Journal of

Risk and Financial

Management

Article
Bitcoin Network Mechanics: Forecasting the BTC
Closing Price Using Vector Auto-Regression Models
Based on Endogenous and Exogenous
Feature Variables
Ahmed Ibrahim 1 , Rasha Kashef 2, *, Menglu Li 2 , Esteban Valencia 3 and Eric Huang 4
1 Computer Science Department, Wilfried Laurier University, Waterloo, ON N2L 3C5, Canada;
[email protected]
2 Electrical, Computer, and Biomedical Engineering Department, Ryerson University, Toronto,
ON M5B 2K3, Canada; [email protected]
3 IVEY Business School, Management Science Department, London, ON N6G 0N1, Canada;
[email protected]
4 Advanced Analytics, Toronto, ON M5J 2P1, Canada; [email protected]
* Correspondence: [email protected]




Received: 29 July 2020; Accepted: 17 August 2020; Published: 19 August 2020


Abstract: The Bitcoin (BTC) market presents itself as a new unique medium currency, and it is often
hailed as the “currency of the future”. Simulating the BTC market in the price discovery process
presents a unique set of market mechanics. The supply of BTC is determined by the number of miners
and available BTC and by scripting algorithms for blockchain hashing, while both speculators and
investors determine demand. One major question then is to understand how BTC is valued and how
different factors influence it. In this paper, the BTC market mechanics are broken down using vector
autoregression (VAR) and Bayesian vector autoregression (BVAR) prediction models. The models
proved to be very useful in simulating past BTC prices using a feature set of exogenous variables.
The VAR model allows the analysis of individual factors of influence. This analysis contributes
to an in-depth understanding of what drives BTC, and it can be useful to numerous stakeholders.
This paper’s primary motivation is to capitalize on market movement and identify the significant
price drivers, including stakeholders impacted, effects of time, as well as supply, demand, and other
characteristics. The two VAR and BVAR models are compared with some state-of-the-art forecasting
models over two time periods. Experimental results show that the vector-autoregression-based
models achieved better performance compared to the traditional autoregression models and the
Bayesian regression models.

Keywords: Bitcoin; blockchain; autoregression; time-series analysis; simulation; predictive modes;

endogenous; exogenous variables

1. Introduction
Bitcoin (BTC) is a digital currency alternative to real currency and is the most popular among the
cryptocurrencies. The BTC was created by a cryptologist known as “Satoshi Nakamoto”, whose real
identity is still unknown (Nakamoto 2008). As blockchain currencies are not as liquid as other forms of
currency, understanding the behavior of this market draws insights as to how one could capitalize on
this asset over time. Especially as society becomes more digitally inclined, the viability of a blockchain
currency such as BTC to become a common currency seems like a possible reality. There are both
winners and losers in the context of each capital market transaction. There are several drivers impacting

J. Risk Financial Manag. 2020, 13, 189; doi:10.3390/jrfm13090189 www.mdpi.com/journal/jrfm

J. Risk Financial Manag. 2020, 13, 189 2 of 21

the Bitcoin market, such as the total number of Bitcoin available, the difficulty of Bitcoin mining,
and average blockchain size. Therefore, determining the essential endogenous and exogenous drivers
in BTC markets is a critical task. Each of these endogenous and exogenous variables can be treated as
a time series, and therefore suitable multivariate time series forecasting models are needed.
Vector autoregression (VAR) is one of the most widely-used stochastic process models to analyze
interdependencies of multivariate time series, and it has proven to be a useful model to describe the
behavior of economic and financial time series, and to forecasting (Campbell et al. 1996). The VAR model
is an extension of the univariate autoregression model to multivariate time series data. In the VAR
structure, each variable is a linear function of past lags of itself and the past lags of the other variables.
However, the limited length of standard economic datasets may produce over-parameterization
problems (Koop and Korobilis 2009) thus, the Bayesian vector autoregression (BVAR) model was
introduced in Litterman (1980) to solve this problem. The BVAR model uses Bayesian methods to
estimate a vector autoregression. In comparison with the standard VAR models, the BVAR model treats
input parameters as random variables, and prior probabilities are then assigned. A feature-selection of
the cryptocurrency drivers is strongly needed to enhance the performance of a multivariate time-series
(e.g., BTC) prediction model. In this paper, we applied direct forecasting using VAR and BVAR models
to simulate the BTC market to understand the behavior of market participants as well as their most
and least favorable market conditions according to the closing price of BTC based on an optimal set
of exogenous variables. The simulated BTC market includes forecasting the endogenous variables,
such as the equilibrium closing price of the market for BTC as denominated by the US dollar (MKPRU),
the number of unique MyWallet users (MWNUS), and the total BTC available in the market to date
(TOTBC). Experimental analysis over 7-year and 10-year timeframes shows the efficiency of the VAR
and BVAR models in predicting the set of endogenous variables compared to traditional autoregression
and Bayesian regression models using the optimal selected set of exogenous variables. The rest of this
paper is organized as follows: Section 2 introduces the background of Bitcoin; Section 3 focuses on the
related work; Section 4 describes the prediction models for Bitcoin closing price; Section 5 presents and
discusses the results of the prediction models; and Section 6 outlines the conclusions and future works.

2. Background on Bitcoin
Bitcoin is a unique digital currency with the potential to change the nature of the transactions
that people conduct in digital space. Bitcoin enables consumers for the first time to make electronic
transactions from person to person without the need for an intermediary between them, like cash
(Brito 2014). Transactions conducted in the digital space with BTC allow individuals to push payments
directly to the merchants without having to share personally identifiable information, which could be
intercepted by cybercriminals for fraud. One of the greatest concerns for BTC as a commonly accepted
currency is the security, as there is no intermediary to ensure the coverage on stolen BTC, should theft
occur (Brito 2014). As the value of the asset appreciated 63% YTD in 2016, and 87% YTD in 2020,
identifying historical patterns of behavior could help in understanding how the BTC security (and the
security of similar cryptocurrencies) is likely to behave from inception.

