in
Litecoin takes 2.5 minutes to process, but each block in Bitcoin takes 10 minutes. (Niaz
Chowdhury, 2020, p. 85)

Ripple (XRP)
Ripple is a profit-generating technological platform with its own token, XRP, established by
Ripple Labs. The firm offers financial institutions such as banks real-time transaction and
currency exchange service settlements of any amount and for a marginal cost. Over 100
companies have adopted the Ripple protocol, including Morgan Stanley, Western Union,
Barclays, Bank of England, and Banco Santander (Tapscott and Tapscott, 2016).

Rather than using mining to validate transactions, Ripple employs a consensus mechanism in
which each block is authorized by a selected group of carefully chosen nodes/servers before
being added to the network. (Franco, 2015, p. 204)
El Salvador: Bitcoin as legal Tender
Introduction
El Salvador is the most densely inhabited nation in Central America, and it is a coastline
country in the northern half of the continent. El Salvador has a land area of 21,040 square
kilometers and is split into 14 districts. It is bordered by the Pacific Ocean. The population of
the nation is around 7 million people. El Salvador has a sluggish industrial and agricultural
sector due to its cash-based economy, and over 70% of the population lacks bank accounts or
credit cards. (McClurg, 2021)

On June 8, 2021, El Savador's Legislative Assembly approved the "Bitcoin Law". These
regulations allow the use of cryptocurrencies, primarily bitcoin, as an instrument for co-
payment of the US dollar, which has been the Central American nation's official currency
since 2001. President Nayib Bukele, a former businessman and the leader of the right-wing
populist Nuevas Ideas party, was the first to present the measure. While the United States
dollar was adopted to decrease currency risk and stimulate international trade, it has resulted
in a dependency on the United States for monetary policy and produced an economy with
limited upward mobility for its citizens.

In a nation where remittances account for 23% of GDP, there is an obvious need for a
monetary system that reduces or eliminates service costs while also reducing or eliminating
time delays. When you combine these exorbitant costs and delays with the fact that only
around 30% of the population has access to a bank account, you have a large segment of the
nation in desperate need of money but facing economic and physical hurdles to getting it.
(Gorjón, 2021, p. 2)

According to El Salvador's Bitcoin Law, all firms or businesses must accept bitcoins as legal
tender for products and services, unless they lack the required infrastructure to complete the
payment. The government of El Salvador made bitcoin legal tender with the hope that
investors and tourists who possess bitcoin would visit the nation and boost the economy of El
Salvador. This decision is based on Bitcoin's market capitalization, which has surpassed $1.5
trillion worldwide. (Gorjón, 2021)

El Salvador's government intends to increase the country's economy, which has grown at a
slow pace for many years. The majority of El Salvador's population does not have a bank
account, and remittances supplied by a huge community of expatriates working abroad, who
offer benefits to around 360,000 families. (Gorjón, 2021)
El Salvador formally recognizes bitcoin as legal currency on September 9, 2021, followed by
the introduction of your own Bitcoin wallet called Chivo, which may be used on the same
day. El Salvador's government purchased 400 bitcoins worth around $20.9 million on
September 8, 2021, as a first step in encouraging its people to utilize bitcoin. Citizens may use
the software to buy and sell BTC. However, this utility has had several issues with upgrades
and usage, since many users have devices that are incompatible with the security needed by
this program. (Gorjón, 2021)

Furthermore, President Nayib Bukele granted $30 in cryptocurrency to every individual who
signed up for the digital wallet. Every individual who downloads it and registers as a user
with a phone number and ID number will have funds paid into their account. (Gorjón, 2021)
Customers may pay firms in dollars using bitcoins from their wallets. As a result, bitcoin
payments are lawful, according to the authorities. (Arslanian et al., 2021) El Salvador's
government will also train individuals and businesses on bitcoin transactions and boost
Internet and mobile phone usage in order to stimulate the use of cryptocurrencies. (Arslanian
et al., 2021)

It is now revealed that the private corporation Chivo, S.A. de C.V., which owns the
application, comprises Nuevas Ideas party members and supporters. (Artiga and Lopez, 2021)
El Salvador partnered with Jake Maller's Lightning Network payments platform strike, to
create the "El Chivo" wallet, which allows residents to transact in bitcoin for free. (McClurg,
2021)
Figure 1: How the El Chivo Wallet Operates (McClurg, 2021)

Advantage and Disadvantage of Using Bitcoin as Legal Tender

El Salvador is embracing Bitcoin for three primary reasons:
• Improving international remittance efficiency: According to the World Bank, remittances
account for more than 20% of El Salvador's GDP, meaning that a large section of the
population is dependent on money transfers from outside the country. A remittance sent from
the United States to El Salvador costs between 30 and 50% of the amount sent, without
including the problems and expenses associated with waiting for the money to arrive in El
Salvador. (Arslanian et al., 2021)

Reduce the number of people who are unbanked by: Approximately 70% of El Salvador's
population lacks access to a bank account. Bitcoin technology has the potential to make
financial services more accessible to a greater segment of the public. (Investopedia, 2022)

One of the main goals of Salvadoran law is to cut down on the country's dependence on
the US dollar: Bitcoin can be used as a neutral store of value for savings. On the other hand,
since 2001, El Salvador has chosen to conduct transactions in a major currency, the US dollar.
Dependence on another country's currency has its own set of complications, many of which
are expensive. El Salvador's government can't print its own money and the country's economy
can't benefit from the Federal Reserve's money-printing in the United States. As a result, El
Salvador will have to borrow or earn the funds it needs. El-Salvador will also lose currency
sovereignty as well as monetary policy independence.

A stronger US currency might be terrible for Frontier-market countries like El Salvador.

Adopting bitcoin as legal tender provides these nations with a currency that is unaffected by
market circumstances in their own or any other country's economy. Bitcoin works on a global
scale and is therefore heavily influenced by larger global economic trends. (Euklidiadas,
2021)

Bitcoin mining has a number of drawbacks, one of which is that it uses a lot of energy: The
Bitcoin Network used a total of 83.91 terawatt-hours (TWh) on a worldwide scale between
January and October of this year, according to statistics compiled by the Cambridge Bitcoin
Electricity Consumption Index (CBECI), which is more than 13 times the annual consumption
of El Salvador. (Artiga and Lopez, 2021)
In light of this, it's important to remember that at least 11 Salvadoran houses out of every 100
lack direct access to power, requiring them to rely on neighboring countries and on natural
gas ´like, kerosene, candles to meet their demands. (Artiga and Lopez, 2021) El Salvador
continues to rely on imported energy from Honduras and Guatemala accounted for 21.8
percent of overall energy consumption in 2019, according to SIGET. (Artiga and Lopez,
2021)

Figure 2: Imported Energy Consumption Index.jpg (Artiga and Lopez, 2021)

Latin American Adoption

Other nations in the area are considering official adoption after El Salvador's success:

On August 20, 2021, the Central Bank of Cuba passed Resolution No215/2021 (published in
a special edition of the Official Gazette of the Ministry of Justice of the Republic of Cuba
No73 on August 26, 2021). For the purposes of this Resolution, a virtual asset is defined as a
"digital representation of value that may be exchanged or transmitted digitally and used for
payments or investments." (McClurg, 2021)

The resolution is absolutely revolutionary. On the one hand, it uses the region's common
definition of "digital value representation," which allows the object to be classified more as an
intangible asset, but on the other hand, it directly recognizes the admissibility of
cryptocurrency payments, even though Cuba has not gone as far as El Salvador, i.e., it has not
made cryptocurrency a legal (mandatory for all individuals and legal entities) means of
payment. (Resolución 215/2021. BANCO CENTRAL DE CUBA, 2021). However, there are
some limitations. First, the resolution establishes a market access permitting procedure (the
Central Bank is the regulator); second, there are some limitations on the types of entities that
are permitted to conduct monetary and investment transactions with cryptocurrencies,
including the ability to conduct cryptocurrency transactions for government entities, political
parties, non-governmental organizations (NGOs), and enterprises, institutions, and nonprofit
organizations. (Resolución 215/2021. BANCO CENTRAL DE CUBA, 2021)

