Topic : Quantitative Analysis of cryptocurrencies to assess their viability in the peer to peer market

CHAPTER ONE:

1.0 INTRODUCTION

This study focuses much on the viability of cryptocurrencies in peer to peer market. The
background of the study, the statement of the problem, the objectives of the study and the
research questions are laid out and explained much in detail in this chapter in order to provide
a conceptual foundation through which the research problem for this study can be understood.
The purpose of the study, the significance of the study and the assumptions of the study are
well presented and described. Key concepts of the study are defined and the structure of the
study is spelt out.

1.1 BACKGROUND OF THE STUDY

Bitcoin is the original cryptocurrency and was initially introduced in Japan to the public by
Satoshi Nakamoto (2008). It was launched in early year of 2009 as a decentralized electronic
payment system, a peer-to-peer version of electronic cash without intermediaries, constructed
with a cryptographic system that enables it to protect the identity of its users and is able to
steadily recreate itself according to predetermined supply. Nakamoto (2017) noted that bitcoin
dominates the market of digital currencies, representing 53% of the total market capitalization.
Bitcoin, the first decentralized cryptocurrency, has gained a large following from the media,
academics and the finance industry since its inception in the year of 2009. Built upon block
chain technology, it has established itself as the leader of cryptocurrencies and shows no signs
of slowing down.

Instead of being based on traditional trust, the currency is based on cryptographic proof which
provides many advantages over traditional payment methods such as Visa and Mastercard
including high liquidity, lower transaction costs, and anonymity, to name just a few. Indeed,
the global interest in Bitcoin has spiked once again in recent months, for example, the UK
government is considering paying out research grants in Bitcoin; growing numbers in China
are buying into Bitcoin and seeing it as an investment opportunity.

There are seven cryptocurrencies which fall into the category of having existed for more than
two years and are within the top 15 currencies by market capitalization. John (2017) noted that
these are Bitcoin, Ripple, Litecoin, Monero, Dash, MaidSafeCoin, and Dogecoin. Bitcoin is

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the most popular cryptocurrency. Hencic and Gourieroux (2014) established a model and
predicted the exchange rate of Bitcoin versus the U.S. Dollar. Their results show that the daily
Bitcoin/USD exchange rate shows local trends which could indicate periods of speculative
behaviour from online trading.

Sapuric and Kokkinaki (2014) investigate the volatility of Bitcoin, using data from July 2010
to April 2014, by comparing it to the volatility of the exchange rates of major global
currencies. Their analysis indicates that the exchange rate of Bitcoin has high annualised
volatility, however, it can be considered more stable when transaction volume is taken into
consideration. Briere et al. (2015) use weekly data from 2010 to 2013 to analyse diversified
investment portfolios and find that Bitcoin is extremely volatile and shows large average
returns.

Surprisingly, the results indicate that Bitcoin offers little correlation with other assets,
although it can help to diversify investment portfolios. In Kristoufek (2015), the influencing
factors of the price of Bitcoin are investigated and applied to the Chinese Bitcoin market.
Short and long term links are found, and Bitcoin is shown to exhibit the properties of both
standard financial assets but also speculative assets, which fuel further discussion on whether
Bitcoin should be classed as a currency, asset or an investment vehicle. Chu et al. (2015) give
the first statistical analysis of the exchange rate of Bitcoin. They fit fifteen of the most
common distributions used in finance to the log returns of the exchange rate of Bitcoin versus
the U.S. Dollar. Using data from 2011 to 2014 they show that the generalized hyperbolic
distribution gives the best fit.

Again, confidence remained, but more eyebrows were raised (Zhou, 2018). Then MMM East
Africa, MMM Zimbabwe’s parent organisation, froze all participants accounts and promised
to have them reopened in a month after the Mavros system was replenished. The freezing
allowed people to PH (deposit) but would not let anyone GH (withdraw) and this left a lot of
people confused, the end of the fairytale ride was truly coming.
Globally cryptocurrencies have got many advantages, (John, 2017). In traditional business
dealings, brokers, agents, and legal representatives can add significant complication and
expense to what should otherwise be a straightforward transaction. There’s paperwork,
brokerage fees, commissions, and any number of other special conditions which may apply.
One of the advantages of cryptocurrency transactions is that they are one-to-one affairs, taking
place on a peer-to-peer networking structure that makes “cutting out the middle man” a
standard practice. This leads to greater clarity in establishing audit trails, less confusion over

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who should pay what to whom, and greater accountability, in that the two parties involved in a
transaction each know who they are.
Mazikana (2017) describes the cryptocurrency blockchain as resembling a “large property
rights database,” which can on one level be used to execute and enforce two-party contracts
on commodities like automobiles or real estate. But the blockchain cryptocurrency ecosystem
may also be used to facilitate specialist modes of transfer. For example, cryptocurrency
contracts can be designed to add third party approvals, make reference to external facts, or be
completed at a specified date or time in the future. And since you as the cryptocurrency holder
have exclusive governance of your account, this minimizes the time and expense involved in
making asset transfers. Moreover cryptocurrency has another advantage that each transaction
one make is a unique exchange between two parties, the terms of which may be negotiated
and agreed in each case. What is more, is the exchange of information is done on a “push”
basis, whereby one can transmit exactly what you wish to send to the recipient and nothing
besides that.

Kinateder (2016) noted that the US government is a major player in the Bitcoin market. He
went on to say that the FBI actually holds a large amount of Bitcoin. It is said that there is a
downside to it, for example it makes it easier to facilitate settlements for illegal transactions
such as drugs, firearms and so on. But there is also a downside to Fiat currency. Meanwhile
in Zimbabwe bitcoins are peer-to-peer recognized not by a country or corporation like how
Zimbabwe back the U.S. Dollar and the Brits back the Pound. This can cause some problems.
For example, a web designer was just let off the hook in Miami for Bitcoin laundering on a
count of it not actually being a form of currency (Samuel, 2009).

1.2 STATEMENT OF THE PROBLEM

Investors in the peer to peer market for Bitcoin face several challenges related to liquidity, counterparty
risk, regulatory risk, security risk, and price volatility. These challenges can make it difficult for traders
to execute trades and manage their risk effectively. Bitcoin is a highly volatile asset, and its price can
fluctuate rapidly in response to market events and news. Traders in the P2P market may need to be
prepared for significant price movements, which can increase their exposure to market risk.

1.3 AIMS
the researcher want use black scholes model to investgate the risk free rate and volatility underlying on
trading bitcoin

OBJECTIVES
 Use a Black-Scholes model to analyse volatility of the cryptocurrencies and determine
their viability.
 use Black-Scholes model to estimate the fair value of Bitcoin options and other derivatives.
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  Fit suitable probability distribution on bitcoin to determine risk value and expected shortfall.
SIGNIFICANCE OF THE STUDY
Researcher can better understand its viability and identify opportunities for growth and innovation.
however , bitcoin it is also a highly volatile and risky asset, which can make it difficult for investors to
decide whether to invest in Bitcoin and how much to allocate to it. By studying the viability of Bitcoin,
investors can make more informed investment decisions and manage their risk exposure.