2.1. Bitcoin Ledger

Each block in the Bitcoin blockchain contains a summary of all transactions in the block using
a Merkle tree (aka binary hash tree) such that each transaction is first put into a pool of pending
transactions. Then, they are put into the transaction chain (blockchain) (Antonopoulos 2014). Each block
is linked in a chain by a reference to a previous header hash in which the addition of a transaction into
the chain is through a “mathematical lottery” (United States Securities and Exchange Commission 2017).
The miner solves the math problem (cryptographic hashing) and puts the transaction into the chain.
The math helps everyone with a wallet know the order of transactions as well as all past transactions.
J. Risk Financial Manag. 2020, 13, 189 3 of 21

2.2. Bitcoin Development Process

As other cryptocurrencies aim to perform the same computer distributed task, there are risks that
any new digital currency faces from inception until maturity. There are three primary characteristics
that a digital currency must satisfy to be deemed a sound form of currency. The following are the key
success factors (Barski and Wilmer 2015):

• The network effect;

• Cryptocurrency volatility;
• Cryptocurrency-pegging technology.

2.2.1. The Network Effect

The simple concept of money is that people will be willing to use the currency (medium of
exchange) so long as someone else is willing to accept it as a form of payment. Without an appropriate
network for the payment mechanism, it is unlikely that people would desire to use the specific
cryptocurrency if it turns out to be illiquid.

2.2.2. Cryptocurrency Volatility

For any cryptocurrency that is getting newly established as a payment method, the “fair”
established value must be stable for consumers to be comfortable purchasing with the digital
currency. As BTC is a newly available asset, the price discovery mechanism requires that the
group of buyers and sellers exchanging the currency come to an agreed-upon value for the underlying
asset (Pagnottoni and Dimpfl 2019). As the value of a BTCUSD in November 2016 was roughly $740,
the currency was far from stable at the time. Seeing prices as high as $1200 in 2013, $15,000 in 2020,
and as low as $355 in 2016 for BTCUSD, a true concern for consumers is to make a purchase with
an asset that has varied so much in value. However, there are many cases of money being just as
volatile. One famous example being the Zimbabwe hyperinflation, where the currency experienced
80 billion percent inflation in a single month.

2.2.3. Cryptocurrency-Pegging Technology

As the supply for the total BTC is limited to 21,000,000, more users have begun to use the BTC,
which has modestly reduced volatility. The advantage of BTC over other cryptocurrencies is that it
has been established and generated credibility for a sufficient network of users to adopt the use of the
coin. Primarily, this has helped BTC outpace other digital currencies to normalize volatility. For any
potential new e-coin that could enter the cryptocurrency market, it would make sense that the coin
merges its stability according to a more stable cryptocurrency such as BTC.

2.3. Market Participants

The following are the market participants worthy of further analysis accompanied by a brief
description of their role in the market:

• Miners—The market participants who are proactively adding transaction records to Bitcoin’s
public ledger of past transactions or blockchain and fueling the supply of BTC.
• Individual investors—Investors for the digital assets to purchase goods or services with the
digital currency.
• Payment mechanism—Conduct business internationally as international payments are now
available via BTC.
• Retail investors—Funds that are likely to pick up the currency as a portion of their portfolio to
hedge, like gaining exposure to traditional currency markets.
J. Risk Financial Manag. 2020, 13, 189 4 of 21

2.4. Stakeholders
As digital currency changes the evaluated value of money and other financial assets,
several stakeholder requirements and motives should be considered. The following are the stakeholders
(formal and informal) affected by the adoption of cryptocurrencies: savers/bullish investors,
government, other cryptographers, BTC exchanges/brokers, illegal black markets, BTC miners,
and members of the public. As stakeholders desire stability and strength with any medium of transaction,
some stakeholders are opposed to the widespread adoption of BTC. Specifically, the government and
other cryptographers may have an issue with the widespread adoption of the BTC as decentralized
digital money where no government or single entity can control the price or value.

3. Related Work
In modeling and simulation of the economics of mining in the Bitcoin market
(Cocco and Marchesi 2016), authors have discussed how a miner is impacted by BTC prices
(Cocco and Marchesi 2016). The goal of this artificial market model is to model the economy of the
mining process from the inception of the Graphics Processing Units (GPU) generation. The important
findings for this computational experiment encompass the ability to reproduce the unit root property,
the fat tail phenomenon, and the volatility clustering of the BTC prices (Cocco and Marchesi 2016).
Research on Bitcoin price forecasting are mainly based on two approaches: machine learning and time
series methods.

3.1. Machine Learning Prediction Methods

Felizardo et al. (2019) presented a comparative study of price prediction performance among
several machine learning models: long short-term memory (LSTM), WaveNet, support vector machine
(SVM), and random forest (RF). The results indicated that for time-series data, the LSTM model
tends to perform better than other machine learning models. The research of Tandon et al. (2019)
gave a similar conclusion. They applied three different machine-learning methods to forecast the
Bitcoin price, and compared their prediction ability. As a result, the RNN (recurrent neural network)
with LSTM gave a lower mean absolute error than the random forest and linear regression models.
Many research focuses on improving the LSTM model to increase forecasting accuracy. Wu et al. (2018)
proposed an LSTM called LSTM with AR(2) model to forecast Bitcoin’s daily price. The conventional
LSTM model only considers the previous price of to predict the current price; instead, the LSTM
with AR(2) takes the previous two days’ prices into account. The experimental results demonstrated
that the proposed model with AR(2) achieved a better forecasting accuracy with a lower mean
squared error. Hashish et al. (2019) proposed the addition of hidden Markov models (HMMs) to the
conventional LSTM. The HMM was used to describe the historical movements of Bitcoin. The proposed
hybrid of HMM and LSTM outperformed the traditional forecasting of LSTM by decreasing the mean
squared error from 49.089 to 33.888. The main drawback of the machine-learning models is that these
models need high computational capacity, and so the execution time of the forecasting process is
very time consuming. Thus, in this paper we focus on time-series prediction models. Support vector
machine, latent source, and multilayer perceptron models work better for classification problems.
The LSTM model performs well in solving long-term dependency problems, which means it is suitable
for price prediction. However, the LSTM model needs a long computation time and has a large
memory requirement.