On August 8, 2017, the Venezulean government authorities began introducing the centralized
cryptocurrency Petro based on Ethereum cryptocurrency technology and backed by the
country's oil reserves to circumvent the foreign economic blockade under Decree No 3196 ,
and Petro was later granted official means of payment status. The official cryptocurrency,
however, did not gain popular support due to significant public distrust of government
financial policy, which ended in hyperinflation. Venezuela's cryptocurrency program was
handed a further blow when the US announced Executive Decree No. 13827 on March 19,
2018, restricting US citizens from trading in Venezuelan cryptocurrency assets, including
Petro. (Corp. Pandectas Digital, C.A., 2017)

Venezuela permitted mining activities on September 21, 2020, but only for miners who had
obtained a special state license and operated on a unique state platform where the state
controlled the distribution of mining proceeds. After that, the Venezuelan National Assembly
passed the Constitutional Anti-Blockade Law for National Development and Human Rights
on October 8, 2020. This law gives the executive branch the power to design and use any
cryptocurrency as a currency. On November 14th, citizens will be able to swap BTC for fiat
currency on a dedicated cryptocurrency market. As a consequence, even if cryptocurrency is
now considered a financial instrument, lacking the official status of money, foreign currency,
or a mode of payment, Venezuela de facto recognizes cryptocurrency's payment character but
only for miners who have obtained a special state license and operated on a unique state
platform where the state controls the distribution of mining proceeds. (McClurg, 2021)

In Colombia, bitcoin is a legal asset. However banks are not permitted to offer financial
services for cryptocurrency transactions, and financial institutions have been forbidden from
holding and investing in cryptocurrency since 2014. Various agencies are divided on how to
determine its legal status. As a result, the Colombian Central Bank and the Financial
Supervision Authority refuse to define cryptocurrencies as legal tender, money, cash, or
securities, instead recognizing them as intangible assets, while tax authorities see them as a
commodity. (Colombia Cryptocurrency Laws, 2020)

Argentina became one of the most active countries in terms of cryptocurrency development as
a result of its defaults in the 2000s. This seems to have been supported not by advantageous
investment and innovation conditions, but by the public's and businesses' need to protect
themselves from bank losses and currency depreciation, as well as the urgent need for export-
import payments. Argentina's legal framework for cryptocurrencies, in contrast to existing
economic activity, is still in its infancy. Cryptocurrency transactions are considered legal
since they are not prohibited (M. Diehl Moreno and O'Farrell Mairal, 2021) The Financial
Information Unit (UIF) of Argentina defines cryptocurrencies as:

"A digital representation of value that can be sold digitally and function as a medium of
exchange, a means of accounting, and/or a means of preserving value, but does not have
official payment status in any jurisdiction and is neither issued nor guaranteed by any
government or jurisdiction." (M. Diehl Moreno and O'Farrell Mairal, 2021).

Main criticisms
The International Monetary Fund (IMF) made a statement on July 26, 2021, saying that they
were worried about how bitcoin would be used as legal tender. Several El Salvadorans took to
the streets to protest as the backlash grew. The Salvadoran Association of International Cargo
Carriers says it will add a 20% fee to freight customers who pay in bitcoin to ease fears about
the currency's volatility.

Let's look at the IMF's claims about the hazards of bitcoin adoption in more detail: (Carare et
al., 2022)

1) Volatility

The International Monentary Fund (IMF) is worried about bitcoin's monetary stability due to
its volatility. When we examine the volatility of bitcoin, we can observe that it goes to the
upside rather than the downside, as many currencies do due to inflation. I think that
widespread acceptance will balance out this insecurity. (McClurg, 2021)

2) Macroeconomic Stability
The International Monetary Fund (IMF) has expressed concern about the effect of bitcoin
adoption on macroeconomic stability. Unfortunately, this undermines the need to increase
global financial inclusion. Emerging market nations should be able to employ technology and
innovation to empower their people and their country as a whole. (Arslanian et al., 2021)

3) Financial Integrity:

Due to its anonymity characteristics, bitcoin may be used for illegal money, terrorist
financing, and tax evasion. Attempts to identify Chivo users have resulted in financial
integrity issues. Because of hacking or cybercrime could make the system unstable, it could
cause problems with other countries and with the banks that work with them. Since anti-
money laundering and counter-terrorist financing legislation aren't often implemented, service
providers have a lot of flexibility. International norms for virtual asset providers are required.
(McClurg, 2021)

Theoretical Framework
The chapter that follows gives an outline of the theoretical topics related to this research. This
will serve as a foundation for understanding current research as well as an explanation for the
bitcoin market analysis. Following a review of existing literature for each theoretical concept,
this will be immediately related to how it works in the bitcoin market. As a result, the
theoretical framework is continuously employed as the basis for describing the bitcoin market.
Market Microstructure

The market microstructure theory is used to study price formation in financial markets and
Obtaining information about price formation is a fundamental part of finance. Such
information is crucial for market regulation, the development of new trading instruments, and
the understanding of investor behavior. Simply defined, price is determined by market supply
and investor demand. (O'Hara, 1995, p. 10)

In the 1970s, Mark Garman developed the term "market microstructure," which has since
become a key concept for defining how economic variables affect transactions, quotes, and
prices. (Biais et al., 2005). Market Microstructure Theory is utilized as a conceptual
framework for explaining price formation in financial markets. It aims to elucidate how
investors' latent demands result in new transactions and, as a result, alter prices and volumes.
(Madhavan, 2000, p. 205).

As stated by Biais et al., market microstructure focuses on how closely short-term prices
correspond to their long-run equilibrium prices. Microeconomic theories are therefore
confronted with the reality of actual markets when markets are studied in light of market
microstructure. (Biais et al., 2005). In his original paper on market microstructure, Garman
(1976) provides an alternative to established economic theories of exchange markets. Garman
believes that as trade volume on the world's markets has grown, the market structure has
evolved, emphasizing the need to research market microissues. (Garman, 1976, p. 257).

In contrast to many other financial theories, such as in the field of investments, market
microstructure contends that asset prices are vulnerable to a variety of frictions and may not
fully reflect the available information. (Madhavan, 2000, p. 207). According to Madhavan
(2000), informational economics is a critical topic in market microstructure research. He
claims that a market's informational efficiency and information structure have significant
consequences for agent activity and, as a result, market outcomes. (Madhavan, 2000, p. 207).
However, according to O'Hara (1995), some evidence suggests that each individual trader acts
competitively. Others suggest that the availability of private information guarantees that some
investors will behave strategically and try to profit from it. (O'Hara, 1995, p. 98).

According to the rational expectations literature, investors are intended to draw inferences
about each other's knowledge in these strategic models, which will eventually decide the
equilibrium price. As O'Hara (1995) points out, this may be divided into two parts: one that
targets informed traders and the other that includes uninformed traders. Market makers and
informed traders compete in the first round, whereas noisy traders make decisions based on
variables that are exogenous to the model. (O'Hara, 1995, p. 135). Within the second part,
Uninformed traders who base their tactics on the actions of informed traders are also included.
(O'Hara, 1995, p. 135).