LIMITATIONS
One of the biggest limitations of Bitcoin is its scalability. The Bitcoin network can only
process a limited number of transactions per second, which can lead to long confirmation
times and high transaction fees during periods of high demand. This has led to the
development of alternative cryptocurrencies and scaling solutions such as the Lightning
Network. Bitcoin operates in a regulatory grey area, which can create uncertainty and lead to
legal and regulatory challenges. Governments around the world are still grappling with how to
regulate Bitcoin, which can create challenges for businesses that want to use Bitcoin or other
cryptocurrencies. Bitcoin mining requires significant amounts of energy, which can have
environmental and sustainability implications. The energy consumption required to mine
Bitcoin has been criticized as being wasteful and contributing to climate change. Bitcoin is a
highly volatile asset, which can be a challenge for investors and businesses that want to use it
as a store of value or medium of exchange. The price of Bitcoin can fluctuate rapidly in
response to market events and news, which can lead to significant losses for investors. Bitcoin
is a digital asset, which means it is vulnerable to cyber attacks and hacking. The security of
Bitcoin wallets and exchanges can be a challenge, and there have been several high-profile
hacks and thefts in the Bitcoin ecosystem.

CHAPTER TWO
LITERATURE REVIEW
2.0 INTRODUCTION
This section of the research study shall look at the finding by other researchers on
cryptocurrency and other related areas of study from different countries and places. This
chapter provides a detailed literature review in trying to provide solutions of the research
questions identified in the research paper. This involves a review of literature relating to
cryptocurrencies and bitcoins. This chapter shall also look into various theories and findings b
other authors on bitcoins being able to solve liquidity crunch faced by various nations and
factors that influence the adoption of bitcoin by banks

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2.1 Cryptocurrencies
According to Trautman (2014), cryptocurrencies are a subset of digital currencies, which may
either have centralized institutions or are based on a decentralized network (Trautman 2014).
Bryans (2014) is of the idea that, for a centralized currency scheme, the digital currency is
issued by one institution, which ensures that the digital coins can be exchanged back to fiat
currencies or can be used to buy and sell digital goods. One example for this centralized
digital currency is the Linden Dollar, issued by Linden Lab, which can be used in the online
virtual world Second Life. It shares some characteristics with fiat currencies. Like in the
traditional money system, a central institution serves as a source of trust.

However according to Karlstrom (2014), decentralized currency schemes try to avoid central
institutions as much as possible and are built on a network of transaction partners As long as
the transaction partners can observe each other, they can build up trust based on their
behaviors. If observation of the transaction partners is not possible, other mechanisms have to
be found to establish reliable transactions. One solution lies in cryptocurrencies, which are
decentralized currency schemes based on cryptography.

According to Bryans (2014) a cryptocurrency is a digital token produced by cryptographic

algorithms. This token is then transported across cyberspace using protocols such as peer-
topeer networking. Its value is mainly derived from the demand and supply for such tokens
and an important part of their appeal resides in the decentralization of the system of which
they exist. The general discourse on cryptocurrencies has led to varying levels of support for
the innovation, where some regulators have been very wary of it while the Financial
Technology community have argued about the inevitable widespread use of cryptocurrencies
(Bryans, 2014). The main benefits as cited by Harvey (2015) include the security features,
ease of use on mobile devices, relatively cheap costs of production and transmission via the
block chain transmission protocol and low long-term inflation risks. Global financial
corporations such as Citibank are developing their own cryptocurrency due to these perceived
benefits of utilizing the aforementioned protocols (Madore, 2015).

Harvey (2015) also noted that the main issues with the adoption of cryptocurrencies include an
early track record of illiquidity, high volatility and potentially nebulous uses. Harvey (2015)
went on to say most of the issues surrounding the successful adoption of cryptocurrencies is
marred in the confusion of whether they are digital or virtual currencies, and as such, how
their values are determined.

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There has been a proliferation of virtual currencies across the globe. These include Facebook
Credits, Microsoft Points and Amazon coins. Harvey (2015) mentioned that unlike Bitcoins,
as alluded to before, these currencies are issued by companies and are not linked to any claims
on real assets. If a large company like Facebook does launch a currency to compete with
traditional currencies, network effects could ensure that the currency is taken-up quite quickly
by members of the network. Furthermore, Wagner (2014) explained that the value and
distribution of virtual currencies are typically controlled by centralized authority, which is
usually the issuing corporation, and are used to solely facilitate online purchases.
Cryptocurrencies are closer in form to physical currencies due to their usage as a medium of
exchange for physical assets. Ironically Harvey (2015) posits that most of the modern world’s
money supply is in digital form and, as such, can be considered to be in the form of
cryptocurrencies.

Another area of compelling arguments has been the issue of whether cryptocurrencies should
be considered to be currencies or digital assets. Given the aforementioned definition, one
could expect to view the token as a currency but Glaser et al. (2014) further convey that users
of cryptocurrencies are not interested in an alternate transaction system but seek to participate
in an alternative investment vehicle.

Drawbaugh and Temple-West (2014) noted that the U.S. Inland Revenue Service sees
cryptocurrencies as a virtual currency and therefore it should be considered to be an asset.
Such property, under U.S. financial law, is largely subject to capital asset taxes. Other early
adopting jurisdictions, such as Norway, Sweden and Canada also recognize cryptocurrencies
as an asset. However, Germany which is also a very early adopter accepts that
cryptocurrencies are a unit of account to be used for trading and taxation within the country
but in the form of “private money” (Clinch, 2013). There has basically been no global
consensus how best to define cryptocurrencies as an asset or currency. These matters have
dealt within the parameters of every jurisdiction and their capabilities to regulate it.

Given the possibility of such a quick take-off, Gans and Halaburda (2013) investigate whether
there is a need for regulation and oversight of these cryptocurrencies. The authors argue that
most of these cryptocurrencies issued by companies are largely subsidies for buyers to
participate in the network or platform such as Amazon coins and Kindle. Such a system is also
cheaper for the company, as these currencies have to be spent on items on the platform such as
Amazon rather than some outside good or service. For cryptocurrencies not tied to a particular
platform for instance Bitcoin, Gans and Halaburda (2013) note that these currencies can

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impact on price stability, financial stability and payment stability. Therefore, there might be a
case for further regulation.

If there is a relatively low level of interaction between these virtual currencies and traditional
currencies, there might not be a need for any regulatory intervention. There are five potential
risks associated with virtual currencies that are of interest to central banks. These are price
stability, financial stability, payment system stability, lack of regulation and reputation (ECB,
2012). Virtual currencies could make the goal of price stability somewhat difficult if they
affect the central bank’s control of the money supply through open market operations. This
reduced control over the money supply can also impact on financial stability through the
central bank’s ability to intervene in the foreign exchange rate market. In addition, speculation
with respect to the virtual currency could occur due to the history of cyber-attacks and since
there is no lender of last resort for these currencies. The value of virtual currency union
depends largely on whether or not a second party is willing to accept the unit as a means of
final payment, hence there is no guarantee of payment (FCB, 2012). Moreover, since there is
no legal basis for virtual currencies, there is no clear definition of the rights and obligations of
each party.

ECB (2012) notes that while the virtual currencies may be subject to price, financial, payment
and lack of regulation risk, given that lack of interaction between virtual currencies and those
issued by central banks. The paper, however, notes that these currencies do pose some degree
of reputational risk for central banks, as most economic agents look to the central bank to
ensure the smooth functioning of the payment and financial system. Therefore, if a major
event does occur the general public might perceive that the central bank was not doing its job
effectively.

While ECB (2012) suggests that the implications for central bank policy at present might be
limited. Economic models’ technological innovations within the banking system suggests that
digital money can impact on the demand for money. Berensten (1998) notes that monetary
policy depends on a stable velocity of money. However, as digital money becomes a both
popular means of payment, it can impact on the income velocity of money and reduce the
monetary base and more significantly reduce the precision of the central bank’s control of
monetary liabilities.