3.2. Time-Series Prediction Methods

Bakar and Rosbi (2017) proposed the autoregressive integrated moving average model (ARIMA)
to forecast the exchange rate between Bitcoin and the US dollar. In this method, the upcoming price
depends upon autoregression, integration, and moving average, respectively. They believed the ARIMA
model could be a reliable model to forecast the volatile characteristic of Bitcoin. Both Roy et al. (2018)
J. Risk Financial Manag. 2020, 13, 189 5 of 21

and Anupriya and Garg (2018) applied the ARIMA model to predict Bitcoin’s price. The experimental
result demonstrated the strong forecasting ability of the ARIMA. The mean error between the actual
prices and the predicted prices was less than 6% for most values. Roy et al. (2018) also compared
the performance of the ARIMA model with the autoregressive model (AR) and moving average
model (MA), and the ARIMA model resulted in better accuracy than the other two models. However,
the ARIMA model’s shortcoming is that this it can give a more accurate prediction for short-term data,
based on the research result of Ariyo et al. (2014). Rane and Dhage (2019) introduced nine approaches
for Bitcoin price prediction and discussed each methodology in their research. The ARIMA model
targets to forecast uncertainty time-series data within a short-term period, but class imbalance can bias
it. Linear regression is unsuitable to predict Bitcoin price as the time series data.
The strength of the vector autoregression (VAR) model and the Bayesian vector autoregression
(BVAR) model to estimate currency and exchange rate fluctuations have been demonstrated in recent
research. VAR has been used widely by financial theorists and economists in predicting time series
economic variables in systems that involve supply and demand (Ito and Sato 2006; Wang et al. 2017;
Carriero et al. 2009; Alquist et al. 2013; Sims 1993). We found several papers that use VARs to estimate
currency and exchange rate fluctuations, notably Koray and Lastrapes, who use a VAR model to estimate
the exchange rate on a series of macroeconomic variables (Koray and Lastrapes 1989). Additionally,
Ito and Sato performed VAR research on the exchange rate of post-crisis Asia (Ito and Sato 2006).
Wang et al. (2017) established a VAR model to analyze the impact of exchange rate volatility on
economic growth. Furthermore, there is some research on forecasting using the Bayesian vector
autoregression (BVAR) method. For example, Carriero, Kapetanio, and Marcellino demonstrated
that the BVAR model produced better forecasting for exchange rates (Wang et al. 2017). In the
econometric/finance community, (Catania et al. 2019) and (Bohte and Rossini 2019) have studied the
forecasting performance of cryptocurrencies by vector autoregression with and without time-varying
volatility. (Bianchi) has investigated the possible relationship between returns on cryptocurrencies
and traditional asset classes. Bianchi et al. (2020) discussed the relationship between the returns on
stable-coins and major cryptocurrency pairs within the context of a large Bayesian vector autoregression
model. The BVAR model extends the classical VAR model by using Bayesian methods to estimate
a vector autoregression. The BVAR model treats input parameters as random variables, and prior
probabilities are then assigned. Current related work to both VAR and BVAR models in forecasting
BTC prices does not focus on selecting the set of endogenous and exogenous variables and drivers that
control the BTC market, which is the primary focus of this paper.

4. BTC Closing Price Prediction Models

Both VAR and BVAR models are used in this paper to forecast the Bitcoin price and simulate the
BTC market to understand market participants’ behavior as well as the market conditions according to
the closing price of BTC.

4.1. Endogenous and Exogenous Variables

An autoregressive model is typically used to develop predictions and understand the trend of
a time series. However, in financial and economic data, several factors are affecting the time series,
such as supply, demand, and regulation. The complex nature of any financial market warrants a more
sophisticated model. The performance of the VAR and BVAR forecasting models depends on the
optimal selection of the set of endogenous variables of interest. Several variables were tested as proxies
to represent the price, demand, and supply of the BTC market, respectively, after trying out numerous
iterations of VARs and BVARs and using sensitivity analysis with different variables, lags, and time
frames. The final set of endogenous variables is defined in Equation (1). Let Yt be a vector of the
endogenous variable of interest such that:

Yt = {MKPRU, MWNUS, TOTBC} (1)

J. Risk Financial Manag. 2020, 13, 189 6 of 21

t1 = [04-01-2009,
J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 22-11-2016] 6 of (2)
21

t2 = [01-01-2011, 01-08-2020] (3)

t2 = [01-01-2011, 01-08-2020] (3)
where MKPRU represents the equilibrium closing price of the market for BTC as denominated by the US
where MKPRU1represents
dollar (Figures and 2). MWNUS the equilibrium closing
is the number price ofMyWallet
of unique the market for BTC
users, and as denominated
TOTBC byBTC
is the total the
US dollar in
available (Figures
the market 1 and to2). MWNUS
date, as thereisisthe number
a limited of unique
amount of BTCMyWallet
available users, and TOTBC
at 21,000,000. Ouristime
the
total
framesBTC areavailable
across two in the market the
intervals, to date,
first as
one there is a limited amount
is [04-01-2009, 22-11-2016] of BTC available
(Figure 1), andat 21,000,000.
the second
Our
period time
is frames are across
[01-01-2011, two intervals,
01-08-2020] (Figure the first decision-making
2). The one is [04-01-2009, 22-11-2016]
process (Figure1), and
uses reasonable the
metrics
second
deemedperiod is [01-01-2011,
viable drivers 01-08-2020]variables,
of the endogenous (Figure 2).whereThethe
decision-making process as
following were selected uses
thereasonable
exogenous
metrics
variables: deemed
Average viable
Blockdrivers of the
Size in, MBendogenous
(AVBLS), Bitcoinvariables, where
Difficulty the following
(DIFF), Numberwere selected as the
of Transactions per
exogenous
Block (NTRBL), variables:
Miner’s Average
Revenue Block Size in,Change
(MIREV), MB (AVBLS), BitcoinofDifficulty
in the Number (DIFF), Number
unique addresses (NADDU), of
Transactions
Total Output Volumeper Block (NTRBL),
(TRVOU), andMiner’s
Hash Rate Revenue
(HRATE). (MIREV), Change
A majority of theinfactors
the Number of unique
selected were those
addresses
that had been(NADDU),
a result of Total
the Output Volumetransaction
BTC network’s (TRVOU),behavior
and Hash andRatehow(HRATE). A majority
the fundamental of the
mechanics
factors selected
influenced the were
closing those thatThe
price. hadvariables
been a result of theDIFF,
AVBLS, BTC TRVOU,
network’sand transaction
HRATE behavior
were taken andashow
the
the fundamental
variables mechanics
which dictated influenced
the difficulty of the closing
accessing andprice. The variables
supplying BTC to the AVBLS,
market.DIFF,
NTRBLTRVOU, and
considers
HRATE werenumber
the growing taken asofthe variables which
transactions dictated
occurring the difficulty
per block of BTC as of aaccessing
measureand supplying volume
of transaction BTC to
the
per market.
availableNTRBL
block ofconsiders
BTC. Thethe growing
NADDU number
variable of transactions
considers the changingoccurring
number perofblock
uniqueof addresses
BTC as a
measure
performing of BTC
transaction
transactionsvolume per available
to understand blocktrends
behavior of BTC.
overThe
time.NADDU
TRVOUvariable
measuresconsiders
the exchangethe
changing
trade volumenumberof USD of unique
within the addresses
BTC market,performing BTC transactions
which serves as a guideline to as
understand
to how thebehavior trends
market reacts to
over time.inTRVOU
changes value when measures
buying theorexchange
selling BTC.trade volume
Finally, Xtof
, asUSD within
the list the BTC market,
of exogenous which
variables, serves
is defined
as
in aEquation
guideline (4)asas:to how the market reacts to changes in value when buying or selling BTC. Finally,
𝑋 , as the list of exogenous variables, is defined in Equation (4) as:
Xt = {MIREV, NTRBL, AVBLS, DIFF, NADDU, TRVOU, HRATE} (4)
𝑋𝑡 ={MIREV, NTRBL, AVBLS, DIFF, NADDU, TRVOU, HRATE} (4)

