Crypto prices predicted by social media sentiment more than headlines: Study

According to a recent study by finance professors and a PhD student at Pennsylvania State University, social media networks are extremely effective resources for forecasting cryptocurrency prices.
They discovered that social media mood has a considerable impact on short-term crypto returns. However, sentiment from the news media seldom made a difference.

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“The results… strongly support the hypothesis that sentiment extracted from social media predicts cryptocurrency returns, whereas sentiment derived from news media does not,” the study’s authors write.

Reflections presented in the article, “An Anatomy of Cryptocurrency Sentiment,” demonstrate that smaller cryptocurrencies, which receive less media coverage, are more influenced by the market’s general mood as transmitted through social media.

We notice that both cryptocurrency-specific and market-wide sentiments matter, but that the latter’s predictive potential is statistically and economically stronger.

This discovery may seem counter-intuitive because it would make sense to assume that only sentiment connected to fundamental events would have predictive value, but it turns out that sentiment in the bitcoin market does important for returns even when it is unrelated to fundamental events.

Stablecoins were not included in the study, which covered 267 cryptocurrencies from January 1, 2018, through April 4, 2021. All tokens’ market capitalization were less than $1 million.

When sentiment is positive, the “momentum” method is successful.

The group looked at the daily returns of a long-short cryptocurrency portfolio with a one-week holding period.

It was feasible to determine the profitability of short-term “momentum” initiatives based on social media chatter and similar phenomena by comparing data during periods of both positive and negative sentiment.

Quantifying market sentiment for certain cryptocurrencies and “longing the winners, shorting the losers” effectively sum up the momentum strategy.

The researchers discovered that while the momentum strategy was profitable when market excitement was high, it was not always so. Additionally, the method wasn’t really successful when market mood was poor.

In general, rising cryptocurrency prices (or “perceived cryptocurrency value”) were linked to rising market euphoria.

“We conclude that market exuberance affects price perception and/or investors’ demand, thereby contributing to explaining momentum returns in the cryptocurrency space,” the researchers wrote.

This research implies that rather than responding to any obvious changes in the fundamentals, market participants may be responding to an overall sentiment of optimism or pessimism, expressed in market enthusiasm.

Researchers from Yale University recently conducted a separate study to look at the impact of social media on cryptocurrency returns. They found that crypto projects had a tendency to have worse long-term returns when there were more tweets from Twitter bots.