# Do Cryptocurrency Prices Camouflage Latent Economic Effects? A Bayesian Hidden Markov Approach +
## 1 Introduction  
What are cryptocurrencies? How do they compare to traditional financial instruments? Are they like traditional money, like commodities, a hybrid of the former or an utterly new type of asset that merit their own definition and understanding? Early research, mainly focusing on Bitcoin(henceforth BTC), provides mixed insights. While the creation of new BTCs resembles the mining process of gold--or precious metals in general--its attributes clearly differentiate it from conventional commodities [1]. The claim that BTC is fundamentally different from valuable metals like gold is also backed by [PERSON] et al. [2] due to its shortage in stable hedging capabilities. Along with [3], [PERSON] and [PERSON] [1] also argue that standard economic theories cannot explain BTC price formation and using data up to 2015, they provide evidence that BTC lacks the qualities necessary to be qualified as money. However, using GARCH models, [PERSON] [4] demonstrates that BTC has similarities to both gold and the US dollar (USD) and somewhat surprisingly that it may be ideal for risk-averse investors. Also, while the BTC is useful to diversify financial portfolios--due to the negative correlation to the US implied volatility index (VIX)--it otherwise has limited _safe-haven_ properties [5; 6; 7]. Using data from a longer period (between 2010 and 2017), [PERSON] et al. [8] conclude the opposite, namely that BTC may indeed serve as a hedging tool, due to its relationship to the Economic Policy Uncertainty Index (EUI). The fact that cryptocurrencies are different from any other asset in the financial market is further supported by [9; 10; 11]. High volatility, speculative forces and large dependence on social sentiment at least during its earlier stages--as measured by social media and Internet data (Google trends, Wikipedia searches and Twitter posts)--are qualified by many as some of the main determinants of BTC prices [12; 13]. Yet, a large amount of price variability remains unaccounted for. Moreover, the proliferation of cryptocurrencies other than BTC that are supported by different technologies, i.e., variations of the standard Proof-of-Work distributed consensus of the BTC blockchain, e.g., [14], calls for a more comprehensive research approach. Despite the high documented correlation in the price of the various cryptocurrencies, it is highly debated whether this trend will also continue into future or not [15; 16]. In the present paper, we make an effort towards understanding the correlation between a set of traditional assets and cryptocurrencies. We adopt an economic/financial perspective and use a set of 14 financial and economic predictors comprising main exchange rates (4 variables), equity indices (4 variables), commodity future prices (oil and gold) and economic uncertainty indicators (2 variables) along with 2 quasi-economic and 2 cryptocurrency specific variables: the hash rate which captures the amount of investment on mining equipment and hence accounts for the economic size of the network and the average block size which implicitly measures the amount of transactions and hence the activity in the respective cryptocurrency. All the variables and the applied transformations are summarized in Table 1. Also, we report the correlations between the explanatory variables in Table 2.  
Earlier studies highlight the scarcity of results on cryptocurrencies other than BTC and underline the need for a better understanding of the entire cryptocurrency ecosystem and its properties (statistical and economic), see e.g., [11; 17]. Studies that go beyond the BTC prices and confirm via various financial models the importance of using diverse cryptocurrencies--rather than a single one--in portfolio optimization include but are not limited to [18] and [15]. In view of the above, in the present study, apart from Bitcoin (BTC), we also focus on Ether (ETH), the native coin of the Ethereum blockchain [14; 19], and currently the second largest cryptocurrency in terms of market capitalization [20].