Figure 1. Bitcoin closing price in USD (MKPRU), [04-01-2009, 22-11-2016].

Figure 1. Bitcoin closing price in USD (MKPRU), [04-01-2009, 22-11-2016].

Figure 2. Bitcoin closing price in USD (MKPRU), [01-01-2011, 01-08-2020].

J. Risk Financial Manag. 2020, 13, 189 7 of 21

Figure 1. Bitcoin closing price in USD (MKPRU), [04-01-2009, 22-11-2016].

Figure 2. Bitcoin closing price in USD (MKPRU), [01-01-2011, 01-08-2020].

Figure 2. Bitcoin closing price in USD (MKPRU), [01-01-2011, 01-08-2020].
4.2. Vector Autoregression (VAR) Model
A Vector autoregression (VAR) (Sims 1993), (Kuschnig et al. 2020), and (Kuschnig and Vashold
2019) model was developed to understand the relationship between the system of variables that are of
interest (Equations (1) and (4)). Thus, the VAR of interest is as follows:

Yt = β0 + β1 Yt−1 + β2 Yt−2 + β3 Yt−3 + · · · βn Yt−n + βn+1 Xt + t (5)

where the betas (β0t s) are vectors of constants and coefficients representative of the relationship between
the variables, where n is the number of lags used in the VAR model. The purpose of selecting this model
is to use the model coefficients to simulate a certain period of BTC endogenous variable (Equation (1))
given the exogenous variables (Equation (4)). Furthermore, one could ideally forecast out the BTC price
behavior over time, such that there are verified and validated forecasts of the exogenous variables.

4.2.1. Model Assumptions

A few assumptions were made in this VAR model in an effort to use real market data to forecast just
over six months. First, the model assumes that the relationship between the variables is static. A variety
of timelines were tested accordingly in order to understand differences in behavior. The following are
the timeframes selected for analysis:
Experiment A: Full timeframe: [04-01-2009, 22-11-2016], Post-boom timeframe: [10-12-2013,
22-11-2016], the Year of 2016 timeframe: [01-01-2016, 22-11-2016]. Experiment B: Full timeframe:
[01-01-2011, 01-08-2020], Post-boom timeframe: [01-01-2017, 01-08-2020], the Year of 2020 timeframe:
[01-01-2020, 01-08-2020]. For both Experiments A and B, the second assumption made in the model
was the segregation of endogenous and exogenous variables. The decision-making process yielded
a qualitative and intuitive measure for the variables.

4.2.2. Model Validation and Verifications

The process of validating the model was among the most difficult tasks throughout the entire
process. Ultimately, the selected set of endogenous variable contained the BTC exchange rate, a variable
for supply, and a variable for demand. Collectively, these variables help represent the market mechanics
of Bitcoin. Based on the selected endogenous and exogenous variables, the following parameters
were used:

• lag.max = 366—to accommodate a full year of seasonal behavior and trends;

• type = ‘both’—to evaluate the deterministic regressors.

The resulting selection of a timeframe was selected according to Akaike Information Criterion
(AIC), Schwarz Criterion (SC), Hannan Quinn (HQ), and Forecast Prediction Error (FPE). This screening
J. Risk Financial Manag. 2020, 13, 189 8 of 21

process served as a deterministic selection of the timeframe for the forecasting by encompassing
summary statistics such as p-value and R2 to verify the accuracy of the relationship that was being
estimated. Additionally, other combinations of variables were attempted with exceptionally poor
results. Most of the other variables that were included as an aggregate to those used in the model
projected dramatic market crashes with negative asset value.

4.3. Bayesian Vector Autoregression (BVAR) Model

The classical VAR model may have over-parameterization problems because of the large
number of parameters and limited availability of time-series datasets (Sims 1980); alternatively,
the Bayesian vector autoregression model can be used. The BVAR model applies Bayesian methods
to estimate a VAR and treats the VAR model parameters as random variables. It also assigns and
updates the prior probabilities of both observed and unobserved parameters based on available
data (Miranda-Agrippino and Ricco 2018). The BVAR model in this paper uses the same variables of
interest in the VAR model as described in Section 4.2. Let Yt be a list of variables used in this BVAR
model, such that:
Yt = {MKPRU, MWNUS, TOTBC} (6)

As in the VAR model, the BVAR model also assumes the chosen variables have static relationships
and uses several different timelines to observe forecasting outputs. The BVAR model uses the same
timeframes (Experiment A and Experiment B) used in the VAR model in order to compare their
forecasting abilities.