The past several decades have seen an increase in market microstructure research, driven by
major market developments such as structural transformations. and technical innovation,
regulatory reforms. The bitcoin market is a great illustration of how technical advancements
drive financial market transformation. Due to its newness, little research has looked at the
components that govern the bitcoin market microstructure and how they affect price
formation. The market microstructure assists in understanding the reasons behind investors'
decisions to invest in bitcoin, which is the focus of this study. This theory better explains
bitcoin investors' motivations and how the price of bitcoin changes as a result. (Biais et al.,
2005).

Bitcoin Trading Mechanism

The rules that regulate the trading mechanism will create the foundation for an assets price
development, as outlined by (O'Hara, 1995, pp. 15–16). According to the table below, by the
end of 2021, roughly 18 million BTC will be in circulation. (Bindseil et al., 2022, p. 2). The
supply function is influenced by the speed at which bitcoin is mined, as well as the number of
bitcoin owners who are willing to sell. (Lee Kuo Chuen). The total amount of bitcoin is
limited to 21 million BTC, and around 80% of all bitcoin has already been mined. As of 2021,
miners receives 6.25 BTC as a reward for verifying and validating transactions by solving
complex mathematial puzzle. (Vigna and Casey, 2015).

For the first time in November 2021, the market value of crypto assets exceeded 3 trillion
USD, with Bitcoin responsible for over 1.3 trillion USD. Considering that bitcoin was just
founded in 2009, the market has grown significantly. (Bindseil et al., 2022, p. 2). The first
bitcoin exchange, Bitcoinmarket.com, launched in 2010. (Lee Kuo Chuen). The number of
bitcoins exchanged in a single day hit a record high of 400,000 in early 2021, as more
individuals became interested in the cryptocurrency. In December 2020, Bitcoin had over
330,000 daily transactions. (Best, 2022).

Bitcoin is traded against a range of currencies on a number of exchanges across the world.
Litecoin, Ripple, and Ethereum are some of the other currencies that can be traded on the
exchanges. (Bitcoin (BTC) Price, Charts, and News | Coinbase: bitcoin price, btc price,
bitcoin price usd, 2022). According to the table below, Binance, Coinbase, and Kraken are the
top three exchanges right now, with Kraken divided into two markets: American and
European. Because USD is the most commonly traded currency for bitcoin, accounting for 85
percent of the market, BTC can be sold for USD on these three exchanges. (Bitcoin (BTC)
Price, Charts, and News | Coinbase: bitcoin price, btc price, bitcoin price usd, 2022).

Table shows how the bitcoin exchange rates for the same currency on different exchanges
vary substantially. (CoinMarketCap, 2022).

The 30-day average price on Binance was BTC/USD 42857.15, while the 30-day average
price on Coinbase was BTC/USD 44735.02. (CoinMarketCap, 2022). According to Shleifer
(2000), such pricing differences might lead to arbitrage opportunities. (Shleifer, 2000). Taking
advantage of such arbitrage on the bitcoin market, however, has been difficult (Wong, 2014).
For example, between August 2013 and February 2014, the price of bitcoin on Mt.Gox, the
former leading bitcoin exchange, sometimes deviated considerably from the price of bitcoin
on other exchanges. The difference between Mt.Gox and BTC-e was as high as 26% on
January 28th, 2014. There were problems with the Mt.Gox exchange, so withdrawals of
bitcoins from the exchange were limited. This meant that a strategy to arbitrage would not
work. (Shleifer, 2000).

Bitcoin market characteristics

Investors of bitcoin
The bitcoin market is unrelated to gold or any other commodity, and its value is independent
of any country's central bank. (Grinberg, 2012). As a result, bitcoin's value is not determined
by macroeconomic factors. (Kristoufek, 2013, p. 2). The value of bitcoin is determined by
supply and demand in an open market. Furthermore, the value is mostly influenced by short-
term swings and long-term rising tendencies, both of which are heavily influenced by
speculation. The value of bitcoin is influenced by supply and demand, certain events, the
number of exchanges, and specific legislation. (Briere et al., 2017) As previously stated, the
overall amount of bitcoin in circulation remains constant, but the daily supply traded
fluctuates from day to day depending on investor interest in trading. Bitcoin's demand
fluctuates depending on how confident investors are in the currency's inevitable development.
As a result, understanding bitcoin price volatility requires a knowledge of bitcoin investors
and the sources of investor demand (Kristoufek, 2013, p. 2) The bitcoin market is said to be
dominated by trend chasers, short-term investors, noise traders, and speculators. (Kristoufek,
2013, p. 2) As a result, the market is dominated by individual, inexperienced traders.
Institutional investors are growing increasingly interested as the business evolves. (Yermack,
2013) . According to Grinberg (2011, p. 175), Bitcoin is particularly vulnerable to bubbles
and a loss of investor confidence, resulting in a demand-supply disequilibrium. (Grinberg,
2012).

Efficient Market Hypothesis

The Efficient Market Hypothesis (EMH) is a central concept of modern finance. (Malkiel,
2003, p. 59) Its existence has major consequences for the link between asset prices and
information. (Fama, 1970). As a result, it is an important starting point for our research. The
EMH assumes that market equilibrium can be represented in terms of expected returns, and
that the market takes into account all available information. (Fama, 1970). Ritter (2003) said
that the EMH is based on rational investor ideas and the anticipated utility hypothesis(Ritter,
2003, p. 429). Even if all investors' rationality is not required, markets must be rational and
capable of making impartial projections of the future. The EMH assumes that the market
possesses fair game characteristics. (Fama, 1970) (Shleifer, 2000, p. 4) stated that The
existence of experienced arbitrageurs assures that prices will never diverge substantially from
their underlying value. (Shleifer, 2000). In this sense, the EMH operates in a speculative and
unpredictable market under the constraint of a zero-profit competitive equilibrium. (Jensen,
1978, p. 4) The EMH is linked to the random walk hypothesis, which states that prices follow
a random walk and that the price of tomorrow is unrelated to the price of today. Moreover,
new information is inherently unpredictable, and since prices represent all available
information, prices are similarly unstable. (Malkiel, 2003, p. 59) Malkiel (2003, pp. 59–60)
argued that neither technical nor fundamental analysis can predict future prices since new
information spreads quickly and is incorporated into prices nearly instantaneously. As a
consequence, investors will be unable to generate above-average returns without taking on
above-average risks. (Malkiel, 2003, p. 59) Despite the fact that price movements are caused
by the revelation of new information, the no-arbitrage requirement assures that this new
information cannot be used to anticipate future returns. (Shleifer, 2000)

Three Forms of Efficient Markets

According to the strong form of market efficiency, prices reflect all available information, and
no one has monopolistic access to price-forming information. (Fama, 1970) According to
Fama (1970), three kinds of efficient markets have been thoroughly analyzed via research.
(Fama, 1970) The semi-strong-form, all publicly accessible information, θt, that is available at
time t, is integrated in price. As a result, it is less restricted, and actual evidence supporting
such an efficient market has been discovered. As a result, it has become a widely recognized
literary paradigm. The biggest issue with this kind of EMH is determining what constitutes
"all publicly accessible information." (Fama, 1970) The main difference between forms is
how they define the information set θt., which is used to evaluate the strength of efficiency.
(Jensen, 1978, p. 4) As a result, at time t, the information set θt represents all available
information. (Jensen, 1978, p. 4) Finally, in the weak form of market efficiency, past price or
return sequences are thought to have been taken into account when prices are set. (Fama,
1970).

