Random walk theory in cryptocurrency.

Random walk theory in cryptocurrency​

Random walk theory is a staple of modern economic thought. The theory holds that prices and other economic variables evolve as a result of the actions of rational investors, who are solely interested in maximizing their profits.

Random walk theory has been successfully applied to financial markets around the world, with some exceptions. Cryptocurrency, which is still in its early stages of development, may be one of those exceptions.

In this post we will explore the application of random walk theory to cryptocurrency markets and see whether or not they conform to the predictions of the theory.

What is Random Walk theory?​

The Random Walk theory is the idea that stock prices move randomly and that it is impossible to predict future movements. The theory is based on the efficient market hypothesis which is based on the assumption that all investors are rational and have access to all information, so they will always buy or sell at the correct price. As a result, stock prices will only change when new information becomes available, and these changes will be random.

Since only new information can influence the price of stocks and no one knows new information, it is not possible to time the trades or make informed investment decisions. This means that the only way for investors to make profit from trades is through consistently riskier investments.

While the Random Walk theory has been debated by economists for centuries, it still holds a lot of weight today. Many people believe that stock prices are impossible to predict, and that trying to do so is a waste of time. Even if you could predict where the market was going, you would still need to take into account the fact that other investors would also be trying to do the same thing, which would ultimately cancel out your efforts. Thus, while the Random Walk theory may not be perfect, it is still a useful way to think about the stock market.

How does this apply to cryptocurrency?​

Cryptocurrency on the other hand is a new and emerging market, which means that it is still subject to a lot of uncertainty. Investors in this market are still trying to figure out how it works and what its future will be.

Several studies have recently been carried out to study crypto currencies and determine whether the random walk theory applies to crypto currencies or not.

A study conducted by Verma, Sharma and Sam(2022) found that Bitcoin prices do not follow a random walk. The authors used the data of top 5 crypto currencies including Bitcoin, Ethereum, Ripple, Litecoin and Tether. They also used a variety of empirical tests to reach this conclusion, including the Augmented Dickey-Fuller test, the Phillips-Perron test, Breusch–Godfrey serial correlation LM test and ARIMA model.

The conclusion of this study brought forth strong evidence to refute the applicability of random walk theory in the cryptocurrency market.

Another study conducted by Palamalai, Kumar and Maiity(2021) found that the prices of top ten crypto currencies do not follow the random walk theory. The authors used parametric and non parametric tests to reach this conclusion.

Both of these studies concluded that the cryptocurrency market does not follow the random walk theory. These studies prove that the crypto currency market is an inefficient market. So what does this mean for the investors?

Implications for investors​

Investors in the cryptocurrency market need to be aware that the market is still very young and unproven. There is a lot of speculation going on, and prices can move erratically. As a result, it is important to be careful when making investment decisions.

There are a few possible explanations for why random walk theory does not seem to apply to crypto currencies.

One possibility is that the market is still too young and immature. The random walk theory assumes that all investors are rational and have access to all information. However, this is not necessarily true in the case of crypto currency markets. Many investors in this market are still learning about how it works and what its future will be. As a result, they may not always make rational decisions or have access to all of the relevant information.

Another possibility is that the prices of cryptocurrencies are too volatile to follow a random walk. The theory assumes that stock prices only change when new information becomes available. However, in the case of cryptocurrency markets, there is often a lot of speculation and speculation can drive prices up or down very quickly. This means that the prices of cryptocurrencies may not always reflect the underlying fundamentals of the market.

Finally, it is also possible that the random walk theory simply does not apply to cryptocurrency markets. There may be other factors at play that are causing the prices to move in a certain way.

How can investors benefit from inefficiency in crypto currency markets?​

The fact that random walk theory does not apply to crypto currency markets means that investors can use past information, trends and technical analysis to predict future returns. These studies imply that speculative investors need to create gainful investing strategies.

Arbitrageurs and hedgers will be especially attracted to the crypto market because of the market inefficiency. By analyzing past price movements, they will be able to take full advantage of future price movements.

Day traders can also benefit from this market inefficiency by using technical analysis to find patterns and exploit them for abnormal profits.

It is worth noting that, even if you are able to find patterns in the data, there is still a risk that you could lose money. Crypto currency markets are still very new and there is a lot of uncertainty about the future. As a result, you should always do your own research and only invest an amount that you are comfortable losing.
Well, yes. Random Walk theory is a good description of how financial markets work in general. However, I think that there may be some exceptions when it comes to cryptocurrency markets. I have seen patterns in these markets that do not seem to fit the Random Walk theory. For example, there seems to be a lot of price manipulation going on in these markets. There also seems to be a lot of insider trading. I think that these factors may cause the prices in cryptocurrency markets to deviate from what would be expected under the Random Walk theory.

I am not sure if the Random Walk theory can be applied to cryptocurrency markets in the same way as it can be applied to other financial markets. I think that more research is needed in this area before any definitive conclusions can be drawn.