Given that cryptocurrencies reduce the effectiveness of monetary policy at the country level,
Plassaras (2013) argues for greater international cooperation through the International

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Monetary Fund (IMF). The author notes that typically central banks hold reserves to counter
speculative attacks against the currency. They can also raise interest rates or intervene in the
currency market. If the central bank runs out of reserves, it can draw down on its quota’s at
the IMF. However, if wealthy Bitcoin investors launch a speculative attack on a currency
there is relatively little that can be done at present as neither the central bank nor the IMF hold
Bitcoin. Plassaras (2013) therefore argues that the Fund could either attempt to excise indirect
control of the currency or it could offer the digital currency quasi-membership status. Such
approaches will need to be further discussed as there are governance issues that would need to
be addressed. Given the growth of Bitcoin, there is a clear need to be prepared for potential
speculative attacks and incorporate this means of payment better into the financial system.

Crypto Currencies is a type of digital currency which relies on cryptography, usually

alongside a proof-of-work scheme, in order to create and manage the currency. A
decentralized network of peer-to-peer computer nodes working in sync creates and verifies
transactions of transfer of said currency within the network (Ahamad, Nair and Varghese,
2013). Crypto Currencies can be transferred instantly and securely between any two parties,
using the internet infrastructure and cryptographic security with no need for a trusted third
party. Its value is not backed by any single government or organization (Ametrano, 2014). A
cryptocurrency is a modern digital medium of exchange. It is a new decentralized, limited and
peer–to–peer payment system. Most cryptocurrencies are created to introduce new units of
currency, whose total amount is limited. All cryptocurrencies use cryptography to control the
creation and transfer of money. All cryptocurrencies use public key cryptography; a pair of
public and a private cryptographic key make Bitcoins safe (Wiatr, 2014).

Crypto technologies are technologies that are based on cryptography. Cryptography has a long
tradition in human history. However, modern mathematical cryptography has been developed
only over the last few decades. Public key cryptography, that will be mentioned below, was
introduced for the first time in 1976 and first attempts to create a cryptocurrency were made in
the beginning of 1980´s (Omohundro, 2014:19). Crypto-technology is a class of software
systems that use cryptography. Generally, these software systems can implement a system to
transfer virtual goods and at the same time they can implement complex agreements between
parties.

There are various kinds of virtual goods such as songs, online documents and pieces of
software. However, there are other kinds of virtual goods that might not be that obvious such
as ownership of almost anything, an approval, notarization or verification of almost anything

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or a unit of currency (Eckersley, 2004:87). Cryptocurrency and other digital money such as
bank deposits are typically files on computers that people consider having a certain value and
is seen as money. The nature of money consists of building trusts among the strangers who
use money to trade. One must be confident that others are willing to accept their money in the
future and that the money will keep a certain value so that it can be used for future trades
(Camera, 2017). Money has three functions. According to Asmundson and Oner (2012) these
functions are store of value that is saving, unit of account provide a common base for prices
and medium of exchange that is trade.

With traditional money people attach a certain value to a paper banknote and the government
and central banks make sure that the money remains valuable and that trust is remained. For
private e-currency there is not an authority that fulfils this task of maintaining stability and
thus it is one of the reasons that the value of private e-currencies is very volatile. Two
important distinctions that should be made are the differences between sovereign and non-
sovereign digital currency (Camera, 2017). With sovereign digital currency the digital form of
cash is meant, which can be for example commercial bank deposits at the central bank, but
also a Central Bank issued Digital Currency regime. Whereas no sovereign currency is private
currency, such as Bitcoin. For this research non-sovereign private e-currency is compared
with a sovereign version of e-currency, the Central Bank Issued Digital Currency regime.

2.2.1 Characteristics of cryptocurrencies

A cryptocurrency is a digital or virtual currency that uses cryptography for security. A
cryptocurrency is difficult to counterfeit because of this security feature. A defining feature of
a cryptocurrency and arguably its most endearing allure is its organic nature. It is not issued
by any central authority rendering it theoretically immune to government interference or
manipulation. It is designed from the ground up to take advantage of the internet and how it
works. Instead of relying on traditional financial institutions that verify and guarantee your
transactions, cryptocurrency transactions are verified by the user's computers logged into the
currency's network. Since the currency is protected and encrypted, it becomes impossible to
increase the money supply over a predefined algorithmic rate.

One cryptocurrency, in particular, has entered the public lexicon as the go-to digital asset:
Bitcoin, often is regarded as father of cryptocurrencies and all other cryptocurrencies are
referred as altcoins. Since 2009, the finance world has been watching the crackerjack rise of
Bitcoin with a combination of fascination and, in many cases severe scepticism.
Characteristics of Bitcoin make it fundamentally different from a fiat currency which is

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backed by the full faith and credit of its government. Fiat currency issuance is a highly
centralized activity supervised by a nation’s central bank. On the other hand, the value of a
Bitcoin is wholly dependent on what investors are willing to pay for it at a point in time. It
uses peer-to-peer blockchain network that is chronologically arranged chain of blocks where
each block has a list of transactions information where all members are equal.

2.2 Bitcoin
Bitcoin is a communication peer-to-peer protocol that enables a payment system and use of
virtual currency (Böhme, Edelman, Christin and Moore 2015). Bitcoin was introduced in 2008
by a group of anonymous developers or single developer named Satoshi Nakamoto
(Nakamoto 2008). Although the concept of cryptocurrencies was described and suggested
firstly in 1998, Bitcoin became the first "practical" proof of the theory (Kelly 2014).
Now that the terminology about cryptocurrencies is established, the most famous example of a
cryptocurrency, namely Bitcoin is used to explain how an e-currency works. Bitcoin was
introduced back in 2009 and since then the usage of Bitcoin has been growing rapidly. Bitcoin
had 6.56 million users in 2016 and 11.05 million one year later in 2017 (Weber, 2017).
Bitcoin works with a blockchain, a blockchain is a new technology that uses encryption. The
blockchain is a ledger that is updated constantly and maintained by computers. Thus,
eliminating the traditional role of a middleman, for example banks that are supervised by
authorities.

An important feature of the blockchain is that it is public and everyone can see it as it acts as a
public ledger, which is updated after every transaction. Everyone owns their own copy of the
ledger, although this might imply a lack of privacy, this is not entirely true as the transactions
and accounts in the blockchain are anonymized by recoding it, a technical computerized
process. The main advantage of the public ledger is that you do not have to trust a third party
or middle man anymore. Every transaction becomes a block which is then checked by others’
computer and approved, these verifiers are the so called miners (Dwyer, 2014).

After it is approved the transaction is added to the chain of blocks that is the blockchain and
goes through. Every transaction is public and if someone tries to corrupt it, the mathematics
behind it would flag it and prevent a consensus among all the ledgers and thus basically
preventing fraudulent transactions. So the middlemen, banks for example are partly replaced
by cryptographic verification (Swan, 2015). The existing blockchain technology used for
private e-currencies could also be the basis for a central-bank issued cryptocurrency. Bitcoin’s
main function seems to be as a means of payment, transaction costs for Bitcoins are kept very

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low, making it easy and affordable to transfer sums of money with fast speeds all over the
world (Sauer, 2016). Transactions are executed almost instantly and anytime. (Bitcoin,
2017). However, Bitcoin is still considered as a complement and not a substitute for
traditional currency (Sauer, 2016). Nowadays Bitcoins are mainly used for speculative
purposes rather than a mean of payment, resulting in a lot a volatility that is much higher than
similar derivatives, such as currency exchange rates, as shown below in Figure 2.1. The
Figure shows the volatility of Bitcoin (blue line) compared to the volatility of the USD/GBP
exchange rate (red line). This volatility results in uncertainty about Bitcoin value, making it a
risky investment and even riskier as a substitute for traditional currency (Hay, 2017).