Prior Specification
In the BVAR model, the informative prior probability distribution of the VAR coefficients (β0t s in
Equation (5)) can be assigned before observing the sample data. The Minnesota prior was introduced and
developed by Robert Litterman and other researchers at the University of Minnesota (Litterman 1980),
and was chosen in our BVAR model. This prior is based on the behavior of most macroeconomic
variables, which is approximately a multivariate random walk model with drift. The parameters of the
Minnesota prior are set as follows:

• Parameter λ with max = 5 and min = 0.0001, to control the tightness of the prior;
• Parameter α with max = 3 and min = 1, to manage variance decay with increasing lag order;
• var = 10,000,000, to set the prior variance on the model’s constant.

5. Experimental Analysis
Real datasets of the Bitcoin market in three different timeframes were used in this paper across
two different time periods, Experiment A, t1 = [04-01-2009, 22-11-2016], and Experiment B, [01-01-2011,
01-08-2020]. For Experiment B, the data were normalized using the logarithm of each return variable.
Both the VAR and BVAR models were applied and tested on these datasets to forecast the Bitcoin
market price. The forecasting results were analyzed to evaluate the performance of our models.

5.1. Experimental Dataset

The primary source of data and information was the Quandl Dataset sourced from Blockchain.com
(Quandl 2020). The source contains up to 32 datasets, including the BTC market price. Each dataset
contains a time series for a variable. The secondary dataset was the average OHLC (open-high-low-close)
candlestick values across multiple exchanges scraped from Rbitcoincharts.com (Bitcoin Charts 2020).
Additionally, any of the transforms accepted were denoted upfront before the variable. In the
circumstance of the BTC simulation, the Quandl transform applied was “diff”, which implied the
change over time depending on the frequency (i.e., daily frequency data would be sampled as daily
frequency change of that variable). The OHLC candlestick chart data (Figure 3) were sourced directly
J. Risk Financial Manag. 2020, 13, 189 9 of 21

from Rbitcoincharts.com, consolidating the average OHLC candle according to a number of varying
exchanges which trade BTC and similarly pegged altcoins. One of the major difficulties encountered
upon sourcing the data was to get a consistent market price from BCHAIN, which would match the
OHLC charts sourced. The difference appeared to be according to when the different data sources
selected their end-of-day settlement. Rbitcoincharts.com was selected, as the close price difference was
roughly around ($1–$2).
J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 9 of 21

Figure 3.
Figure 3. OHLC
OHLC (open-high-low-close)
(open-high-low-close) candlestick.
candlestick.

5.2. Forecasting Results

Both VAR and BVAR BVAR models
models were tested with three timeframes in two two different
different experiments.
experiments.
Experiment
Experiment A: A:For
Forthe 2016
the 2016timeframe, values
timeframe, of variables
values described
of variables in Sections
described 4.2.1 and
in Sections 4.2.2and
4.1.1 between
4.2.2
01-01-2016 and 30-09-2016
between 01-01-2016 were imported
and 30-09-2016 as input toasthe
were imported two to
input models.
the two Formodels.
the Post-boom timeframe,
For the Post-boom
data from 10-12-2013
timeframe, data fromto 30-09-2016towere
10-12-2013 imported
30-09-2016 wereas imported
input. Both asmodels forecasted
input. Both modelstheforecasted
Bitcoin price
the
in USD price
Bitcoin for theinperiod 01-10-2016
USD for to 30-10-2016
the period 01-10-2016and compared and
to 30-10-2016 the forecasting
compared the results with theresults
forecasting actual
Bitcoin
with theprice.
actual For the price.
Bitcoin Full timeframe,
For the Fullthe time period
timeframe, selected
the time periodto selected
forecast to
was the last
forecast was199
thedays
last
[05/08/2016–11/22/2016] to evaluate the effectiveness of these two models. Experiment
199 days [05/08/2016–11/22/2016] to evaluate the effectiveness of these two models. Experiment B: For B: For the 2020
timeframe, input andinput
the 2020 timeframe, output andvariables between between
output variables 01-01-2020 and 01-08-2020
01-01-2020 were used
and 01-08-2020 for both
were used the
for
VAR
both and BVARand
the VAR models.
BVARFor the Post-boom
models. timeframe,timeframe,
For the Post-boom data from 01-01-2017 to 01-08-2020
data from 01-01-2017 were used.
to 01-08-2020
For
werethe FullFor
used. timeframe,
the Full the time period
timeframe, selected
the time for selected
period forecasting
for was the last was
forecasting six months
the last[01-02-2020,
six months
01-08-2020]
[01-02-2020,to evaluate the
01-08-2020] effectiveness
to evaluate of these two models.
the effectiveness of these two models.

5.2.1. Results of
5.2.1. Results of the
the VAR
VAR Model: Experiment A
Model: Experiment A
The
The model
model selects
selects the
the most
mostsuitable
suitablecoefficients,
coefficients,where
wherethe
theoutcome
outcomeminimizes
minimizesFPE.FPE. Figures
Figures 4–6,
4,
respectively show the evaluation of the Full, Post-boom, and the Year of 2016 timeframes
5, and 6, respectively show the evaluation of the Full, Post-boom, and the Year of 2016 timeframes forecasting
in comparison
forecasting to the BTCUSD
in comparison OHLC
to the BTCUSD candle fromcandle
OHLC Rbitcoincharts.com, where “fcst”
from Rbitcoincharts.com, is the“fcst”
where forecasted
is the
closing price, “lower” is the lower bound (95% CI), and “upper” is the upper
forecasted closing price, “lower” is the lower bound (95% CI), and “upper” is the upper bound (95% bound (95% CI).
The endogenous variables were simulated from the estimated VAR, as shown in
CI). The endogenous variables were simulated from the estimated VAR, as shown in Figures 7, 8, and Figures 7–9 for three
different
9 for threetimeframes. The simulated
different timeframes. exogenous
The simulated variables variables
exogenous were the were
real datasets taken from
the real datasets takenQuandl
from
for the aforementioned timeframe. Ultimately, by evaluating the results
Quandl for the aforementioned timeframe. Ultimately, by evaluating the results of different of different timeframes,
the full timeframe
timeframes, the fullusing the VARusing
timeframe model theshowed
VAR modelthe best forecasting
showed performance.
the best forecastingThe Full timeframe
performance. The
represents
Full timeframethe most data the
represents available
most dataand available
incorporates
and the relationships
incorporates over different
the relationships timeframes.
over different
Although
timeframes. theAlthough
significance theofsignificance
the relationship
of thebetween these between
relationship variables these
may change over
variables maytime, the 7-year
change over
timeframe surely aided in modeling the market behavior.
time, the 7-year timeframe surely aided in modeling the market behavior.
J. Risk Financial Manag. 2020, 13, 189 10 of 21
J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 10 of 21
J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 10 of 21

