This article was originally posted on RealClearScience.
Bitcoin, the digital currency du jour, is a bit of an economic curiosity. Unlike gold, it has no intrinsic value. Unlike a currency issued by a country, its price is not affected by GDP, inflation, interest rates or any other typical macroeconomic indicator. So what gives Bitcoin value, and what is behind its incredible price volatility? Supply and demand. And since supply is already predetermined by an algorithm, demand is the biggest factor driving both its value and volatility.
Thus, understanding Bitcoin demand is central to analyzing the currency. But how exactly do you measure demand? Economist Ladislav Krištoufek from Charles University in Prague thinks he has an answer: Use Google Trends and Wikipedia to determine how many times people search for the term “Bitcoin.”
Plotting Internet searches against the value of Bitcoin, Dr. Krištoufek found a strong correlation between the two. (See figure.)
Furthermore, Dr. Krištoufek found that the variables were linked by a bidirectional causation; that is, Bitcoin’s price influenced search queries and search queries, in turn, influenced Bitcoin’s price. This leads to both “virtuous circles” (in which good news drives Bitcoin’s price even higher) and “vicious circles” (in which bad news drives Bitcoin’s price even lower).
Dr. Krištoufek believes such volatility is the natural consequence of speculators chasing after an asset with no inherent value. Therefore, he concludes, “The market is thus dominated by short-term investors, trend chasers, noise traders and speculators.”
Source: Ladislav Krištoufek. “BitCoin meets Google Trends and Wikipedia: Quantifying the relationship between phenomena of the Internet era.” Scientific Reports 3, Article number: 3415. Published 04-December-2013. doi:10.1038/srep03415