Strix Leviathan designs and operates algorithmic trading software for the cryptocurrency markets. The global nature and uncertainty surrounding the nascent cryptocurrency asset class leads to a market that is entirely defined by the behavioral patterns of market participants. Separating fact from fiction and noise from signal is no easy task in a market with such highly fractured datasets and limited historical precedent. One particular question we decided to explore given the timing is, does a halving event result in a statistically different return profile that leads to outperformance against the market?
We found no evidence that cryptocurrency assets experiencing a halving event outperform the broader market in the months leading up to and following a reduction in miner rewards.
An asset’s return distribution prior to and following a halving is statistically the same as the rest of its return distribution with a high degree of confidence, suggesting that there is no evidence of abnormal pricing action from a shift in supply and demand dynamics.
LTC outperformed the market in the months leading up to both halvings but performance fell to the bottom 25% of the market following the first halving.
BTC displayed the polar opposite behavior of LTC, with poor relative performance leading up to the halving and a stronger relative performance following the halving.
The development of a narrative to explain complex and opaque market behavior persists in every financial market; however, cryptocurrency investors must do so with an extremely limited historical record. This has led to all sorts of unsubstantiated belief systems with scant supporting evidence that are nonetheless widely accepted as true. One such narrative in the cryptocurrency asset class centers around the Bitcoin halving event and can be summarized as follows:
The halving of mining rewards has the effect of reducing sell pressure from miners which in turn creates an imbalance in supply and demand that then facilitates a dramatic escalation of price.
Perhaps right on cue, commentary around the halving narrative grew exponentially during Q2 of 2019. If you follow both traditional media and social media conversations surrounding the upcoming reduction in miner rewards for the Bitcoin and Litecoin blockchains, then you would suspect the narrative is a settled fact and all one needs to do is HODL in order to reap the excess returns. While the narrative is certainly feasible as a logical theory, it is equally possible that we are dealing with an illusion of validity and previous bull runs were the result of nothing more than increasing levels of speculation within the asset class.
Limited sample sizes and historical data make validation of any narrative particularly difficult in this space. So, in order to test the supply and demand theory underpinning this widely accepted narrative, we gathered data on 32 halvings across 24 assets (full list below) that experienced a reduction in miner rewards based on a predefined schedule as well as 320 additional markets for cross-sectional comparison which we define as the market. We then split the data into a one, three, and six-month pre-halving period, a one, three, and six-month post-halving period, and a non-halving period performing the following analysis:
Backtested the performance of cryptocurrencies with a mining reward reduction and cryptocurrencies not experiencing a halving during the same timeframe then bucketed each asset’s performance metrics into quartiles.
Utilized statistical analysis to determine if an asset’s halving period return distribution was statistically different than the return distribution when the asset is not within a halving period.
Before discussing results, it is worth acknowledging two assumptions we find to be implicit if the halving event results in an underlying shift in supply and demand dynamics:
An immediate and abrupt shift in supply relative to demand will represent itself in an asset’s price fairly quickly following a miner reward reduction.
Cryptocurrencies that experience a halving will, on average, outperform the rest of the market during the post-halving timeframe since one set of assets experiences reduced selling pressure from the mining community while the other set does not.
After completing our analysis, we found that there is limited impact of a halving event on pricing action. Examining total return, Sharpe, and Sortino ratios reveals that assets experiencing a halving — both leading up to and following a halving — perform no better than the rest of the market. In terms of the two most prominent cryptocurrencies in which the halving narrative proliferates, Bitcoin (BTC) & Litecoin (LTC), we see the polar opposite behavior. LTC has now outperformed the market twice in the pre-halving period with performance falling to the bottom 25% in the six months following the first halving. BTC on the other hand lagged the market leading up to the halving but was in the first quartile of performance following the last halving. The divergence and seemingly random results before and following a halving suggests that the underlying factors driving price is not a shift in supply and demand dynamics.
Further evidence suggesting the halving event has a limited impact on market prices can be found by analyzing each asset’s time series and comparing the asset against itself. What we find is that the return distribution of an asset’s halving periods versus the return distribution outside of its halving periods reveals that they are statistically the same at a 99% confidence level. In other words, we did not find evidence that a halving event results in abnormal pricing action and we are dealing with a circumstantial illusion.
So what exactly does this mean in a broader sense and for BTC in particular which did outperform the market following the last halving? From a broader standpoint, there is little-to-no evidence within the data that suggests an asset’s pre- and post-halving returns are the result of anything other than broader market sentiment. In regards to BTC, it is possible that the asset experienced greater-than-market performance due to the widespread belief in the narrative amongst cryptocurrency enthusiasts. However, the lack of evidence supporting the theory underpinning the halving narrative when examining a broader group of assets indicates the previous BTC bull runs were equally likely to be the result of other factors. Additionally, we advise against drawing inferences about any single market from a sample size of one.
The supply and demand theory underpinning the narrative is logical and thoughtfully conceived but we would do well to remember that the world of financial markets is filled with tens of thousands of logical and thoughtfully conceived theories that don’t turn out to be true in practice. It appears more likely that the return behavior before, during, and after a halving coincides more with increasing levels of speculation than with an underlying shift in sell side pressure.
Research conducted by Nico Cordeiro and Ava Masucci
Assets evaluated in this analysis include: BTC, LTC, XVG, FTC, MONA, NMC, FLO, POT, ABY, CURE, NYC, MOON, VTC, EMC2, IOP, MEME, COLX, ONION, DIME, LINDA, UNO, TRC, ANC, and SXC.
The information contained or attached herein is not intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. This material may contain forward-looking statements that are within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on management’s beliefs, as well as assumptions made by, and information currently available to, management. Although management believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to be correct. This research is for informational purposes only and does not constitute an offer to sell, or the solicitation of an offer to buy, any security, product, service of Strix Leviathan LLC. Copyright 2019 Strix Leviathan LLC. All Rights Reserved.