Figure 2.1: Comparing Bitcoin volatility with GBP volatility.

Source: Hay (2017:113)
The supply side of bitcoins is based on the blockchain network that creates and transfers the
bitcoins among its users, without an authority controlling it. Supply of Bitcoins is limited to
21 million. When this amount is reached no new Bitcoins can be issued. Issuance of Bitcoins
takes place when transactions are verified by the so called “miners” (Dwyer, 2014). When the
maximum supply is reached the only way to acquire Bitcoins would be by trading.

The Bitcoin supply was rapidly issued in the first years after introduction, reaching 10.5
million (50% of all available Bitcoins) already in 2013, merely 4 years after its introduction.
What happens when this 21 million is reached, and money supply will be fixed at this 21
million, is unclear. On the Bitcoin (2017) websites they state: “The number of new Bitcoins

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created each year is automatically halved over time until bitcoin issuance halts completely
with a total of 21 million bitcoins in existence. At this point, Bitcoin miners will probably be
supported exclusively by numerous small transaction fees”. This suggests that Bitcoin trading
and verifications can still take place because “miners” will verify transactions in exchange for
transaction fees. Although there is no underlying theory supporting this and a back-up plan if
this does not happen.

The popularity of Bitcoin mainly results from the anonymity it provides and the fast and cheap
way of transferring all over the world. Bitcoin is sometimes associated with criminal
activities, for example with ransomware hacks where the hackers ask for payments in bitcoins
(Thomson Reuters, 2013). On the other hand, bitcoins are sometimes stolen by hackers as
well. When bitcoins are stolen this is done by acquiring the password of a Bitcoin
accountholder and transferring the funds to another account via untraceable ways. To some
extend contradicting Sauer (2016) and despite some of the risks associated with Bitcoin,

2.3 Theoretical framework

2.3.1 Mises Regression Theorem
One of the most confusing aspects of bitcoin is how they get their value. Bitcoin has been
cited as violating Ludwig Von Mises's regression theorem (LeRoux, 2014). The regression
theorem demonstrates that all money, rather the money is commodity money like gold or
government backed fiat currency, must ultimately derive its purchasing power from a
historical tie to a commodity that was valued in a state of barter. Jeffrey Tucker (2014) goes
into great detail with his article titled, ‘What Gave Bitcoin Its Value’ published by the
Foundation for Economic Education and mentioned that the theory of the value of money as
such can trace back the objective exchange value of money only to that point where it ceases
to be the value of money and becomes merely the value of a commodity.

In this way one can continually go further and further back one must eventually arrive at a
point where he can longer find any component in the objective exchange value of money that
arises from valuations based on the function of money as a common medium of exchange;
where the value of money is nothing other than the value of an object that is useful in some
other way than as money. Before it was usual to acquire goods in the market, not for personal
consumption, but simply in order to exchange them again for the goods that one really
wanted, each individual commodity was only accredited with that value given by the
subjective valuations based on its direct utility. Bitcoin's value is subtle, but substantial. It's
redeemability and the fact that it is a meta-currency that is inflation proof is what gives bitcoin
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value (Patterson, 201 4). To better put this into context, imagine the phenomenon that
occurred to gold with paper. How much more convenient, portable, divisible, easier to handle,
and easier to count, paper was compared to gold and why the market made people desire to
have paper currency instead of gold coins or bars anymore. According to Graf (2013) the
regression theorem is a temporal-sequential explanation of the initial emergence of indirect
exchange value”. The regression theorem was propounded by Mises (1953) as a praxeological
statement that ties together with a comprehensive theory of the origination, formation and
development of modern-day money. Prior to the theorem, Murphy (2013) in support with
economist explained the valuation of money through marginal utility analysis and the quantity
theory, creating a circularity in which the exchange value of money was explained by its
marginal utility, derived from its own purchasing power.

According to Murphy (2013) Mises solved this circularity through the regression theorem by
building upon works of Bohm-Bawerk and Menger before him with emphasis on the
subjectivist approach to valuations. Mises acknowledged that the value of money is the result
of the marginal utility of goods for which it can be exchanged; its expected purchasing power.
Following this Mises identifies that people expect future purchasing power based upon current
and previous observed purchasing powers. In his own words Mises noted that, “Objective
exchange value today is derived from yesterdays under the influence of subjective valuations
of individuals frequenting the market” (Mises, 1953 p.121). The mises regression theorem
shows that it is possible to regress to a point in time where the objective exchange value of
money has no component based upon its function as a medium of exchange, but that its value
at this time is only based on its use in some other form that is for consumption or production.

It is at this point in time where people first emerged from a state of barter. Mises states that
this is an observable “phenomenon of economic history” and not merely an abstraction. The
mises theorem ties together at this moment in history with Menger’s origin of money
(Murphy, 2013). Menger argues that money formed organically, similar to language, as the
natural result of traders overcoming inefficiencies in a barter economy; inefficiencies
stemming from the difficulty satisfying the double co-incidence of wants. Traders would trade
indirectly for other goods, even if they gain no use value for the goods received, so long as the
acquired goods had a higher ‘marketability’ than the goods they forfeit. This process would
continue until there would be an “Inevitable tendency for the less marketable of the series of
goods used as media of exchange to be one by one rejected until at last only a single
commodity remained, which was universally employed as a medium of exchange” (Mises,

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1953 p.32). It attributes the prevailing of gold and silver as early media of exchange to their
divisibility, identifiably and durability, all of which contributed to their high marketability.

Krugman (2013) has criticized Bitcoin for being an unreliable store of value. Thus Krugman
(2013) denied the validity of bitcoin as money, although he concedes that bitcoin is likely a
successful medium of exchange. As many scholars denotes that bitcoin can be at least a
secondary medium of exchange it could be inferred that the mises regression theorem is either
wrong, or misunderstood (Zhou, 2017).

Zhou (2017) noted that a new adaptation of the regression theorem is needed to encompass the
technical, unforeseen nature of bitcoin. Zhou (2017) mentioned that, for the theorem to work,
a medium of exchange must already have the attributes necessary for a medium of exchange,
having a price and be accepted on the market. Both price and liquidity that is being accepted
on a market are elements of the market. If the prospective medium of exchange possesses
these elements then it points toward a demand for it a demand that must exist before it
becomes a medium of exchange that is then by definition a non-monetary demand. A medium
of exchange might eventually cease to have non-monetary demand but continues to be
sustainable. Even though Mises sees non-monetary demand as being necessary for the
emergence of price and marketability, he still states that money only provides utility for
obtaining other goods and services in exchange for it (Mises, 1953, p. 101).

This essentially means that even though non-monetary demand is necessary for the emergence
of money, it is not necessary to sustain it. Rothbard (2014) further clarifies what Mises stated
by saying that it is not necessary that the direct use of the money as a commodity continues, as
long as the money has been established. Rothbard (2014) stated this by writing that even if
gold were to lose its value as an aesthetically pleasing, easily controllable metal that doubles
as a fantastic conductor, it would not necessarily mean that gold would lose its value as
money. Rothbard (2014) however uses the premise that all monies must necessarily originate
as commodity with direct uses, a claim that is difficult to accept.

2.3.2 Garch model

The cryptocurrency market has seen an unprecedented level of interest from investors in 2016.
Bitcoin, the world's largest digital currency, has risen more than 1,500 percent since the start
of 2017. However, the market is significantly more complex than the public lexicon might
suggest. While there have been plenty of studies examining the future of Bitcoin and its
volatility, according to Polasik et al. (2015), there have been few that explore the broader
cryptocurrency market and how it is evolving. Bitcoin is currently trading at around $16,000;
14
at the beginning of the year 2016, Bitcoin price was at $1,000 in 2017, raising warnings from
some analysts and prominent financial figures that it’s a bubble. The currency is
extraordinarily volatile despite its recent ever-peaking performance, rising by thousands of
dollars in value on one day only to fall by even more the next day.

