Dynamic Network Perspective of Cryptocurrencies
IRTG 1792 Discussion Paper 2019-009
54 Pages Posted: 31 Aug 2020
Date Written: March 23, 2019
Abstract
Cryptocurrencies are becoming an attractive asset class and are the focus of recent quantitative research. The joint dynamics of the cryptocurrency market yields information on network risk. Utilizing the adaptive LASSO approach, we build a dynamic network of cryptocurrencies and model the latent communities with a dynamic stochastic block-model. We develop a dynamic co-variate-assisted spectral clustering method to uniformly estimate the latent group membership of cryptocurrencies consistently. We show that return inter-predictability and crypto characteristics, including hashing algorithms and proof types, jointly determine the crypto market segmentation. Based on this classification result, it is natural to employ eigenvector centrality to identify a cryptocurrency’s idiosyncratic risk. An asset pricing analysis finds that a cross-sectional portfolio with a higher centrality earns a higher risk premium. Further tests confirm that centrality serves as a risk factor well and delivers valuable information content on cryptocurrency markets.
Keywords: Community Detection, Dynamic Stochastic Block-model, Spectral Clustering, Node Co-variate, Return Predictability, Portfolio Management
JEL Classification: C00
Suggested Citation: Suggested Citation