Figure4.4. Forecasting
Figure Forecasting Bitcoin
Bitcoin closing price using Full timeframe.
timeframe. Data
DataVs.
Vs.BTC
BTCOHLC.
OHLC.
Figure 4. Forecasting Bitcoin closing price using Full timeframe. Data Vs. BTC OHLC.

Figure 5. Forecasting Bitcoin closing price using Post-boom timeframe. Data Vs. BTC OHLC.
Figure5.
Figure 5. Forecasting
Forecasting Bitcoin closing price
price using
using Post-boom
Post-boomtimeframe.
timeframe.Data
DataVs.
Vs.BTC
BTCOHLC.
OHLC.
J. Risk Financial Manag. 2020, 13, 189 11 of 21
J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 11 of 21

J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 11 of 21

Figure6.6.Forecasting
Figure Forecasting Bitcoin
Bitcoin closing
closing price
price using
using Year of 2016
Year of 2016 timeframe.
timeframe. Data
Datavs.
vs.BTC
BTCOHLC.
OHLC.
Figure 6. Forecasting Bitcoin closing price using Year of 2016 timeframe. Data vs. BTC OHLC.

Figure 7. Forecasting the endogenous variables using Full timeframe data (VAR).
Figure7.7. Forecasting
Figure Forecasting the
the endogenous
endogenous variables
variablesusing
usingFull
Fulltimeframe
timeframedata
data(VAR).
(VAR).
J. Risk Financial Manag. 2020, 13, 189 12 of 21

J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 12 of 21

J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 12 of 21

Figure8.8.Forecasting
Figure Forecastingthe
the endogenous
endogenous variables
variables using
usingPost-boom
Post-boomtimeframe
timeframedata
data(VAR).
(VAR).
Figure 8. Forecasting the endogenous variables using Post-boom timeframe data (VAR).

Figure 9. Forecasting the endogenous variables using Year of 2016 timeframe data (VAR).
Figure9.9.Forecasting
Figure Forecasting the
the endogenous
endogenous variables
variables using
usingYear
Yearof
of2016
2016timeframe
timeframedata
data(VAR).
(VAR).
J. Risk Financial Manag. 2020, 13, 189 13 of 21

J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 13 of 21

5.2.2.
J. RiskResults
Financial of the 2020,
Manag. VAR13,Model: Experiment
x FOR PEER REVIEW B 13 of 21
5.2.2. Results of the VAR Model: Experiment B
In this experiment, we evaluated the performance of the VAR model using the
5.2.2.InResults of the VARwe
this experiment, Model: Experiment
evaluated B
the performance of the VAR model using the period [January
period [January 2011–August 2020] Full timeframe data, Post-boom timeframe data
2011–August 2020] Full timeframe data, Post-boom timeframe data [January 2017–August 2020], and
[January In this experiment,2020],
2017–August we evaluated
and thethe performance
Year of the VARdata
of 2020 timeframe model using the
[January period [January
2020–August 2020].
the Year of 2020 timeframe data [January 2020–August 2020]. We can observe that the VAR model
2011–August 2020] Full timeframe data, Post-boom timeframe data [January
We can observe that the VAR model could effectively predict the prices of the BTC using 2017–August 2020],
theand
three
could effectively predict the prices of the BTC using the three timeframes for the variables MKPRU,
the Year offor
timeframes 2020
thetimeframe data [January
variables MKPRU, MWNUS,2020–August 2020].asWe
and TOTBC, can observe
shown that
in Figures the VAR
10–13, withmodel
the best
MWNUS, and TOTBC, as shown in Figures 10–13, with the best performance obtained for the Full
could effectively
performance predict
obtained for the
the prices of the BTCperiod.
Full timeframe using the three timeframes for the variables MKPRU,
timeframe period.
MWNUS, and TOTBC, as shown in Figures 10–13, with the best performance obtained for the Full
timeframe period.

Figure 10. Forecasting the endogenous variables using Full timeframe data (VAR).
Figure 10. Forecasting the endogenous variables using Full timeframe data (VAR).
Figure 10. Forecasting the endogenous variables using Full timeframe data (VAR).

Figure 11. Forecasting the endogenous variables using Post-boom timeframe data (VAR).

Figure 11. Forecasting the endogenous variables using Post-boom timeframe data (VAR).
Figure 11. Forecasting the endogenous variables using Post-boom timeframe data (VAR).
J. Risk Financial Manag. 2020, 13, 189 14 of 21
J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 14 of 21

Figure 12. Forecasting the endogenous variables using Year of 2020 timeframe data (VAR).

