Researchers at Pennsylvania State University recently analyzed whether attitudes and emotionality surrounding cryptocurrency could help predict returns. What they found may stand in stark contrast to related financial markets.
According to the team’s research paper, social media plays an outsized role in adoption and activity rates, while cryptocurrency journalism isn’t a great predictor of market movement:
“Our findings indicate that social media sentiment significantly predicts crypto returns, while sentiment from news media does not.”
The researchers used natural language processing to analyze millions of financial news articles and social media comments and generated sentiment scores along 53 topics and attention metrics for over 300 cryptocurrencies.
They then compared the ground truth returns over a given period of time to the coinciding news and social media sentiment.
Perhaps most interesting among their findings is their conclusion that while social media sentiment is a good predictor of crypto returns, the risk premium channel is not.
The risk premium channel is a sort of lens by which consumers make investment decisions. It is directly related to market and asset volatility.
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Cryptocurrency is often discussed as a highly volatile asset. In typical markets, such volatility usually leads to a higher risk premium and lower adoption and activity.
Taking the housing market as an example, research shows that as market volatility increases, consumer sentiment decreases and would-be purchasers tend to become risk-averse.
The Penn State team’s research indicates that this isn’t the case with cryptocurrency. In its conclusion, the team writes that market exuberance is positively related to momentum but that it “does not positively predict volatility.”
“This suggests,” the paper continues, “that sentiment influences returns through price perception and demand shocks rather than the risk premium channel.”
The researchers ultimately conclude that this may be due to the large number of consumer investors with large cryptocurrency portfolios active on crypto social. They also suggest that further research on the relationship between social media sentiment and crypto returns is merited.