Efficient market anomalies

As further abnormalities were revealed during the 1980s, the EMH became more and more
questioned. (Shiller, 2003, p. 84) Lux (1995) said that empirical research has revealed that
stock prices are more volatile than fundamentals or expected returns. (Lux, 1995). This shows
that excessive volatility might lead to the predictability of the returns. (WEST, 1988, p. 639)
Excess price volatility has shown to be the most troubling anomaly, since the others may be
addressed in part by the efficient market concept. When compared to those indicated by
exchange-rate overshooting or price stickiness, the volatility anomaly is significantly deeper.
Price movements that are too volatile seem to occur for no apparent cause, forexample
because of mass psychology. The consistent failure to demonstrate the EMH suggests the
existence of noise as a disruptor to perfectly efficient markets. (Shiller, 2003, p. 84) Thus,
West (1988) says that more models that don't rely on the rational investor need to be used. As
a result, the efficient market hypothesis will be talked about and compared in this theoretical
setting. (WEST, 1988, p. 654). Given the significant volatility of the bitcoin price, such
theories may give useful insights into why this has happened. Following Fama's (1970)
different forms of efficient markets, these theories should have a strong market form, which
means that the price is based on all available information without any kind of noise
disturbance. This assures that the price cannot be changed by a particular individual or entity.

The Efficiency of the Bitcoin Market

Shleifer (2000) stated that, in an efficient market hypothesis, there should be no influence on
price unless the explanation for changes in supply and demand of an asset is accompanied by
news about a change in its intrinsic worth. (Shleifer, 2000) It is difficult to apply the efficient
market hypothesis to the bitcoin market because the price of bitcoin is determined by
variables such as the cost of generating one bitcoin via the mining process, the amount a
person gets as a reward for mining a bitcoin, and the number of competing cryptocurrencies.
(Kristoufek, 2013, p. 2) The bitcoin price, on the other hand, has demonstrated considerable
fluctuation throughout its history, making it intriguing to investigate its origins. Despite this,
the emphasis of this research is not on applying the EMH to the bitcoin market and
determining its efficiency. Nonetheless, the efficient market hypothesis provides a theoretical
framework for understanding how information is absorbed into prices and is therefore critical
for any investigation of asset price volatility.

Behavioral Finance
Trade happens as an outcome of different investor preferences, opinions, or endowments
(Grossman and Stiglitz, 1980, p. 393) As previously noted, economists typically believe that
investors make rational investment choices and that markets efficiently reflect these views.
(Fama, 1970) However, there have been many situations when the random walk and the
efficient market hypothesis haven't worked out. This has led scholars to look for other ways to
explain how prices change. (Lux, 1995) All of this has resulted in the rise of behavioral
finance. Behavioural finance is limited to arbitrage and is based on cognitive psychology
fundamentals. (Ritter, 2003, p. 429) Not all investors are rational due to preferences or
mistaken beliefs, resulting in informationally inefficient markets. As a consequence,
behavioral finance stresses the need to investigate the underlying reasons of investors' trading
decisions. Behavioral finance may supplement market microstructure and efficient market
hypothesis in this study by providing additional insight into the sources of investor demand.
(Ritter, 2003, p. 430) Simon (1955), as well as Tversky and Kahneman(1974), are
acknowledged with discovering behavioral finance. Tversky and Kahneman (1986) argued
that other models fail to match the rational choice model's simplicity, scope, and robustness.
They argue, however, that despite the mathematical and normative difficulties, psychological
elements must be considered. (Kahneman and Tversky, 2019) Similarly, Ritter (2003, p. 437)
predicts that behavioral finance will gain momentum in mainstream financial research and
implementation. He believes that it should not be regarded as a distinct discipline, but rather
as an extra source of information for analyzing financial markets. (Ritter, 2003, p. 437)
Wilkinson and Klaes (2017) agreed with these claims. He said that behavioral economics is a
way to add to the framework of traditional economic theory. Taking this into account,
behavioral variables should be taken into account while assessing the bitcoin market.
(Wilkinson and Klaes, 2018, p. 4)

Decision-Making under Risk and Uncertainty

When investors assess an investment opportunity, they "know neither the ultimate realization
of the asset's payout (risk) nor the likelihood of it happening (ambiguity)." (ILLEDITSCH,
2011) (Tversky & Kahneman, 1989) argued that Investors are unable to develop rational and
realistic probability calculations under such conditions. (Tversky and Kahneman, 2019,
p. 209) Hence, Kahneman and Tversky (1986) published Prospect Theory, which postulate
that the framing of a situation impacts an investor's ability to behave rationally and make
utility-maximizing decisions. (Tversky and Kahneman, 2019, p. 209) Furthermore, Illeditsch
(2011) demonstrates that most investors want to minimize uncertainty and that hedging
against such events creates portfolio inertia and excess volatility. In nontransparent and
uncertain conditions, investors make illogical decisions based on these beliefs. Connecting
these assumptions, investors make irrational judgments in nontransparent, uncertain
circumstances.However, when the situation is clear and open, investors may make educated
and sensible decisions since they have access to all the facts. (ILLEDITSCH, 2011) Prospect
theory divides the decision-making process into two stages. During the first step, the available
prospects are looked at and simplified into more simple forms that are easier to understand
and learn about.This process of framing prospects within the boundaries of its actions,
conditions, and outcomes varies based on the investor's norms, habits, and expectations.
(Kahneman and Tversky, 1979, p. 274) In the second stage, the prospects that have been
framed are analyzed, and the prospect with the highest value is selected. This final selection
will be based on a belief that one option outperforms the other, or on a monetary value
comparison. Disparities in investor preferences, according to prospect theory, stem from the
earliest stages of decision-making. Hence, the ultimate decision will be determined by how
the possibilities are portrayed. (Kahneman and Tversky, 1979, p. 274)

