EXCHANGE RATE VOLATILITY AND BITCOIN: A STATE SPACE AND KALMAN FILTER MODEL

OVIRA, TOFANI (2015) EXCHANGE RATE VOLATILITY AND BITCOIN: A STATE SPACE AND KALMAN FILTER MODEL. Masters thesis, UPT. Perpustakaan Unand.

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Abstract

Background Everyday activities people often make or receive payments in exchange for goods and services that have been received or given. The importance of the activities of payment itself is sometimes closed in the shadow of the urgency of its underlying transaction. Whereas payment function is particularly important in order to support the underlying transaction can run smoothly and work well. In a modern economy, traffic exchange of goods and services has been so fast that requires the support of the availability of reliable payment systems that allow payments faster, efficient, safe and reliable (Bank of Indonesia, 2006). Payment system is a system that includes setting, agreements, contracts/agreements, operational facilities, technical mechanism, standards and procedures that establish a framework that is used for the delivery, validation and acceptance of payment instructions as well as the fulfillment of payment obligations through an exchange of economic value (money) between the parties (individuals, banks, other institutions), both domestic and crossborder using payment instruments. In general, the payment system consists of several components in the form of policies, instruments/means of payment, clearing and settlement mechanism, institutional, supporting infrastructure and legal instruments. Some examples of tools/instruments of payment which has been known to us is cash, debit cards, credit cards, traveler's checks, and electronic payment instruments such as Internet banking, RTGS, credit transfers through clearing and so on (Bank of Indonesia, 2006). In terms of non-cash payment system, Bank Indonesia's interest to ensure that the non-cash payment system that is used by the people can run safely, efficiently and reliably. Therefore, the development of the use of non-cash payment have serious attention from Bank Indonesia in view of the development of non-cash payments is expected to reduce the burden of the use of cash and increase the efficiency of the economy in society. Although alternative technologies in terms of the use of non-cash payment instruments is very feasible to replace cash however the psychological aspects, safety, convenience and public confidence in the cash likely to remain an obstacle that still must be faced in the development of non-cash payment instruments (Bank of Indonesia, 2006). In the process, non-cash payment system is strongly influenced by the progress of technology development and changes in lifestyle of the people. Currently, the development of non-cash payment instrument goes very rapidly along with the development of payment systems technology in recent years have brought an enormous impact on the parties involved in the payment system. With the support of increasingly advanced technology, the user community as well as providers of non-cash payment systems are constantly searching for alternative non-cash payment instruments more efficient and safer. In addition, changes in trends and lifestyle of the people who accompanied the increase in the efficiency of the lifestyle demands the availability of telecommunication facilities and transport are so fast that the barriers of distance and time can be reduced. The development of telecommunications and transportation also have a considerable influence on financial transactions mainly related to the way of making payments between the parties. The last condition shows the interlinkage between the telecommunications industry, transportation and financial services among the three industries where there has been a convergence that integrates activities between the industry. For example, the mobile telecomunication services provider in order to increase the value added business has to offer to its customers the facility of payment transactions using a mobile phone. Similarly, in the field of transport, to improve efficiency in the transportation industry a wide range of payment instruments have been used so that transport users can make payments more quickly, efficiently and safely. Convergence between different industries such as financial services, telecommunications and transportation is a beginning that will be the trigger for non-cash payment instruments in society (Bank of Indonesia, 2006). The future will be more industries that will be converged because the growing of interlinkage. Various new business is expected to continue to grow and develop, especially since the development of telecommunication network, computer and internet access is growing among the people and the technology is getting cheaper. This is certainly going to push the cost of non-cash payment transactions become more affordable because of lower handling fee when compared to using cash transactions (Bank of Indonesia, 2006). In the development of non-cash payments, today in various countries shows that the tools/instruments micro payments has also developed rapidly along with the development of technology and the needs of society to use the payment instrument that is easy, safe and efficient. Micro payment instruments are payment instruments that are designed to address the needs of a transaction with a very small value but high volume transaction processing and takes relatively very fast. Micro payment instrument needs arise because if the payment is made using other payment instruments that exist today (eg cash, debit cards, credit cards