Katsiampa (2017) estimates the volatility of Bitcoin through a comparison of GARCH models
and finds that the AR-CGARCH model gives the most optimal fit. He underlines that the
market is high speculative. Bouoiyour and Selmi (2016) study daily Bitcoin prices using an
optimal-GARCH model and show that the volatility has decreasing trend comparing pre- and
post-2015 data. Even tough, they still observe significant asymmetries in the Bitcoin market
where the prices are driven more by negative than positive shocks. Likewise, Dyhrberg (2016)
investigates the asymmetric GARCH methodology to explore the hedging capabilities of
Bitcoin and he finds that it can be used as a hedging tool against stocks in the Financial Times
Stock Exchange Index and against the American dollar in the short term.

On the other hand, El Bahrawy and Alessandretti (2017) examine behaviour of entire market
of 1469 cryptocurrencies between April 2013 and May 2017. They find that cryptocurrencies
appear and disappear continuously and their market capitalization is increasing exponentially
while several statistical properties of the market have been stable for years. Particularly,
market share distribution and the turnover of crytocurrencies have remained quite stable.
There is a wide agreement on that the cryptocurrencies will not only affect the trading
practices of different countries and business organizations, but they will also affect the
dynamics of international relations.

There are still a lot of people who are never accommodating the idea that cryptocurrencies
will revolutionize how we do businesses. They cannot figure out how the whole blockchain
technology and other annexes work. Furthermore, advancements in technology are
introducing digital tools that companies can use to better interact with their customers. A
rising shift from traditional platforms to digital platforms has also brought about an abundant
supply in data from sources like social media, mobile devices, online retail platforms and so
on. Due to technology advancements in the areas of gathering, storing, and sharing data, large
sets of data are easily shared among companies in every sector and country for little to no
costs. The widespread accessibility of data has also brought about concerns over data privacy
of individuals and their online transactions. Transactions carried out online leave digital trails,
as a result, individuals are opting for more anonymous ways to use the internet and conduct

15
online transactions. The Bitcoin cryptocurrency was introduced to address the issue of privacy
concern.

2.4 Key features and uses of cryptocurrencies

According to Bryan (2015) money denominated in a particular currency includes money in a
physical format with legal tender status and different types of electronic representations of
money, such as central bank money or commercial bank money. Bryan (2015) defined
electronic money, as terms used in payments and settlement systems as value stored
electronically in a device such as a chip card or a hard drive in a personal computer, also
commonly used around the world.

Some jurisdictions have developed specific legislation regulating e-money such as the
EMoney Directive in the European Union (Bryan, 2014). E-money balances according to the
legislation applicable in a particular jurisdiction that is e-money in a narrow sense are usually
denominated in the same currency as central bank or commercial bank money, and can easily
be exchanged at par value for them or redeemed in cash. Since the mid-year of 1990, the
CPMI (2010) has studied the development of e-money and the various policy issues
associated with it. These categories include cash, central or commercial bank money, and e-
money in a narrow
sense are traditionally perceived as “money” in a specific currency, giving rise to a currency’s
single.
Bryman (2014) noted that the definitions of e-money have widened the concept to include a
variety of retail payment mechanisms, possibly extending to digital currency schemes. While
cryptocurrencies may meet the broad conceptual definition of e-money, in most jurisdictions
they typically do not satisfy the legal definition of e-money (Bryman, 2014). For example, in
many jurisdictions, the value stored and transferred must be denominated in a sovereign
currency to be considered e-money; however, in many cases cryptocurrencies are not
denominated in or even tied to a sovereign currency, but rather are denominated in their own
units of value. In the case of the European Union, the legal definition of e-money includes the
requirement that the balances issued should be a claim on the issuer, issued on receipt of
funds. Given this, units of cryptocurrencies in some schemes will not be considered e-money
in a legal sense as they are not issued in exchange for funds even though they can be
subsequently bought and sold, and may not be issued by any individual or institution
(Bryman, 2014).

16
Hundreds of digital currency schemes based on distributed ledgers currently exist, are in
development or have been introduced and have subsequently disappeared (Meiklejon et al,
2016). These schemes share several key features, which distinguish them from traditional
emoney schemes. First, in most cases, these cryptocurrencies are assets with their value
determined by supply and demand, similar in concept to commodities such as gold (Meiklejon
et al, 2016). However, in contrast to commodities, they have zero intrinsic value. Unlike
traditional e-money, they are not a liability of any individual or institution, nor are they
backed by any authority. As a result, their value relies only on the belief that they might be
exchanged for other goods or services, or a certain amount of sovereign currency at a later
point in time. The establishment or creation of new units that is the management of the total
supply, is typically determined by a computer protocol. In those cases, no single entity has the
discretion to manage the supply of units.

2.5 How cryptocurrencies work

According to Meiklejon et al (2016) bitcoin is a purely online virtual currency, unbacked by
either physical commodities or sovereign obligation; instead, it relies on a combination of
cryptographic protection and a peer-to peer protocol for witnessing settlements. Consequently,
Bitcoin has the unintuitive property that while the ownership of money is implicitly
anonymous, its flow is globally visible. Bitcoin initially was introduced by the
(pseudonymous) Satoshi Nakamoto in 2008. From that time it has experienced a huge boom
and generated millions of profit to those engaged in this business. Meiklejon et al (2016: 87)
explain that as follows: Briefly, a bitcoin can be thought of as a chain of transactions from one
owner to the next, where owners are identified by a public key from here on out, an address
that serves as a pseudonym; that is, users can use any number of addresses and their activity
using one set of addresses is not inherently tied to their activity using another set, or to their
real-world identity.

Meiklejon et al (2016) went on to say in each transaction, the previous owner signs using the
secret signing key corresponding to his address a hash of the transaction in which he received
the bitcoins and the address of the next owner. Meiklejon et al (2016) noted that transactions
can have many input and output addresses. This signature that is transaction can then be added
to the set of transactions that constitutes the bitcoin because each of these transactions
references the previous transaction that is in sending bitcoins, the current owner must specify
where they came from, the transactions form a chain. To verify the validity of a bitcoin, a user
can check the validity of each of the signatures in this chain. To prevent double spending, it is
necessary for each user in the system to be aware of all such transactions.

17
Double spending can then be identified when a user attempts to transfer a bitcoin after he has
already done so (Meiklejon et al, 2016). To determine which transaction came first,
transactions are grouped into blocks, which serve to timestamp the transactions they contain
and vouch for their validity. Blocks are themselves formed into a chain, with each block
referencing the previous one and thus further reinforcing the validity of all previous
transactions. This process yields a block chain, which is then publicly available to every user
within the system. This process describes how to transfer bitcoins and broadcast transactions
to all users of the system. Bitcoin is decentralized and there are no central authority minting
bitcoins, we must also consider how bitcoins are generated in the first place. In fact, this
happens in the process of forming a block: each accepted block that is each block incorporated
into the block chain is required to be such that, when all the data inside the block is hashed,
the hash begins with a certain number of zeroes.

2.6 Advantages of cryptocurrencies in banks

There are different and confronting opinions regarding the future of cryptocurrencies in
general and bitcoins in particular (Bryman, 2014). Whilst, those with libertarian views of life
are optimistic and embrace the cryptocurrency system, other authors, economists, and scholars
from this field are not enthusiastic about the use of cryptocurency in the system of payments
and financial transactions. Ivaschenko, (2016) noted that the optimistic view of
cryptocurrencies use is backed by the fact that they make it easier to transfer funds between
two parties in a transaction; these transactions are facilitated through the use of public and
private keys for security purposes.

