Principal Components Analysis: Impact on Alternative Crypto-Currencies

Principal Components Analysis: Impact on Alternative Crypto-Currencies

Nabiha Haouas (University of Sousse, Tunisia) and Asma Sghaier (University of Sousse, Tunisia)
DOI: 10.4018/978-1-7998-9117-8.ch006
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Today, cryptocurrencies are rapidly gaining popularity and sweeping all the economies of the world, but the bulk of the literature is devoted to a few cryptocurrencies only. The purpose of this chapter is to analyze of the cryptocurrency market. More than 2000 cryptocurrencies are examined, and a set of 70 cryptocurrencies were recovered for a sample spanning 2015-2018. The degree of relationship between the variables was then investigated. The PCA was performed. This analysis allows the initial variables to be replaced by five factors that retain almost all of the information (91.028% of the total information) and have the advantage of being uncorrelated. Therefore, the authors have concluded that the first factor corresponds to the cci30 index used by the crypto funds while the rest of the factors can be distinguished according to some variants.
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Nowadays crypto-currencies represent a combined market capitalization of about 500 billion dollars, says the portal CoinMarketCap. Moreover, according to the latest report from the US firm “Research and Markets”, the global market for crypto-currency and blockchain technology will grow by 35.2% over the 2016-2022 period. Crypto-currencies are a real revolution both technologically and financially. Indeed, crypto-currencies are rapidly gaining popularity in recent years and sweeping all the economies of the world. Now, we have many crypto-currencies, but most are similar and derive from the first full implementation: Bitcoin.

The creation of this crypto-currency corresponds to the financial crisis of 2008, which was a consequence of a loss of investors’ confidence in the traditional financial system. Moreover, as any radical innovation, the disruptive nature of the technology that carries the crypto-currency, supported by the new economic logic that generates the expansion of the Internet, appears as a potential threat vis-à-vis the existing monetary order. It should also be emphasized that these crypto-currencies are based on cryptographic mechanisms that have many important properties, such as the transparency of transactions and the absence of a central regulatory authority. Today, they are alternative currencies because they do not have legal tender in any country, even if they are for the moment widely tolerated. It is therefore important to consider crypto-currencies as a means of “democratizing finance” within alternative (transnational) spaces and to restore to individuals this “common good” that is money.

We will start with a small definition of crypto-currency: “A crypto-currency, also called crypto-currency or cryptographic currency, is electronic money usable on a peer-to-peer or decentralized computer network, based on the principles of cryptography, that we can self-issue and settle transactions “. Although the established crypto-currencies have most often a price in euro or dollar (it is easier to reason by saying that 1 Bitcoin worth 11348 USD), a crypto-currency could simply be a means of unencrypted payment. In addition, it is a currency in the primary sense of the term that only allows the measurement of wealth, which will serve as a Gold Exchange Standard. For this reason, these crypto-currencies offer possibilities for expansion and autonomy with respect to the standard system and their current development is a continuation of the upheavals introduced by the deployment of digital techniques in the field of computer software and communication.

At the same time, many innovations have reached maturity. Indeed, these last ten years have seen the maturity of different computer protocols implementing various crypto-currencies. While, regularly quoted in the media, Bitcoin appears as the most popular crypto-currency of the public among the various existing virtual currencies, it is not necessarily the most popular with investors in the market. Internationally, the year 2019 was a decisive year for crypto-currencies with a daily volume of transactions exceeding that of certain stock exchanges. Regardless of all these factors and concerned about the potential cap on the price of equities, investors are increasingly injecting funds into crypto-currencies, a largely untapped market that until recently was still the realm of professional traders. While various laws against fraudulent activity protect traditional financial investments, the crypto-currency markets are totally devoid of this protection. In such a case, any losses due to a stock market crash could be enormous.

The transactions are fast and global, they spread almost instantly on the network and are confirmed in minutes. They are completely indifferent to your physical location, because they occur in a global network of computers. The crypto-currency market is fast and free. Almost every day, new crypto-currencies emerge, old ones disappear, pioneers get richer and investors lose money. To do this, all people ask the same question: what is the best crypto-currency in which to invest? It is therefore essential to examine carefully the crypto-currency in which an investor wants to invest and understand the content of this market.

Key Terms in this Chapter

KMO (Kaiser-Meyer-Olkin): Is a statistical measure to determine how suited data is for factor analysis. The test measures sampling adequacy for each variable in the model and the complete model. The statistic is a measure of the proportion of variance among variables that might be common variance. The higher the proportion, the higher the KMO-value, the more suited the data is to factor analysis.

CCI30 Index: The CCi30 is a rules-based index designed to objectively measure the overall growth, daily and long-term movement of the blockchain sector. It does so by tracking the 30 largest cryptocurrencies by market capitalization, excluding stablecoins. It serves as a tool for passive investors to participate in this asset class, and as an industry benchmark for investment managers. For achieving its objectives, the CCi30 has been designed with 5 main characteristics: 1. diversified; 2. replicable; 3. transparent; 4. provides in-depth coverage of the entire sector; 5. presents the best risk-adjusted performance profile possible.

Bitcoin: Is the cryptocurrency with the highest valuation. But it is also the name of a blockchain protocol that allows peer-to-peer transactions to be carried out transparently and securely.

CoinMarketCap: Is the world's most trusted and accurate source for crypto market capitalizations, pricing, and information.

Principal Component Analysis (PCA): Or, depending on the field of application, Karhunen–Loève transformation (KLT) or Hotelling transformation, is a method of the family of data analysis and more generally of multivariate statistics, which consists of transforming linked variables between they (known as “correlated” in statistics) into new variables uncorrelated from each other. These new variables are called “principal components” or principal axes. It allows the statistician to summarize information by reducing the number of variables. This is an approach that is both geometric (the variables being represented in a new space, along directions of maximum inertia) and statistical (the search for independent axes best explaining the variability — the variance — of the data). When we want to compress a set of N {\displaystyle N} N random variables, the first n {\displaystyle n} n axes of the principal component analysis are a better choice, from the point of view of inertia or the variance. The mathematical tool is applied in fields other than statistics and is sometimes called orthogonal eigenvalue decomposition or POD.

CoinDesk: Is a news site specializing in bitcoin and digital currencies. The site was founded by Shakil Khan and was subsequently acquired by Digital Currency Group.

Ethereum: Is a decentralized exchange protocol allowing users to create smart contracts. These smart contracts are based on a computer protocol to verify or enforce a mutual contract. They are deployed and publicly viewable in a blockchain. Ethereum uses a unit of account called Ether as a means of payment for these contracts. Its corresponding acronym, used by trading platforms, is “ETH”. Ethereum is the second largest decentralized cryptocurrency with a capitalization exceeding 448 billion euros in October 2021.

Cryptocurrency: Cryptocurrency, sometimes called crypto-currency or crypto, is any form of currency that exists digitally or virtually and uses cryptography to secure transactions. Cryptocurrencies don't have a central issuing or regulating authority, instead using a decentralized system to record transactions and issue new units.

Litecoin: Litecoin (LTC) is decentralised money, free from censorship and open to all. Send low cost private, secure, borderless payments to anyone, anytime, anywhere.

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