The New Era of Financial Innovation: The Determinants of Bitcoin’s Price

Abstract

Financial innovation has entered a new era in which a digitalized system and cryptocurrency have been created. This paper examines the factors that influence the price movement of bitcoin. This is not a legal currency in Indonesia; the Indonesian government has not made any regulations legalizing bitcoin's use, but it has also not issued any new laws to prohibit the trade in bitcoins and other digital currencies. The demand for, and price growth of, bitcoin are interesting matters to study, especially for Indonesians who still have questions about the progress of bitcoin transactions and the factors that influent them. In Indonesia itself, without any protection from the government, the bitcoin price on December 14, 2017 had already reached more than IDR224.5 million, compare to IDR60 million in October 2017. Bitcoin is the first peer-to-peer currency, and was introduced by Satoshi Nakamoto in 2008. Since its inception, bitcoin has served more than 17 million users, including Indonesians. Bitcoin behaves in a different manner, compared to traditional currencies and the one that affects bitcoin's price is its attractiveness for investors. The Vector Error Correction Model (VECM) is applied to analyze the short-term and long-term influences. VECM is used in this research because the data is stationary in the first difference and has a cointegration relationship. To make the interpretation clearer, the impulse response function and variance decomposition also are included in this research. The result indicates that the macroeconomic indicator, represented by the Dow Jones Industrial Average (DJIA), the demand for bitcoins and the gold price influence bitcoin's price fluctuations in the short-run and long-run. Bitcoin's supply does not influence its price fluctuation in the long-run but does influence it in the short-run. The implication of this research is bitcoin could compete as an alternative investment compared to the capital markets and gold.

Bitcoin: A New Asset Class?

“…Bitcoin is a digital currency that uses the concept of cryptography as a security system (Darmawan, 2014) and becomes an innovation in the financial sector (Sukamulja & Sikora, 2018). Satoshi Nakamoto introduced Bitcoin in 2008 through an article entitled '"Bitcoin: A peer-to-peer Electronic Cash System."…”

“…Bitcoin is a new financial instrument and an alternative investment (Sukamulja & Sikora, 2018). However, according to Kristoufek (2015), the price of bitcoin cannot be explained by classical economic theories such as cash flow, purchasing power, and interest rates because the bitcoin market does not have a standard supply and demand balance point.…”

“…Bitcoin is a cryptocurrency, a digital currency that uses the concept of cryptography as a transaction security system that is attracting attention and is proliferating after the 2008 global economic crisis (Sukamulja & Sikora, 2018). Through peer to peer networks, cryptocurrency transactions are carried out without requiring the role of a third party as an intermediary.…”

“…Since 2009, Bitcoin has developed very rapidly. Bitcoin is becoming increasingly popular because of the easy transaction process and no (inexpensive) administrative costs (Sukamulja & Sikora, 2018). Although the demand for Bitcoin continues to increase, the amount will not be increased because it is only limited to 21 million (Nakamoto, 2008).…”

“…Some research has been done to find out the relationship between Bitcoin and USD, gold, shares or other assets such as van Wijk (2013), Yermack (2015), Wang, Xue, & Liu (2016), Kurihara & Fukushima (2018), Sukamulja & Sikora (2018) and Smith (2018). However, the findings from some of these studies give different results.…”