Bounded Rationality and Investor Sentiment

As a result, when investor sentiment takes precedence over facts, the decision-making process
will be undesirable and inefficient. (Baker and Wurgler, 2007, p. [129]) Investors use basic
rules of thumb, or heuristics, to influence decision-making when confronted with uncertainty,
resulting in biased conclusions. (Wilkinson and Klaes, 2018, p. 10) According to Wilkinson
and Klaes (2017), due to the prevalence of ambiguity in financial markets, complete
rationality is unlikely to prevail in most real-life scenarios. Simon's (1955) work serves as the
foundation for the concept of bounded investor rationality. (Wilkinson and Klaes, 2018,
p. 118) Tversky and Kahneman (1974) revealed cognitive errors resulting from the use of
judgemental heuristics . These rules of thumb are often helpful and may result in accurate
forecasts. However, they may lead to mistakes in judgment, which is troublesome since most
individuals are unaware of their own biases. (Tversky and Kahneman, 1974)
Representativeness heuristics are a common concern with investors. (Tversky and Kahneman,
1974) Ritter (2003) outlines how people typically place too little weight on long-term
averages and instead focus too much on recent experience when assessing the probability of a
possibility. (Ritter, 2003, p. 432) This leads to biases such as failing to account for historical
probability of outcomes, misinterpreting sample size in terms of how representative a sample
size is for a population, and misinterpreting chance. (Tversky and Kahneman, 1974) The use
of availability heuristics guarantees that frequently occurring events are remembered better
and quicker. (Tversky and Kahneman, 1974) As a response, investors place a greater focus on
a large number of repeating small events rather than a few major ones. They also have a
tendency to make assumptions about links between events that do not exist. Anchoring
heuristics is a phenomenon that outlines how people choose an initial value to utilize as a
starting point for decision making. (Tversky and Kahneman, 1974) This original value is often
inadequately changed to be relevant. Hence , there is a possibility of conservative bias, in
which the investor leans too much on the past. (Ritter, 2003, p. 432) In the research paper by
De Bondt and Thaler (1985), investor sentiment indicates that the majority of customers
overreact to unexpected and dramatic news events, causing prices to temporarily diverge from
their fundamental values. This demonstrates a tendency to undervalue data and averages
based on the base rate. A continuous pattern of news, such as several favorable news releases
over a longer period of time, is seen by investors as predictive of future price direction.
(BONDT and THALER, 1985, p. 804) Stambaugh et al. (2012) stated that the impact of
sentiment on price is asymmetric, implying that higher sentiment, or optimism, leads to
overpricing more often than lower sentiment, or pessimism, leads to underpricing.
(Stambaugh et al., 2012) As a conclusion, he claims that this finding proves that market
mispricing may explain market anomalies, at least in part. (Stambaugh et al., 2012) The
findings of the study by Baker and Wurgler (2007) also show that businesses with low capital,
young age, and high volatility are most affected by sentiment. Intelligent investors who use
this information may make huge gains and outperform the market. (Baker and Wurgler, 2007,
p. 130)
Bubbles, Fads and Herd Behavior
Throughout history, financial markets have seen a number of bubbles and volatility shocks,
notably the stock market crash of October 1989. (Schwert, 1990, p. 23) , the late nineteenth
century internet bubble. (Scheinkman and Xiong, 2003) as well as the most recent financial
crisis. (Mendel and Shleifer, 2012, p. 303) A bubble is defined as a time in which the price
level deviates considerably from its inherent value. This is due to overconfident investors who
have a different perspective. (Scheinkman and Xiong, 2003) These speculative investors'
intended trading creates such bubbles, which are often characterized by high trading volume,
high prices, and extreme volatility. (Scheinkman and Xiong, 2003) The causes for these
heterogenous views vary and are often discussed. (Schwert, 1990, p. 30) As described by Lux
(1995), not every investor is properly aware of market fundamentals. This lends support to the
idea that inexperienced traders might build expectations based on the behavior and
expectations of others. As a consequence, attitudes and behavior may spread quickly,
resulting in similar herding behavior. (Lux, 1995) The paper by Schwert (1990, p. 30)
indicates that when new information about an asset's underpricing or overpricing is disclosed,
it may inspire investors to make equivalent assumptions about the asset's future price, and
hence purchase or sell correspondingly. (Schwert, 1990, p. 30) According to Scheinkman and
Xiong (2003), an overestimation of the informativeness of this new information is what
produces a trading frenzy and subsequently creates a bubble. (Scheinkman and Xiong, 2003)
Furthermore, by following market price swings, investors often rely on the views of others for
their trading strategy. (Schwert, 1990, p. 30) Price movements may be socially transmitted in
this manner, resulting in a bubble or a very volatile price. Mimetic contagion happens when
investors adjust their prices to match the average prices of other buyers and sellers in the area.
(Topol, 1991, p. 798) Prices rise until investor behavior becomes uncorrelated once again, and
then the bubble burst. (Topol, 1991, p. 788) When a price drop is seen, investors who rely on
stable market pricing will begin to sell their shares. Other investors may notice this pattern
and conclude that these people know something they don't, prompting them to sell their
holdings as well. As a result, the financial markets now include a learning component.
Investors take inspiration from others' actions and adjust their own behavior accordingly.
(Schwert, 1990, p. 30) Bikhchandani et al. (1992) proposed a model that demonstrated how
even little bits of information might have a domino effect on investor behavior. The
researchers refer to this kind of behavior as "informational cascades." According to the model,
investors may act in a way that is unpredictable and unique, which could lead to systemic
consistency among investors. They think that fads, or sudden shifts in public opinion for no
apparent reason, are caused by tiny changes in the underlying values of different decisions.
Even if fresh information only persuades a small number of investors to adopt a certain
action, others may follow suit, resulting in an informational cascade. (Bikhchandani et al.,
1992, p. 1016) In a review of research on excess volatility, West (1998) suggests that fads and
behavioral characteristics may be required to explain the development of bubbles. He claims
that under such a model, naive and irrational traders, who overreact to news, are the causes of
excessive volatility. (WEST, 1988, p. 652)

The Behavior of the Bitcoin Investor

According to prospect theory (Kahneman & Tversky, 1979), framing bitcoin as a potential
investment opportunity is crucial for investors' ultimate trading selection. (Tversky and
Kahneman, 2019, p. 212) Because of its newness and unique characteristics, the bitcoin
market stands apart from other more established financial markets. Due to the fact that few
studies have looked at these aspects, the bitcoin market is extremely ambiguous. The
investor's fear is exacerbated by the anonymity, lack of regulation, and significant risks.
(Rogojanu and Badea, 2014, p. 6) As result, theories based on the existence of irrational
investors prone to biases, sentiment, and heuristics are crucial in assessing bitcoin price
volatility. (Tversky and Kahneman, 1974) The bitcoin market's other characteristics, such as
its very volatile price and small market size, suggest that it is more sensitive to investor
sentiment. (Baker and Wurgler, 2007, p. 130) Throughout its life, the bitcoin price has shown
bubble behavior at different times, such as at the beginning of 2014 and towards the end of
2017. These occurrences have been connected by researchers to informational events. (Bouri
et al., 2019) Scheinkman and Xiong (2003, p. 1186) argued that this is most likely due to
inexperienced traders' responding to new information. (Scheinkman and Xiong, 2003)
Additionally, Bikhchandini et al. (1992) suggested that an aggregate informational cascade
requires just a few investors to react to the new information. (Bikhchandani et al., 1992,
p. 1006) As the bitcoin market is currently dominated by inexperienced traders, it is probable
that they will cause bubble behavior in the price of bitcoin. (Kristoufek, 2013, p. 2)
Furthermore, mimetic contagion, fads, and herding behavior may all play a role in explaining
Bitcoin price movements. (Topol, 1991, p. 798)

Other Macroeconomic Theories

Bitcoin's independence from a central issuer has an influence on macroeconomics.In
macroeconomic theory, there are numerous schools of thought, such as the classical and
neoclassical schools, the Keynesian school, the Monetarist school, and the Austrian school.
The schools have competing views on how the market and its participants function, as well as
how to create an ideal economy. (Hall, 2021)
The Austrian School of Economy
The Austrian school of economics was frequently mentioned in connection with
cryptocurrencies, particularly bitcoin. One of the oldest schools of economics, the Austrian
school is based on the idea that all social phenomena are the result of individual actions and
intentions. Unlike other schools of thought, the Austrian school believes that quantitative and
data-based models of human behavior will be inaccurate due to the uniqueness of human
behavior. (Hall, 2021) The Austrian school also believes that as minimal government
interference as possible is beneficial to the economy and so opposes the existing fiat money
system. In his 1951 book, "The Free Market and Its Enemies," Ludwig von Mises, an
Austrian school economist, says that the gold standard should be brought back. He thinks this
is a good idea. According to Mises, "a fiat money system cannot last indefinitely and must
ultimately come to an end." The dilemma is how to return to the gold standard. (Mises, 2016).

