Risk in Mining and Cryptocurrency Returns: Evidence from Electricity Prices

Abstract

This study extends the production--based asset pricing framework into cryptocurrency markets by examining cryptocurrency miners' optimization. Under q--theory, cryptocurrency miners optimally adjust the supply of cryptocurrencies to changes in electricity prices. The first–order condition of valuation function infers cryptocurrency returns from miners’ exposure to changes in electricity prices. Our empirical analysis confirms the model implications and shows that the rolling--window exposure of cryptocurrency returns to percentage changes in electricity prices (beta_M) can positively predict the cross--section of future cryptocurrency returns across major exchanges. Further evidence reveals that the predictive power of beta_M is more pronounced when estimating beta_M with electricity prices from mining--intensive regions. A global risk--in--mining factor can explain, across different cryptocurrency exchanges, a series of well--documented cryptocurrency anomalies including the ones regarding cryptocurrency market capitalization and momentum.