and so on) to be relatively impractical, inefficient, uncomfortable or even more costly. Unlike other payment instruments such as credit cards or debit cards that setting a minimum number of transactions and the additional cost is quite expensive, micro payment instruments should be used to make payments in small amounts with a relatively small transaction fee anyway. The opportunity for non-bank institutions to be able to become a publisher of micro payment tool will open up opportunities to the general public, though not customers of the bank, to be able to use the facilities of micro-payments. This course will further improve public access to non-cash payment instruments (Bank of Indonesia, 2006). However, after of that today there is a new payment system technology that we are familiar with Bitcoin. Bitcoin is an electronic money created in 2009 by Satoshi Nakamoto. The name is also associated with open source software that he designed, and also uses peer-to-peer without a single centralized storage or administrator where the US Treasury called the bitcoin a decentralized currency. Unlike currencies in general, bitcoin does not depend on the trust major publishers. Bitcoin uses a distributed database and spread to the nodes of a P2P network to journal transactions, and using cryptography to provide basic security functions, such as ensuring that the bitcoins can only be spent by people have it, and should never be done more than one occasion. Bitcoin has served approximately 41.8 million transactions between 62.8 million accounts. As of July 2014, the daily transaction volume was approximately 100,000 bitcoin (roughly $50 million at market exchange rates) and the total market value of all bitcoins in circulation was $8 billion (Blockchain.info, 2014). Furthermore, Moore and Christin (2014) said that as of January 2013, Bitcoin’s market capitalization is approximately US$187 million. However, with success comes scrutiny, and Bitcoin has been repeatedly targetedby fraudsters. For instance, over 43,000 Bitcoins were stolen from the Bitcoinica trading platform in March 2012; in September 2012, $250,000 worth of Bitcoins were pilfered from the Bitfloor currency exchange. Interestingly, experience from previous research does not suggest that failures necessarily trigger an exodus from the currency. The rise of Bitcoin’s popularity has attracted a growing interest among economists in general (Grinberg, (2011); Barber et al (2012); Kroll, Davey and Felten, (2013); Moore and Christin, (2013)), and in BitCoin’ price formation in particular (Buchholz et al (2012); Kristoufek, (2013); Wijk, (2013). Several factors affecting Bitcoin price have been identified in the previous literature: (i) market fundamentals such as Bitcoin supply and demand Buchholz et al (2012); (ii) attractiveness for investors (Kristoufek, 2013); and (iii) development of global financial indicators (Wijk, 2013). Buchholz et al (2012) note that an important determinant of Bitcoin price (as price of any currency) is the interaction between Bitcoins’ supply and demand. The supply of Bitcoin determines the amount of units in circulation and thus its scarcity on the market. The demand of Bitcoin is mainly determined by transaction demand as a medium of exchange. Buchholz et al. argue that Bitcoin price is an outcome of interaction between supply and demand. According to (Kristoufek, 2013), the price formation of Bitcoin cannot be explained by standard economic theories, because supply-demand fundamentals, which usually form the basis of currency price formation, are absent on Bitcoin markets. First, Bitcoin is not issued by a specific central bank or government and thus is detached from the real economy. Second, the demand (and supply) for Bitcoin is driven also by investors’ speculative behaviour, because there is no interest rate for the digital currencies and thus profits can be earned only from price changes. (Wijk, 2013) stresses the role of global financial development, captured by stock exchange indices, exchange rates, and oil prices measures in determining BitCoin price. Wijk also finds evidence that the Jones index, the euro-dollar exchange rate, and oil price have a significant impact on the value of Bitcoin in the long run. The story of Bitcoin is, however, equally unique as it is controversial. With a dollar value of $0.3 per Bitcoin in January 2011, the exchange rate skyrocketed through $1300 in November 2013. This considerable increase in dollar value and foremost the volatile exchange rate fluctuations in early and late 2013 not only incur the attention of national regulators, but also raise concerns about the utility of the Bitcoin transaction system and the rationality of its users. Foremost, the high exchange rate volatility provides indications that Bitcoin is not utilized as alternative transaction system, but rather considered as a speculative financial asset. In 2012, the European Central Bank stated that Bitcoin should be considered as a high-risk system for its users from a financial perspective. Up to now it is not easy to assess whether or not the Bitcoin system might be a pyramid or even a Ponzi scheme (European Central Bank, 2012). China has announced to prohibit the use of Bitcoin as currency for financial institutions (Ruwitch and Sweeney, 2013). The development of Bitcoin growing day by day, for that the author interested to discuss whether the exchange rate can affect the new method that we call Bitcoin. This research will be poured into a thesis entitled: “Exchange Rate Volatility and Bitcoin: A State Space and Kalman Filter Model”

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