Bursting the Bubble: An Analysis of Bitcoin's Peak Prices

Abstract

Bitcoin was introduced as the world’s first decentralized digital currency in a whitepaper published in October 2008 under the pseudonym Satoshi Nakamoto. It would allow for direct peer-to-peer transactions, be maintained by computers within the network, and theoretically protect users’ anonymities. The currency had no intrinsic value or backing other than its finite supply capped at 21 million coins. While the price of a bitcoin was almost negligible at first, it grew over time due to increasing investment and speculation, soaring to price of almost $20,000 by the end of 2017. This pushed financial institutions and regulators to acknowledge the currency and think of ways to control its use. The price of bitcoin is marked with notable volatility, and negative news surrounding prominent exchanges or regulations can send the price plummeting. Thus, the bitcoin industry has seen a number of bubbles form and burst throughout the years, but the one of late 2017 was by far the most significant in size. Its peak was the highest and its crash was felt the strongest. Bitcoin transactions are recorded on a publicly-available distributed ledger known as the blockchain, providing a rich dataset for analysis of the currency. Transactions are stored within a block, and the ledger defines each block’s properties, including the transactions that took place and the addresses they involved. By applying clustering techniques to the addresses, individual entities can be identified. The properties of these clusters, like their size and balance, can be computed for different time periods and compared. Then, using the information provided by the ledger, the transaction network for a certain time period can be visualized as a graph, where the nodes represent individual entities to whom multiple addresses may belong. This paper will analyze the clusters formed during the four biggest bubbles of bitcoin. In particular, it will more closely analyze December 2017 and the peak of the most recent bubble when bitcoin reached its highest price of $19,783.21, before the currency came crashing down the following month. In doing so, this thesis will synthesize the key trends and signals that indicated the impending burst of the bubble.