The Austrian school of economics has some similarities with the philosophy and foundations
of Bitcoin. Like the Austrian school, Bitcoin criticizes fiat money and the need for a central
authority to regulate the money supply. Both parties oppose the fractional reserve banking
system, which permits banks to provide credit beyond their reserves. The Austrian school of
economics thinks that we should return to the gold standard, and bitcoin has been termed the
"digital gold" of today since it has many of the same characteristics as physical gold, such as
scarcity advantages. (European Central Bank, 2012). Despite the fact that Bitcoin seems to
follow the Austrian school's paradigm, it has been questioned by a number of Austrian
economists over the years.The critic points out that bitcoin's value changes a lot, which makes
it unsuitable as a gold alternative. Austrian economist Trace Mayer, on the other hand,
believes that today's economists and capitalists want stability and liquidity that the
conventional fiat money system cannot give. According to Mayer, Bitcoin has no
counterparty risk, is backed by equity, is more portable than gold, and has never lost value. As
a result, Bitcoin may be a viable gold substitute. (Hill, 2022)

Maintaining Economic Stability

Macroeconomic policy, which is separated into two parts: fiscal and monetary policy, is
employed to keep the economy stable. The government is the most common fiscal policy
manager. The central bank or another equal party is in charge of monetary policy, but the
government is in charge of fiscal policy. Macroeconomic circumstances are influenced by
policy. Whether or not economic manipulation is good depends on which economic school
one follows.The Austrian school of economics thinks that manipulating the money supply is
bad for the economy, while Keynesians feel that controlling the money supply is good for the
economy. (MCWHINNEY, 2021) The government uses fiscal policy to keep unemployment
low, control inflation, influence interest rates, and stabilize economic cycles. To support
economic growth, they propose changing tax rates and increasing government investment to
boost consumer spending. A transition to bitcoin would have little effect on the government's
capacity to conduct fiscal policy but would have a major impact on monetary policy.
(LeBlanc, 2016)

The central bank is in charge of monetary policy, which is aimed at keeping inflation low and
stable. This is accomplished by changes in the interest rate as well as the quantity and growth
of the country's monetary supply. Because traditional currencies are not backed by any real
reserve or physical asset, the value of government-issued money is predicated on the
government's and central banks' entire faith and trust. As a consequence, depending on
monetary policies aimed at boosting the economy, any amount of money might be created.
The former method also allowed the government to watch cash flow in order to collect profit
taxes and track criminal activities. Alternatives to traditional currencies and institutions, such
as bitcoin, are being sought by market participants. (LeBlanc, 2016)

Since it does not have an issuer, Bitcoin is neither taxed nor traceable in the same way that
regular money transactions are. The number of coins available is rigorously restricted by the
mathematical limitations mentioned in the Bitcoin protocol, and they are allocated in a
predetermined rate. Because bitcoin's currency supply is unpredictable, it's difficult to
generate additional money to appease political choices. As a result, the shift to
cryptocurrencies might be seen as a danger to central banks, not because they would be
replaced, but because cryptocurrencies could abolish the necessity for a central bank in its
present form. (Frost, 2016) Since not all payments are made via the current payment system, a
cryptocurrency such as bitcoin might contribute in the creation of a more stable payment
system, which is beneficial to the financial industry. (Cermak, 2017)

Controlling the Inflation

The fixed supply of Bitcoin is a significant distinction from conventional fiat currencies,
whose monetary base is modified by central banks to reflect economic development.The
objective is to keep inflation at a moderate level; in most situations, the central bank's target is
2%, and most central banks believe that this is necessary to stimulate spending and
investment, which are vital elements in a rising economy. According to some experts, failure
to do so might result in an economic downturn. (Cermak, 2017)
According to the Austrian school of economics, only the buying power of money matters, and
an economy may function with any monetary foundation.As a result, a limited money supply,
such as bitcoin's, should not be regarded as a constraint. Because the monetary base cannot be
enlarged, economic expansion will lead to a decrease in the price of products and services,
allowing for the purchase of larger quantities for the same amount of money. According to
Keynesian economists, deflation is bad for the economy because it creates incentives to save
rather than spend.The Austrian school opposes this by claiming that prices fall at all phases of
manufacturing, resulting in steady profit ratios. Deflation, according to the Austrian school of
thought, leads to savings, which leads to a decline in interest rates and new investments. As a
result, according to the Austrian school of economics, increasing bitcoin economic growth
and eventual deflation of bitcoin's monetary value do not pose a threat to the bitcoin economy.
(Bhidé, 2009)

Bitcoin's early years were marked by massive inflation. The current growth rate is somewhat
inflationary, with a forecast of 4.5 percent in 2017 dropping to 1.7 percent in 2021 and 0.8
percent in 2025. At this point, the pace of growth will become slower. When the supply of
bitcoin is compared to the monetary base of major fiat currencies like the US dollar, Japanese
yen, Swiss franc, Euro, and British pound, it is evident that bitcoin's growth rate dwarfs that
of the fiat currencies. Due to the characteristics of bitcoin's pre-programmed finite supply, the
tables are expected to be turned within the next decade. By 2025, Bitcoin's annual growth rate
is expected to be lower than that of other major currencies and means of exchange, such as
gold, by 2025. (Cermak, 2017)

Sources of Information
The Factors Influencing Bitcoin Exchange Rate
Even though there are a lot of things that could make bitcoin's return volatile, this study will
only look at a few of them in order to get a clear picture. The parameters were chosen based
on previous research and are considered the most important in determining bitcoin volatility.
Trade volume, information demand, and global stock market index returns are some of the
specific factors that will be examined further in this research. Regardless of the fact that there
are several factors that may influence the volatility of bitcoin returns, this study will only
focus on a few of them in order to give a clear analysis. The criteria were chosen based on
earlier research and are regarded as the most important in understanding bitcoin volatility.
Among the specifics examined in this study are trade volume, information demand, and the
USD/EUR exchange rate.

Methodology
This empirical research employs a logical method to determine how bitcoin returns respond to
various conditions. To address the research topic, this study uses quantitative approaches to
gather and analyze the specific data pertinent to this issue. This chapter talks about the
research methods used in previous studies and the research method used in this study. It will
also go into variable measurement, data collection, sampling, and analysis procedures.

Econometric Methodology
Time Series Analysis
This research investigates the impact of several variables on the volatility of bitcoin returns
over time. A kind of time series analysis may be used because there is just one dependent
variable, bitcoin returns, that can be investigated over a longer period of time. Time series
analysis is a statistical approach for examining series data or trends over a longer period of
time or intervals. (Garcia et al., 2014) Cermack (2015) and Blau (2017) conducted similar
regression analyses in their studies. Cermack (2015), for example, used a least-squares (OLS)
multiple regression model to investigate the impact of several factors on bitcoin's price.
However, there are several limitations to using regression analysis. To begin, the analysis
assumes that the cause-and-effect relationship between the dependent and independent
variables remains consistent across time, which is not always the case. This might result in
inaccurate and misleading findings. (Cermak, 2017) Second, if the relationship between the
dependent and independent variables is not linear, the model will not be able to explain it.
Third, regression analysis may be affected by multicollinearity, which occurs when two or
more independent variables are highly related to one another.This suggests that the variables
effectively measure the same thing, with one independent variable explaining the majority of
the variation within the dependent variable while leaving just a little amount to be interpreted
by the second variable. (Daoud, 2017, p. 2) Because regression analysis has significant
limitations, researchers such as Kristouefek (2015) employs alternative methodologies to
assess the influence of numerous variables on bitcoin return volatility. They began by
checking for stationarity within the time series, which is critical in time series analysis and
will be expounded on later in this work, in order to prevent erroneous regression findings.
(Kristoufek, 2015, p. 6) They used several unit root tests, such as the Dickey-Fuller and
Augmented Dickey-Fuller tests. These tests' outcomes were further characterized as follows:
all variables were non-stationary, all variables were stationary, or all variables were mixed. A
vector autoregression (VAR) model is optimal if all of the variables are non-stationary.
However, when all variables are constant, a vector error correction (VEC) model is preferred.
(Balcilar et al., 2017) A GARCH (1,1) model was utilized in this research, which better
captures the effect of variables on bitcoin return volatility than a regression analysis.