5.2.3. Results of the BVAR Model: Experiment A

The forecasting results of Bitcoin price in USD for Full, Post-boom, and the Year of 2016
timeframes are shown in Figures 13–15, respectively. The red lines in each plot are from the BTC
Market Price dataset (MKPRU) of Quandl. The mean absolute percentage error (MAPE) of each
forecasting result was calculated to evaluate the model performance. The forecasting of Year of 2016
and Post-boom timeframes gave good performances, as the result of the Year of 2016 timeframe has
a MAPE value of 2.38% and the MAPE value of the Post-boom timeframe result is 2.85%. However,
forecasting price using the Full timeframe resulted in the largest MAPE value, 19.88%. The BVAR
model provided
Figure high
Figure 12.
12. forecasting
Forecasting
Forecasting the accuracy with
the endogenous
endogenous fewer
variables
variables data
using
using Yearavailable
Year of 2020
of or shorter
2020 timeframe
timeframe timeframe
data
data (VAR).
(VAR). in the
period of [January 2009–November 2016].
5.2.3. Results of the BVAR Model: Experiment A
The forecasting results of Bitcoin price in USD for Full, Post-boom, and the Year of 2016
timeframes are shown in Figures 13–15, respectively. The red lines in each plot are from the BTC
Market Price dataset (MKPRU) of Quandl. The mean absolute percentage error (MAPE) of each
forecasting result was calculated to evaluate the model performance. The forecasting of Year of 2016
and Post-boom timeframes gave good performances, as the result of the Year of 2016 timeframe has
a MAPE value of 2.38% and the MAPE value of the Post-boom timeframe result is 2.85%. However,
forecasting price using the Full timeframe resulted in the largest MAPE value, 19.88%. The BVAR
model provided high forecasting accuracy with fewer data available or shorter timeframe in the
period of [January 2009–November 2016].

Figure
Figure 13.
13. Forecasting
Forecasting Bitcoin
Bitcoin closing
closing price
price using
using Full
Full timeframe
timeframe data
data (BVAR).
(BVAR).

5.2.3. Results of the BVAR Model: Experiment A

The forecasting results of Bitcoin price in USD for Full, Post-boom, and the Year of 2016
timeframes are shown in Figures 13–15, respectively. The red lines in each plot are from the BTC
Market Price dataset (MKPRU) of Quandl. The mean absolute percentage error (MAPE) of each
forecasting result was calculated to evaluate the model performance. The forecasting of Year of 2016
and Post-boom timeframes gave good performances, as the result of the Year of 2016 timeframe has
a MAPE value of 2.38% and the MAPE value of the Post-boom timeframe result is 2.85%. However,

Figure 13. Forecasting Bitcoin closing price using Full timeframe data (BVAR).
J. Risk Financial Manag. 2020, 13, 189 15 of 21

forecasting price using the Full timeframe resulted in the largest MAPE value, 19.88%. The BVAR
model provided high forecasting accuracy with fewer data available or shorter timeframe in the period
of [January
J. Risk Financial2009–November 2016].
Manag. 2020, 13, x FOR PEER REVIEW 15 of 21
J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 15 of 21

Figure 14. Forecasting

Figure 14. Forecasting Bitcoin
Bitcoin closing
closing price
price using
using Post-boom timeframe data
Post-boom timeframe data (BVAR).
(BVAR).
Figure 14. Forecasting Bitcoin closing price using Post-boom timeframe data (BVAR).

Figure 15. Forecasting Bitcoin closing price using Year of 2016 timeframe data (BVAR).
Figure
Figure 15.
15. Forecasting
Forecasting Bitcoin
Bitcoin closing
closing price
price using
using Year
Year of
of 2016
2016 timeframe
timeframe data (BVAR).
data (BVAR).
5.2.4. Results of the BVAR Model: Experiment B
5.2.4. Results of the BVAR Model: Experiment B
In this experiment, we evaluated the performance of the VAR model using the period [January
In this experiment,
2011–August we evaluated
2020] Full timeframe the
data, performance
Post-boom of the VAR
timeframe data model using
[January the period2020],
2017–August [January
and
2011–August
the Year of 20202020] Full timeframe
timeframe data, Post-boom
data [January timeframe
2020–August 2020],data [January
as shown in2017–August 2020],
Figures 16–18. We and
can
the Year of 2020 timeframe data [January 2020–August 2020], as shown in Figures
observe that the BVAR model could predict the values of the two endogenous variables (MWNUS, 16–18. We can
observe
and TOTBC)that the BVAR model
effectively could
for the predict the
Post-boom values
period andofthe
theYear
two endogenous
of 2020 only,variables (MWNUS,
while the MKPRU
J. Risk Financial Manag. 2020, 13, 189 16 of 21

5.2.4. Results of the BVAR Model: Experiment B

In this experiment, we evaluated the performance of the VAR model using the
period [January 2011–August 2020] Full timeframe data, Post-boom timeframe data
[January 2017–August 2020], and the Year of 2020 timeframe data [January 2020–August 2020],
as shown in Figures 16–18. We can observe that the BVAR model could predict the values of the two
J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 16 of 21
endogenous variables (MWNUS, and TOTBC) effectively for the Post-boom period and the Year of 2020
only,
variablewhile
hadtheitsMKPRU variablefor
best prediction had
theitsYear
bestofprediction forThis
2020 alone. the Year of 2020confirms
experiment alone. This
thatexperiment
the BVAR
confirms that the BVAR model achieves better forecasting
model achieves better forecasting performance for short time periods. performance for short time periods.

Figure
Figure 16.
16. Forecasting
Forecasting the
the endogenous
endogenous variables
variables using
using Full
Full timeframe
timeframe data
data (BVAR).
(BVAR).

Figure 17. Forecasting the endogenous variables using Post-boom timeframe data (BVAR).
J. Risk Financial Manag. 2020, 13, 189 17 of 21
Figure 16. Forecasting the endogenous variables using Full timeframe data (BVAR).

Figure 17.
Figure 17. Forecasting
Forecasting the
the endogenous
endogenous variables using Post-boom
variables using Post-boom timeframe
timeframe data
data (BVAR).
(BVAR).
J. Risk Financial Manag. 2020, 13, x FOR PEER REVIEW 17 of 21

Figure
Figure 18.
18. Forecasting
Forecasting the
the endogenous
endogenous variables
variables using
using Year
Year of
of 2020
2020 timeframe
timeframe data (BVAR).
data (BVAR).

5.2.5. Analysis and Discussion of Results

For the VAR model, the price of BTC was affected by short-term lag of itself as well as the
number of MyWallet users. Surprisingly, it was not affected by the supply of BTC available on the
market. One explanation for this could be that the supply of BTC is limited, and as such, this value is
known by speculators beforehand as a market symmetric variable. The current BTC price was
positively affected by 1, 2, 4, 5, 9, 11, 17, and 20 day lags of itself. It was negatively impacted by 7, 8,
J. Risk Financial Manag. 2020, 13, 189 18 of 21

5.2.5. Analysis and Discussion of Results

For the VAR model, the price of BTC was affected by short-term lag of itself as well as the number
of MyWallet users. Surprisingly, it was not affected by the supply of BTC available on the market.
One explanation for this could be that the supply of BTC is limited, and as such, this value is known by
speculators beforehand as a market symmetric variable. The current BTC price was positively affected
by 1, 2, 4, 5, 9, 11, 17, and 20 day lags of itself. It was negatively impacted by 7, 8, 10, 12, 16, and 18 day
lags of itself, as shown in Table 1.