These fund transfers are done with minimal processing fees, allowing users to avoid the steep
fees charged by most banks. In addition, many countries have started to accept bitcoin as a
valid currency. Especially, countries that aim to get rid of cash have a very friendly approach
to cryptocurrencies. An argument that promoters of bitcoin use is Market Capitalization of
bitcoin, ethereum and other cryptocurrencies, claiming that cryptocurrency market has
become very large and powerful so banning it would be costly for any country (Bryman,
2014). On the other side the opponents of cryptocurrencies claim that cryptocurrencies are
very volatile, can be used for money laundry or financing illegal activities. In this regard,
Tymoigne (2015) for example, is not enthusiastic over cryptocurrency use, providing reasons
why he believes bitcoins are not a viable electronic currency. He notes that bitcoins are
illiquid and have shown high price volatility, and that the discounted cash value of a bitcoin is
zero. He further observes the currency lacks a central issuer, and that there is no financial or

18
economic basis for its creation. Ivaschenko (2016) provides the advantages and disadvantages
of bitcoin as stated below.

2.6.1 Anonymous and Private

Chokun (2014) noted that cryptocurrencies in specific bitcoin transactions are completely
anonymous and private. Chokun (2014) went on to say that, unlike in payments through bank,
where the transactions can be tracked and identified, bitcoin transactions cannot be identified.
According to Chokun (2014) a person can only know the addresses of the bitcoin wallet on
which the payment has been sent and received. Chokun (2014) mentioned that; but to whom
these addresses belong to, cannot be identified. It is like payment to a particular bank account
can be tracked but to whom these accounts belong cannot be known but if a person uses same
bitcoin address for every transaction for a long period of time, there is a possibility that the
person can be tracked.

2.6.2 Cryptocurrencies are fast

According to Blatchford (2015) bitcoin transactions are very fast if compared to banking
channels. Blatchford (2015) went on to say that a bitcoin transaction is as fast an e-mail and
can be processed within 10 minutes. This was supported by Christin (2012) who went on to
say that bitcoins can be instantly processed if they are “zero-confirmation” transactions,
meaning that the merchant takes on the risk of accepting a transaction that has not yet been
confirmed by the bitcoin blockchain. According to Condeisk (2015) the confirmed
transactions are those which takes at least 10 minutes to process. Feuer (2015) noted that
Credit Card or digital wallet services also provides instant approved transactions services but
for this they usually charge a hefty fee, which is not in the case of Bitcoin. Bitcoin has very
low transaction fees even for being super-fast in terms of processing.
2.6.3 Non-Inflationary
Grimbergen (2011) asserts that the reason why bitcoin is called the future of money is because
they are non-inflationary. Marian (2013) noted that the central government can get fiat
currencies printed as much as they want. Marian (2013) went on to say that when the economy
is slowing down it is not able to pay off its national debt, the government orders to print more
currency and inject it into the economy. Woodford (2005) noted that this causes the value of
currency to decrease as more people have more currency. Also printing more notes creates
inflation and increases the prices of commodity. It is because now more people are willing to
pay for a particular commodity and the seller has to increase the price in order to make the
sale. Thus, the person who had gained when government injected more currency can now buy

19
more but those people who were not benefitted from have limited currency and now the prices
of commodity has also increased.

On the other hand, this is not the case in Bitcoins. According to Woodford (2005) only 21
million bitcoins will ever be created and this is known to everyone. This means that after all
the Bitcoins have matured, a greater number of bitcoins cannot grow and thus inflation will
not be a problem. Marian (2013) noted that in the year of 2013 almost 1.7 Million Bitcoins
has been generated and the remaining will be generated over a period of time. Marian (2013)
went on to say that bitcoins are generated through a process called “Mining”.

2.7 Disadvantages of cryptocurrencies in banks

2.7.1 Lack of recourse
According to Khan (2014) if one loses his bitcoin wallet, he has lost all of his bitcoins in that
wallet. Khan (2014) noted that he cannot regain it and they are simply lost forever until and
unless he has backed up the wallet with a backup phrase code. This backup phrase code can be
used to recover the lost bitcoin wallet balance. According to Khan (2014) in a case where a
credit card or debit card stolen, only a call can be processed where one call the merchant to
cancel the card and request for a new one but in case of bitcoins, as it is decentralized and no
one has control over it, we do not have any person or organisation to call.

2.7.2 Deflationary
Hildi (2013) discussed on how bitcoin being non-inflationary can be an advantage to the
economy. But there is one possible negative factor attached to bitcoin because of being
deflationary is that if it gets in the hands of speculator a huge recession will come in bitcoins.
Acording to Hildi (2013) bitcoins are limited in number and if the major chunk is held by
speculators and investors, they will hold it for a longer period of time and will not release it in
the market. When the supply of bitcoin will be short and demand continues to increase, it will
increase the price of Bitcoins and then the speculating investors may get benefited.

2.8 Factors influencing the development and adoption of bitcoin by banks

Ivaschenko, (2016) noted that cryptocurrencies based on the use of a distributed ledger
represent a genuinely new development in the payments landscape. According to Ivaschenko,
(2016) many of the factors that have spurred the development of cryptocurrencies have also
stimulated innovation in more traditional payment methods. Reduced cost and increased
speed, including in the areas of e-commerce and cross-border transactions are some of the
factors underpinning both digital currency development and broader payment system
innovation. In particular, it is worth highlighting the role of technology in driving the
development of cryptocurrencies and other innovations. Ivaschenko, (2016) identified
20
technological advances as a key enabling factor for changes in payment services, with an
impact on both the demand for and supply of these services. However, a range of factors also
exist that are more idiosyncratic to cryptocurrencies based on distributed ledgers, particularly
related to their decentralised attributes.

2.8.1 Supply side factors

On the supply side, the development of cryptocurrencies based on the use of a distributed
ledger has been mostly driven by private sector non-banks. Ivaschenko, (2016) mentioned that
for the most part, banks have tended not to engage directly with digital currency
intermediaries indeed, some have sought to avoid interaction as a result of perceptions of risk
and uncertainty over legal or compliance issues. Only relatively recently have there been
reports that private banks are exploring potential business opportunities arising from
cryptocurrencies and distributed ledgers for example, by investing in companies that
specialize in providing digital currency services, offering their customers interfaces to digital
currency exchanges or exploring the use of decentralised ledgers for back office applications.

When considering whether to implement such digital currency-linked services, banks, or any
other participant involved, may need to assess whether such implementation might pose
security challenges. The drivers that have led these entities to develop digital currency
schemes are also diverse, and underlie many of the differences in design between various
initiatives.
One distinction relates to commercial versus not-for-profit motives. Where commercial
motives are the main driver, the entity might be seeking to earn profits from digital currency
schemes in a number of different ways.

21
Figure 2.2. Factors that Influence Cryptocurrency Prices
Source: Bramford (2014)

Poyser (2017) points three types of crypto price drivers organized into internal and external
factors. Supply and demand of cryptocurrency is main internal factors that have direct impact
on its market price. On the other hand, attractiveness such as popularity, legalization which is
adoption and few macro-finance factors that is interest rate, stock markets, gold prices can be
regarded as external drivers as shown in figure 2.2 above.