ARCH or GARCH
Clustering is one of the features of financial asset volatility.It signifies that the volatility of
financial assets does not remain constant over time, as shown in daily data, but rather tends to
diminish in monthly or yearly data. (Alexander, 2008, p. 131) The relationship between
average returns and their variance is captured using an Autoregressive Conditional
Heteroscedasticity (ARCH) model for assessing volatility levels. The ARCH model expresses
the variance of the current error term as a function of the actual sizes of the error terms in
previous time periods. (Engle, 2001, p. 157) Autoregressive Conditional Heteroscedasticity
(ARCH) Model

The first conditional heteroscedasticity model is the autoregressive conditional

heteroscedasticity (ARCH) model, and Engle (1982) proposed the ARCH (q) model, which
considers the variance of the current error term or innovation as a function of the actual sizes
of the error terms from previous time periods.Yt is assumed to be the dependent variable.
(Engle, 1982, p. 987) Yt = 𝛽Yt-1 + Et

where Yt-1 is is a k * 1 vector of exogenous variables, which may include lagged values of
the dependent variable and 𝛽 is a k * 1 vector of regression parameters.

The ARCH(q) model defines the stochastic error t distribution as a function of the realized
values of the set of variables 𝐼𝑡−1. In this case, q is the length of the ARCH lagged squared-
errors terms 𝜀𝑡2. Based on the information set 𝐼𝑡−1, it demonstrates that 𝜀𝑡 has a conditional
mean and variance. (Engle, 1982, p. 987) On the other hand, the ARCH model is a little more
complicated because it includes various lags, which makes parameter estimation more
difficult. (Tsay, 2010) As a result, Bollerslev (1986) developed the General Autoregressive
Conditional Heteroscedaticity [GARCH] model, which also uses declining weights but, unlike
the ARCH model, never allows the weights to reach zero.This results in a model that is simple
to use and has shown to be particularly effective in predicting conditional variances in
finance. (Engle, 2001, p. 159) The GARCH (1,1) model is created using two different
equations. The first is the conditional mean. This equation determines the behavior of the
specific returns as well as the error term εt , which displays the noise in current period.
Equation below displays a first order regressive model (Alexander, 2008, p. 136) The
conditional mean is calculated as follows:

Equation : Conditional Mean (Alexander, 2008, p. 136) This conditional

mean equation generates an estimate of the error terms based on the information provided by
the previous period's return. The error term is then used in the conditional variance equation.
The variance of the next period can then be estimated in conjunction with the variance of the
previous period.

Equation Conditional Variance Equation (Alexander, 2008, p. 136) The

GARCH model has evolved and altered since its inception, while the simplest model,
GARCH(1,1), is regarded to be the most robust. (Engle, 2001, p. 166)

Hansen & Lunde (2005) support this claim by evaluating different volatility models and
showing no evidence that the GARCH (1,1) outperforms other models of exchange rate
fluctuation. (Hansen and Huang, 2016) The GARCH '(1,1)' indicates that the variance is
calculated using the most recent squared residual observation as well as the most recent
variance estimate. The GARCH (1,1) model was used for this significant bitcoin analysis
because of its strength and flexibility.

Equation : GARCH (1,1) (Hill et al., 2011, p. 526) In the

GARCH (1,1) model, the mean equation attempts to describe the effect of a single variable on
the returns. However, the goal of this study is to look at the impact of a variable on its
volatility rather than its returns. As a result of the impact, the variance equation inside the
GARCH (1,1) model will be the major focus of this study since it will provide the most
important data. However, the mean equation will be employed to facilitate the performance of
the variance equation.

The literature suggests that the mean equation should be modified to incorporate internal
explanatory factors, and the variance equation should be adjusted to include external
explanatory variables. However, apart from intervention events like government laws and
halving intervals, bitcoin lacks any internal variables that may be employed as a function of
returns. According to Dyhrberg (2016), the optimal approach for bitcoin is to adjust the mean
equation in the same way as the variance equation is modified by adding exogenous
explanatory variables, which this paper will also accomplish. (Dyhrberg, 2016, p. 87)
To get the GARCH (1,1) model, you need to look at the statistical features of the mean
equation. Figure 1 in Section 2.3.2 of this research demonstrates that the price of bitcoin is
sensitive to certain shocks, may have a positive temporal trend, and displays a clear picture of
stationarity. As a consequence, bitcoin acts like a random walk. Figure 1 shows that financial
assets can be very volatile and relatively calm at the same time, which is typical. These
findings are heteroscedastic, demonstrating that the GARCH (1,1) model might be used to
predict the price of bitcoin.

By adding the factors that have been identified into the model, this research wants to see if
the variables have a large effect on the price movement of bitcoin. The model is run using the
statistical applications E Views and Python. It is possible to use E View and Python to figure
out the parameters and get a p-value. The p-value indicates whether or not the parameters are
statistically significant. The GARCH (1,1) model might be used to predict the price of bitcoin.
Data Collection and Sample
A five-year average of the daily closing prices of bitcoin was used in this study. This data is
from January 1, 2016, to December 31, 2021. One issue I ran across while gathering the data
was that the closing prices provided on each exchange differed. The major cause of the price
variation is the different approaches used to estimate market capitalization, which is why I
obtained daily bitcoin price data from Barchart.com. There were a total of 1568 data points as
an outcome of this. Because this research is being done over a longer period of time, daily
data has been used to improve its accuracy. Daily data will be utilized for each individual
variable to avoid measurement mistakes and to verify that all variables are measured on the
same dataset.
Google Trends can be used to figure out how much information people want. The information
demand variable is based on how many people search for things every day, which can be
taken away from Google Trends. Data from Google Trends is gathered using data from
https://trends.google.com. The Search Volume Index (SVI) for the keyword "Bitcoin" is
studied. The volume measure is determined by the number of searches for those keywords
that were submitted globally. Google Trends data is relative since it provides a search volume
index rather than an effective number of searches. Google Trends shows a daily timeline for
90 days and a weekly timeline for a longer period of time. In each 90-day period dataset, the
SVI has a maximum of 100 and a minimum of 0. Weekly data is used to adjust daily statistics
since every 90-day period is relative. When weekly and daily SVI data are available, an
adjustment factor is produced by dividing the weekly SVI by the daily SVI.

Daily trade volume data is also obtained from barchart.com and is accessible for the entire
sample. Data on EURO/USD, JPY/USD, and CNY/USD exchange rates can also be retrieved
at barcharts.com. The data for the gold bullion USD/troy ounce rate is collected from
www.barchart.com's Gold Cash (GCY00). The gold prices used in the database are widely
regarded as the worldwide standard for gold pricing.
Measurement
Dependent Variable
The dependent variable in this research is bitcoin returns. Furthermore, Pichl and Kaizoji
(2017) said that logarithmic returns have a benefit over particular price data since they are a
symmetric representation of the price increase and decrease by the comparable multiple, with
just the sign of the associated log return changing. This is another reason why the time series
of a logarithmic return across these prices can be considered stationary rather than the non-
stationary pricing process. (Pichl and Kaizoji, 2017) When computing returns, researchers
utilize either arithmetic or logarithmic returns. According to Kristoufek (2013) and Othman
(2019), they all tracked the returns on their bitcoin investments. (Othman et al., 2019, p. 436)
As a result, the logarithmic return will be used in this research. According to Othman,
Alhabshi, and Haron (2019), the bitcoin return may be stated using the equation below;
(Othman et al., 2019, p. 436).