Table 1. Variables of significance and their effect.

Variables of Significance Effect

1, 2, 4, 5, 9, 11, 17, 20 day lag of BTC +
7, 8, 10, 12, 16, 18, day lag of BTC −
1, 4, 6, 10 day lag of MyWallet users +
2, 5, 12 day lag of MyWallet users −
Miner’s Revenue, BTC Difficulty, Change in the Number of unique addresses +
Number of Transactions per Block, Hash Rate −

The effects of MyWallet users on BTC price were slightly positive overall. In terms of exogenous
variables, the Miner’s Revenue (+), Number of Transactions per Block (−), BTC Difficulty (+), the Change
in the Number of unique addresses used (+), and Hash Rate (−) all played a significant part in estimating
BTC. The R2 of the model was above 99%, with F-Stats significant at a 99% confidence level, as shown
in Table 2.

Table 2. R2 and F-statistics.

Variable R2 F-Statistics
BTC Price 99+% 99+%
MyWallet User 99+% 99+%
Total BTC 99+% 99+%

In addition to analyzing the individual factors of influence on Bitcoin price, the VAR model
predicted a great pattern of fluctuating prices. Compared with the forecasting price curves from the
VAR model, the BVAR model gave a more accurate prediction of Bitcoin price to the actual values in
general. Additionally, the availability and completeness of the input data played a significant role in
the performance of the VAR model, while the BVAR model achieved a great forecasting result with
a low percentage error rate while using only data of the years 2016 and 2020. The results demonstrate
that the BVAR model performed well for a fairly limited number of observations.

5.3. Comparative Analysis

In this section, we compare the performance of the VAR and BVAR models with some of
the well-known autoregression and Bayesian regression algorithms, including the autoregression
integrated moving average (ARIMA) (Chu et al. 2017; Hencic and Gouriéroux 2017) and Bayesian
regression (BR) (Shah and Zhang 2014). ARIMA is a commonly used model to predict the price,
and the model is a combination of three basic time-series models: autoregressive, moving average,
and autoregressive moving average. Bayesian regression uses statistical analysis within the context of
Bayesian inference rules. The comparison was made based on the values of the root mean squared
Error (RMSE), the mean absolute error (MAE), and the mean absolute percentage error (MAPE)
(Tan and Kashef 2019; Tobin and Kashef 2020). In this section, we focus on the data timeframe from
Experiment B [January 2011–August 2020] and the variable of interest MKPRU (the equilibrium closing
price of the BTC market as denominated by the US dollar). As shown in Tables 3–5, for the Full
timeframe, the VAR model had the best performance. For the Post-boom timeframe, both the VAR
J. Risk Financial Manag. 2020, 13, 189 19 of 21

and the BVAR models had the lowest RMSE, MAPE, and MAE values. Finally, for the Year of 2020,
the VAR and the BVAR models had better performance than the ARIMA and BR models.

Table 3. Accuracy of forecasting models: Full Timeframe.

MAPE RMSE MAE

VAR 0.0249 0.3102 0.2260
ARIMA (2,2,1) 0.0421 0.3900 0.3258
BR 0.0362 0.3554 0.3826
BVAR 0.0286 0.3375 0.2501

Table 4. Accuracy of forecasting models: Post-boom timeframe.

MAPE RMSE MAE

VAR 0.0248 0.2708 0.2212
ARIMA (2,2,1) 0.0421 0.3900 0.3258
BR 0.0351 0.3693 0.2776
BVAR 0.0264 0.2806 0.2286

Table 5. Accuracy of forecasting models: Year of 2020 timeframe.

RMSE MAE MAPE

VAR 0.0123 0.1235 0.1023
ARIMA (2,2,1) 0.0143 0.1908 0.1262
BR 0.0129 0.1418 0.1158
BVAR 0.0130 0.1273 0.1247

6. Conclusions and Future Directions

In this paper, two VAR models were developed to analyze and understand the mechanics of the
BTC market. The developed models were tested in predicting the endogenous variables using selected
features of exogenous variables. The two models were compared with the state-of-the-art forecasting
models in order to show their efficiency. This research presents a powerful way to predict Bitcoin
market price and an interesting look at what factors of this BTC network can shape new innovations in
blockchain and the future of digital currency. As a new currency not administered by the government,
there are many interesting behaviors that can be studied. From the perspective of miners, investors,
or users of BTC, these findings may be useful for understanding the movements of the price of the
BTC, and could help to understand what influence each of the exogenous factors has on the price of
BTC. Future experiments for BTC prices will use a non-linear or dynamic VAR, which is suitable for
BTC simulation. Dynamic VAR accounts for the change in a relationship by allowing the coefficients to
change over time, which makes it much more challenging to analyze. The technical indicator could be
extended as an exponential moving average or volume-weighted average price. Different priors can be
suggested for future directions, such as the independent normal-Wishart. Additionally, analyzing the
daily market returns in order to understand the distribution of daily behavior could provide insight
into the classification of upward and downward trends. Incorporating the classification would enable
research to understand price action in more depth with increasingly sophisticated machine-learning
or nonlinear models. Finally, further investigation combing machine-learning prediction models
is recommended.

Author Contributions: Software, A.I., E.V.; Supervision, R.K.; Visualization, A.I., E.V., M.L., and E.H.;
Writing—original draft, A.I.; Writing—review & editing, A.I. and R.K.; Validation, A.I. and M.L.; Source—A.I.,
M.L., E.V., and E.H. All authors have read and agreed to the published version of the manuscript.
Funding: This research received no external funding.
Conflicts of Interest: The authors declare no conflict of interest.
J. Risk Financial Manag. 2020, 13, 189 20 of 21

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