2.9 Empirical studies

This section dwells much on studies that have been conducted by other researchers in the area
of cryptocurrencies. The studies which are looked upon at will assist in creating a better
understanding on cryptocurrencies and bitcoins. The studies will be categorised into global,
African and the local perspective.
2.9.1 Global perspective
Malaysia
Cryptocurrency as an alternative currency in Malaysia: Issues and challenges (Sheila
Ainon Yussof and Abdullah Al-Harthy, 2016)
Yussof and Al-Harthy (2016) conducted a research on Cryptocurrency as an alternative
currency in Malaysia. Yussof and Al-Harthy (2016) noted that one of the most debated
innovations is cryptocurrency which uses blockchain technology to make a direct electronic
payment between two people possible. Cryptocurrency payments do not go through a third

22
party like a bank. This saves costs. Yussof and Al-Harthy (2016) noted that this future money
is pressurising central banks in Malaysia to manage the looming threat of redundancy as it
overshadows “fiat currency” in a world of infinite fintech possibilities.

Yussof and Al-Harthy (2016) concentrated much on bitcoin. They noted that this digital
currency is not produced by minting money in an unlimited supply, but through a virtual
“mining” process designed to control the supply of “money” and make it more valuable.
Yussof and Al-Harthy (2016) went on to say that the increasing pace in financial innovation is
pushing regulators to make a change in the way they define money and what money can be.
Yussof and Al-Harthy (2016) mentioned that traditionally money is used to serve as a medium
of exchange, legal tender for repayment of debt, standard of value, unit of accounting measure
and a means to save or store purchasing power. Bitcoin may not fulfill all the functions of
money but its scarcity value, anonymity or pseudonymity, transparency, and autonomy from
the government, make it attractive to users who are speculators, traders, merchants, consumers
and netizens disenchanted with fiat money.

Yussof and Al-Harthy (2016) mentioned that despite the alluring features of Bitcoin, it is not
spared from potential abuses such as webcrimes, tax evasion, fraud, online black markets,
money laundering and terrorism financing. In their study Yussof and Al-Harthy (2016) made
a forensic examination of Bitcoin’s benefits and risks will help regulators decide whether to
adopt cryptocurrency and provide an appropriate framework to regulate it based on another
jurisdictions’ approach. Yussof and Al-Harthy (2016) went on to recommend that Malaysia
should fully embrace cryptocurrency due to global trends - the Islamic Development Bank is
developing Shariah compliant contracts using blockchain technology; China is leading the
drive to develop its own national cryptocurrency to complement fiat money; and a
Shariahcompliant cryptocurrency has already entered the market backed by gold (Onegram).
Financial and regulatory architectures in Malaysia should accommodate these changes to
remain relevant.

2.9.2 African perspective

South Africa
Regulating crypto-currencies in South Africa: The need for an effective legal framework
to mitigate the associated risks (Karabo Mothokoa, 2017)
The main aims of the study were to understand the concept of crypto-currencies, their
relevance in the financial sector and the risks associated with these virtual currencies. The
other objective was to establish whether there is a compelling need for regulatory intervention
as far as the operation of crypto-currency is concerned. To conduct this study, Mothokoa
23
(2017) used a desktop-research methodology. The nature of the research was analytical,
explorative and comparative. Complex concepts of crypto-currency were analysed and
explored. Mothokoa (2017) then used the comparative method to contrast the legal and
regulatory frameworks of Canada, the US and the EU with the legal position of
cryptocurrencies in South Africa.

The study illustrated that crypto-currencies are decentralised convertible virtual currencies that
are based on cryptographic algorithms. Crypto-currencies are not monitored by a central
authority. It was also found that there are risks that emerge from using crypto-currencies,
some risks were found to be current and other risks could be detrimental owing to the wide
adopting of crypto-currencies. Some of these risks were found to be money laundering,
financial stability and consumer protection caused by factors such as high volatility.
Regarding regulation of these currencies, it was established that Canada, US and EU have
started to formulate legal frameworks to mitigate some of the mentioned risks. It was found
that there is no legal framework that regulates crypto-currencies in South Africa, however the
SARB and National Treasury released position papers that cautions consumers about the risks
of these currencies. It was therefore concluded that there is a compelling need for regulatory
intervention in South Africa. Based on this need, the author made recommendations such as
integrating cryptocurrencies into relevant legislation i.e. Consumer Protection Act 68 of 2008.
Intervention should be succeeded by regulations

CHAPTER THREE

3.1 INTRODUCTION
This chapter illustrates a step by step process of solving the problem taking into account how the
objectives of study are going to be addressed. It will also highlight the data used and where it was
collected from and which software are to be used for data analysis. The first methodology to be used is
technical analysis.
3.2 Data analysis software

24
R is widely used in statistical computation. It is well-suited to do computationally heavy
financial analysis. R provides a wide variety of statistical and graphical techniques, and is
highly extensible. R Packages is also easy to learn and have all dependencies being installed
automatically. The graphical capabilities of Rare outstanding, providing a fully programmable
graphics language that surpasses most other statistical and graphical packages. Because R is
open source, unlike closed source software, it has been reviewed by many internationally
renowned statisticians and computational scientists ( Vaiz Ramaswami, 2016). The brief
details of technical indicators to be used in the study are as follows. In particular, evaluating
performance of trading rule based on technical indicators (Yu, 2016). Data on bitcoin, litecoin
and dash was downloaded from yahoofinance using R studio
3.3 TECHNICAL ANALYSIS
Technical analysis is a type of financial analysis that uses past market data, primarily price
and volume, to identify patterns and make predictions about future market behavior. It
involves analyzing statistical trends gathered from trading activity , such as price movement
and volume . Fast and flexible technical analysis is done with quandmod and TTR packages in
R (Yu, 2016). Performance of all technical indicators against data set is depicted in 2-D
plotThere are many different methods used in technical analysis, but some of the most
common ones include.
3.3.1Trend analysis:
This involves identifying the direction of the market trend based on historical price data.
Trends can be uptrends, downtrends, or sideways trends. . If the trend is up, you may want to
consider buying, while if the trend is down, you may want to consider selling.
Support and resistance levels are price levels that have historically acted as barriers to further
price movements. Support levels are price levels where buying pressure is strong enough to
prevent further price declines, while resistance levels are price levels where selling pressure is
strong enough to prevent further price increases. Once you have identified the trend, you can
use support and resistance levels to identify potential entry and exit points. When the price is
approaching a support level, you may want to consider buying, while when the price is
approaching a resistance level, you may want to consider selling.

3.3.2 Moving averages:

These are mathematical averages of past prices that are used to smooth out short-term
fluctuations and identify long-term trends. Moving Averages are very popular indicators of
technical analysis (Larsen, 2007). These measures are used to eliminate noise and identify
trends by smoothing the data. It is broadly used because of its simplicity and possibility to
25
combine several moving averages together. There are different types of moving averages -
Simple moving average, Exponential moving average, Weighted moving average, Double
Exponential Moving Average and Volume Adjusted Moving Average (Vaiz Ramaswami,
2016). However, this study will look into small moving [Link] moving averages
include the simple moving average (SMA) and the exponential moving average (EMA).

3.3.3 Relative strength index (RSI)

This is a momentum indicator that measures the strength of price movements. The Relative
Strength Index (RSI) was developed by J. Welles Wilder and it calculates a ratio of the recent
upward price movements to the absolute price movement. If the price is making new
highs/lows, and the RSI is not, it indicates a reversal(Vaiz Ramaswami, 2016). The RSI
compares the average gains and losses over a certain time period and provides a numerical
value between 0 and 100. RSI can provide insight into the strength of price movements. If the
RSI is above 70, it may indicate that the market is overbought and due for a correction, while
if the RSI is below 30, it may indicate that the market is oversold and due for a rebound.

