Illinois Tech researchers uncover key predictors of bitcoin returns

CHICAGO—May 19, 2023—Blockchain technology, investor sentiment, and degree of economic stress are significant predictors of bitcoin returns, according to a groundbreaking paper from Illinois Institute of Technology researchers that provides empirical evidence to help guide investors, economists, and academics.

Sang Baum “Solomon” Kang, professor of finance at Illinois Tech’s Stuart School of Business and co-author of the paper, also found that cryptocurrencies are detached from economic fundamentals and therefore may not function effectively as diversification or safe-haven assets. Additionally, Kang reports that returns on commodities, securities, and other assets do not predict bitcoin returns well.

The paper titled “What Information Variables Predict Bitcoin Returns? Dimensionality Reduction Approach,” published in Alternative Investment Journal. Kang co-authored the paper with two of his former doctoral students: Yao Xie (MS Finance ’15, Ph.D. MSC ’21), an associate quantitative analyst at Morningstar Inc., and Jialin Zhao (Stuart Ph.D. MSC ’17), professor quantitative management at St. Mary’s University in San Antonio.

The team used predictive analytics techniques and dimensionality reduction models on data from January 2011 to January 2020, analyzing 25 informational variables under the categories of macroeconomics, blockchain technology, other assets, stress levels, and investor sentiment.

“We found that blockchain technology, investor sentiment and stress levels have predictive power for bitcoin returns,” said Kang. “Similar to traditional assets, bitcoin exhibits higher return predictability with a longer return horizon. These findings support bitcoin’s dual nature as a technical artifact and a speculative asset.”

Key findings include:

• The increasing difficulty of mining Bitcoin positively predicts returns. This supports the theory that as the need for blockchain technology increases, the supply of bitcoin decreases, thus increasing its profitability.
• Bitcoin returns are positively driven by investor sentiment, demonstrating the speculative nature of the cryptocurrency as an asset.
• Higher levels of stress or financial turmoil in the economy lead to reduced future returns on bitcoins, underscoring the risks associated with holding bitcoins as an asset.

According to the researchers, bitcoin has served in three different economic roles over time: as a form of currency, as a speculative security, and as a safe-haven commodity due to its scarcity and the cost of mining.

“In academia, there is a research methodology called asset return predictability studies,” said Kang. “The basic principle is that variables that predict future asset price movements may be important in an economic system. So understanding those variables is important not only for traders looking to take positions in bitcoin, but also for economists looking to understand the nature of bitcoin.”