Figure 3: Logarthemic Return Equation (Othman et al., 2019, p. 436)

Independent Variables
The independent variables in this research are trading volume, gold price, oil price,
Euro/USD, JPY/USD, and CNY/USD exchange rates. As previously stated, when measuring
the volatility of the bitcoin price, trading volume may be used as an explanatory variable.
Trading volume has been proven by Kristoufek (2013), Kristoufek (2015), and Ciaian et al. to
have a strong positive effect on bitcoin returns (2016). The trading volume variable will be
determined by the daily number of bitcoin transactions on the major exchange, 'Binance.' This
data will next be recorded using natural logarithms to overcome the challenges of many
outliers and severe skewness, which are often associated with financial variables. (Pichl and
Kaizoji, 2017)

As previously stated, many research, like those of Vlastakis and Markellos (2012) and
Kristoufek (2013), have shown the importance of information demand as an explanatory
variable for price changes when employing Google Trends search frequencies that contain
certain key terms. The variable information demand is obtained from daily Google Trends
data on the number of 'bitcoin' searches. This supplied absolute data has been normalized and
scaled from 0 to 100, with 100 being the week with the most searches and 0 representing the
week with the fewest over the sample period. Furthermore, to avoid outliers and extreme
skewness, the data will be analyzed using natural logarithms. (Corbet et al., 2018) From Bouri
et al. (2019), bitcoin exhibits an extraordinary level of resilience to a variety of variables that
influence traditional assets, implying that the price of bitcoin is unaffected by market events
or market conditions. (Bouri et al., 2019)

Control Variable
The largest portion of information on bitcoin is offered in US dollars.Currency values, such as
the US dollar vs. the Euro, may fall or rise in relation to other currencies. According to Ciaian
et al. (2016), this has an impact on bitcoin returns. They also said that if the US dollar rose
against the euro, it would almost certainly appreciate against bitcoin. As a consequence,
buying bitcoin costs less money, resulting in lower bitcoin returns. (Ciaian et al., 2016,
p. 1806)

Furthermore, the Japanese cryptocurrency market (Financial Services Authority) is better

regulated than the cryptocurrency business in the United States of America (SEC), which
might have significant influence. (Kristoufek, 2015, p. 5) .As a consequence, this study will
examine if the USD/JPY exchange rate has an impact on bitcoin returns using the daily
closing prices of this particular exchange rate.To account for outliers, skewness, and, most
critically, the non-stationarity of the control variables, both variables will be represented using
natural logarithm.

Data Analysis
Unit Root Test(Stationarity Test)
The time invariant features of time series are referred to as stationarity. (Hill et al., 2011,
p. 484) The condition of stationarity is critical since this study is focused with simulating the
volatility of the bitcoin price using time series data. (Pindyck and Rubinfeld, 1998) The
condition of stationarity is critical since this research is focused on simulating the volatility of
the bitcoin price using time series data. The data does not have to have set values across time
to be stationary; rather, it must display constant statistical features. (Wooldridge, 2013). The
time series is then expected to be strictly stationary, which is a rather strong assumption. In
finance, it's common to assume that asset returns have weak stationarity, suggesting that only
the first and second stages are constant. (Tsay, 2010)
A unit root test may be used to verify stationarity experimentally. There are other variants of
this test, but the Augmented Dicker-Fuller [ADF] test is one of the most commonly used, and
it was also used in this research. (Wooldridge, 2013) Dickey and Fuller (1979) stated that the
time series moves toward stationarity as time goes on and when α<1.The time series will
depict a random walk when α= 1. When α > 1, the time series grows rapidly, indicating that it
is non-stationary in some way. The Augmented Dickey-Fuller test may be used to compare
the null hypothesis (H0); α= 1 to the alternative hypothesis (H1); α<1. (Hill et al., 2011,
p. 484).

Hill (2012) mentioned that the results of this test can be assessed by comparing them to
critical values. If the test value is greater than the crucial value, the null hypothesis of a unit
root is rejected, suggesting that the time series is stationary. On the other hand, if the time
series is non-stationary, as is often the case with level data in finance, it is possible to
transform the time series to a stationary one via a method known as differencing. The
logarithmic returns generated for bitcoin price and trading volume are the first differenced
series, indicating that they are not level data and are therefore likely to remain stationary. If
this isn't the case, there are very definitely numerous unit roots present, and a second
difference is suggested. (Hill et al., 2011, p. 485)

Evaluation of the GARCH Model

Ljung-Box Test Statistic
The model may be assessed after the parameters of the GARCH model have been defined. In
Hull (2012), p. 229, he says that this is based on how well the model removes autocorrelation
from the squared return. This is all about the idea of volatility persistence, which says that a
time of high volatility will almost always be followed by another time of high volatility (Hill
et al., 2011, p. 229)
A well-functioning GARCH model should be able to eliminate such serial autocorrelation.
The accuracy of a time-based forecasting model, such as the GARCH model, may be harmed
by autocorrelation. The Ljung-Box test statistic (Hull, 2012, p. 347) is used to test the
GARCH model for autocorrelation. It's a hypothesis test in which H0: There's no serial
correlation, therefore the data is randomly distributed, and H1: The data isn't dispersed
independently. (Hill et al., 2011, p. 347)

Durbin-Watson Test Statistic

The Durbin-Watson test statistic was shown by Saunders et al. (2012) to be a good way to
look at autocorrelation in a time-based prediction model.The result of this test statistic will
always be between 0 and 4. A score of 2 implies that there is no autocorrelation in the sample.
A positive autocorrelation is defined as a number between 0 and 2, whereas a negative
autocorrelation is defined as a number between 2 and 4. This implies that if the bitcoin price
has a positive autocorrelation, it means that the bitcoin price on one day has a positive
correlation with the bitcoin price on the next day. In this situation, if the price increases one
day, it will almost certainly climb again the next. A bitcoin price with a negative
autocorrelation will exhibit negative trends over time, which means that if it rises one day, it
will almost certainly drop the next day. (Saunders et al., 2012)

Figure 4: Equation : Durbin-Watson test statistic (Wooldridge, 2013)

where DW = test statistic

  ˆ ut=yi – ŷi
yi = the observed value of the response variable for individual i
ŷi = the predicted value of the response variable i (Wooldridge, 2013)
Pearson’s Product Moment Correlation Coefficient
The collected data is subjected to a correlation test in order to investigate the relationship
between the variables. (Saunders et al., 2012) This enables you to analyze the strength of the
correlation between the variables from a statistical approach. Because collinearity (correlation
between independent variables) may complicate regression analysis, the correctness of such a
test is even more important. (Saunders et al., 2012)

The goal of the study is to see if the factors that were identified have an effect on bitcoin price
volatility. It's important that collinearity doesn't affect the estimations of the individual
regression parameters. In this case, the Pearson's Product Moment Correlation Coefficient
[PMCC] was used to figure out how well the two variables were linked because they were
both numerical and had an interval-like nature. To find out if this is the case, descriptive
statistics, distribution tables, normality tests, and scatterplots are made and shown in the next
chapter. (Saunders et al., 2012).

Where
r =correlation coefficient of variable X and Y
σY = standard deviation of dependent variable Y
σX = standard deviation of independent variable X
cov (X,Y) = covariance between variable X and Y (Hill et al., 2011, p. 31)

Figure 5: Equation : Correlation between X and Y (Hill et al., 2011, p. 31)

In most cases, the correlation coefficient is between -1 and 1. With a correlation of 1, the two
variables have a perfect positive correlation, indicating that they move in the same direction.
If the correlation coefficient is 1, the variables have a completely negative relationship and
always move in the opposite direction with the same amplitude. If the correlation test returns
a zero result, the variables are unrelated. (S. Moore et al., 2009).

Limitation of Correlation Analysis

As previously stated, the results of a correlation test may be useful in determining the
relationship between variables. It's vital to keep in mind, however, that this data has
limitations. (S. Moore et al., 2009). This refers to the conclusions that can be drawn from the
data. For example, interpreting the finding as valid for data other than the ones analyzed
should be avoided.The data might represent a linear component of a non-linear relationship.
Additionally, peripheral factors that are not included in the research, so-called lurking
variables, might alter the connection between two variables presented in a correlation test.
Because such hidden factors might explain a link, inferring from a correlation test should be
done with caution. Another reason to be cautious is the possibility of outlier effect, which
might result in a large variation in the correlation coefficient . In this scenario, scatterplots are
beneficial for visualizing the data. (S. Moore et al., 2009)

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