3.3.4 Bollinger Bands

These are a type of technical indicator that uses a moving average and two standard deviations
to create upper and lower bands around the price. The bands can be used to identify periods of
high or low volatility. Bollinger Bands identify potential entry and exit points. Bollinger
Bands were developed by John Bollinger. Bollinger Bands consist of three lines Bollinger
Bands were developed by John Bollinger.
MidBand = SimpleMovingAverageTP
upperBand = MidBand + PriceastTP
LowerBand = MidBand + Priceast(TP)
The middle band is a simple moving average (generally 20 periods) of the typical price (TP).
The upper and lower bands are F standard deviations (generally 2) above and below the
middle band. The bands widen and narrow when the volatility of the price is higher or lower
respectively. Bollinger Bands do not generate buy or sell signals; they are an indicator of
overbought or oversold conditions. When the price is near the upper or lower band it indicates
there may be trend reversal. The middle band becomes a support or resistance level. The upper
26
and lower bands can also be interpreted as price targets. When the price bounces off of the
lower band and crosses the middle band, then the upper band becomes the price target(Vaiz
Ramaswami, 2016). For example, if the price is approaching the lower Bollinger Band, it may
indicate that the market is oversold and due for a rebound.

3.3.5 Moving Average Convergence/Divergence (MACD) Indicator

MACD was proposed by Gerald Appel. MACD is a momentum oscillator that indicates the
dynamics and strength of the current trend and oscillates around the zero line in both
directions. MACD consists of three moving averages. Their normal settings are 9, 12 and 26
( V, 2015).Zero Line Crossover - The strategy is to buy when the MACD crosses above the
zero line, and sell when the MACD line crosses below the zero line. Signal Line Crossover –
The strategy is to buy when the MACD line crosses above the signal line else sell.
MACD line = 12 day EMA−26 day EMA Signal line = 9 day EMA of MACD line Where
EMA
= Exponential Moving Average
3.3.6 Candlestick charts
These are a type of chart that displays price data using candlestick-shaped markers. The
diagram below shows each candlestick represents a specific time period and shows the
opening, closing, high, and low prices for that period.

Candlestick charts are often used to identify patterns and trends in price movement. If the
opening price is above the closing price then a filled (normally red or black) candlestick is
drawn. If the closing price is above the opening price, then normally a green or hollow
candlestick (white with black outline) is shown. The filled or hollow portion of the candle is
known as the body or real body, and can be long, normal, or short depending on its proportion
to the lines above or below it. The lines above and below, known as shadows, tails, or wicks,
27
 represent the high and low price ranges within a specified time period. However, not all
candlesticks have shadows.

3.4 Key technical analysis terms

 Bullish market- is the condition of a market in which prices of cryptocurrencies

are rising or are expected to rise.
 Bearish market- is the condition of a market in which prices of cryptocurrencies
are
falling or are expected to fall.
 Bear- is an investor who believes that a particular cryptocurrency or market is
headed downward and attempts to profit from a decline in cryptocurrency prices.
Bears are typically pessimistic about the state of a given market.
 Bear- is an investor who believes that a particular cryptocurrency or market is
headed downward and attempts to profit from a decline in cryptocurrency prices.
Bears are typically pessimistic about the state of a given market.
 Uptrend market- Describes the change in the price of a cryptocurrency when the
overall direction is up.
 Downtrend market- this is a market comprised of a decrease in price of
cryptocurrencies characterized by lower lows and higher lows.
 Trend reversal- this is when the price of a cryptocurrency changes and moves
back the other opposite direction for instance an uptrend becomes a downtrend
and a downtrend becomes an uptrend.
 Volatile market- Wide price fluctuations and heavy trading typically characterize
volatile markets. They also result from a one-way trade unbalance (e.g., all
purchases and no sales).
 SMA– small moving average lines are comprised of the blue line representing 20
day moving average, green line representing 50 day moving average and 200
day represented by the red line.
 MACD- is depicted below the chart whereby the green bars represent the sale of
the cryptocurrency by the bulls indicating a bull a market in that particular time
period whereas the red bars are the cryptocurrency being bought by the bears
indicating a bearish market.
 Bollinger bands- depicted on the chart as grey bands overlapping on the candles.

CHAPTER FOUR
DATA ANALYSIS
4.1 INTRODUCTION

28
This chapter illustrates the implementation of the methodology described in the last
chapter as a means of achieving the aims and objectives discussed in chapter 1. Data
analysis begins with technical analysis results from 2017 to 2018 -01-01 of bitcoin so
as to investigate historical price movement of the cryptocurrencies in the market and
assess their performance in terms of risk, profitability and investment. Technical
analysis was carried out from 2017-01-01 to 23 -01-01

4.2 TECHNICAL ANALYSIS RESULTS

4.2.1CANDLE STICKS ANALYSIS

The open ,high , low and close reflects of supply and demand bitcoin . The candle will
be green for an upward piercing or red for a downward one . Bulls tend to maximize
profit when close hit high prices while the bears bought when the candle stick is red .

4.2.2 CHART ANALYSIS OF BITCOIN FROM 2017 T0 2018-01-01

BTC-USD 2017-01-01 TO 2018-01-01

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The chart above is characterised by a bullish market as depicted by the graph since it
is an uptrend. Reached an all-time high of $20000. The market was overbought as
depicted by the relative strength index throughout making it highly profitable to trade
in bitcoins. Highly volatile market as shown by the width of the Bollinger band and
helped highlight selling opportunities for the bulls in the market as depicted by white
candles being outside the Bollinger band in May, August, October to December.
Intersection of the blue and green line is an indication of a trend reversal or the red
line with the blue or green line.

4.2.3 BTC-USD Chart Analysis 2018 to 2019-01-01

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In 2018 the graph above depicts a downward trend as a result the bears were in
control of the market as seen by the relative strength index throughout the year being
below or near 30. Constantly volatile market as depicted by the width of the Bollinger
bands which also meant profit potential for traders .Bollinger bands presented few
signals to buy and sell due to the constantly decreasing value of the bitcoin throughout
the year. The intersection of the blue, red and green line are signs of trend reversals
which are also signs for whether traders should buy or sell.

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4.2.4 CHART ANALYSIS OF BITCOIN 2019-01-10 TO 2020-01-01

The diagram above indicates low volatility from January up to the first of April because
the Bollinger bands are close to each at that period . low volatility indicates that the is
high probability of the expansion of the market . From May to November the market is
controlled by the bulls since the trend is moving upwards . During that period there is
high volatility indicated by separate Bollinger bands . Relative strength index is 43.183
shows that the is balance between bulls and bears because the RSL lies between 30 to
70 .

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4.2.4 CHART ANALYSIS OF BITCOIN 2020-01-10 TO 2021-01-01

The chart above is characterised by a bullish market as depicted by the graph since it
is an uptrend. The price reached $30 000 high more 2017. The market was
overbought as depicted by the relative strength index throughout making it highly
profitable to trade in bitcoins. From November there is highly volatile market as shown
by the width of the Bollinger band and helped highlight selling opportunities for the
bulls in the market as depicted by green candles being outside the Bollinger band in
May, August, October to December. Intersection of the red and white line is an
indication of a trend reversal or the red line with the blue or green line. The relative
strength index is 83.473 above 70(overbought) indicating a market is overextended to
the buy side in relation to recent prices.

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4.2.4 CHART ANALYSIS OF BITCOIN 2021-01-10 TO 2022-01-01

On the diagram above, the average of the relative strength index through out the year
is 43.89 which stipulates that there is balance trading between bulls and bears in the
market . From January up December the market is high volatile which indicated by
Bollinger bands lines are not separate from each other .

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