Self-sustained price bubbles driven by Bitcoin innovations and adaptive behavior

TL;DR

This paper demonstrates that self-sustained price bubbles can form in digital currencies like Bitcoin due to traders' adaptive behaviors and the infinite divisibility of the trading commodity, supported by a multi-agent model.

Contribution

It introduces a multi-agent model showing how adaptive investment strategies and commodity divisibility lead to persistent price bubbles in digital currencies.

Findings

Bubbles can be self-sustained through adaptive trader behavior.

The model quantifies return, volatility, and crash risk of bubbles.

Digital currencies are plausibly driven by such bubble dynamics.

Abstract

We show that infinite divisibility of a trading commodity leads to a self-sustained price bubble when traders use adaptive investment strategies. The adaptive strategy can be viewed as a psychological response of a trader to the situation when the trader's estimation of future prices does not match the actual, realized price. We use a multi-agent model to illustrate the price bubble formation and to quantify its main statistical properties such as the return, the volatility, and the systematic risk of the price bubble to crash. We discuss the plausibility for bubbles to drive prices of digital currencies.