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

As it turns out, social media sentiment may really be the key to profitable short-term crypto trading strategies.

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Social media platforms are quite powerful tools for predicting crypto prices, according to a recent study by finance professors and a PhD student at Pennsylvania State University. 

They found sentiment on social media significantly influences short-term crypto returns. Sentiment from the news media, however, barely moved the needle.

“The results … strongly support the hypothesis that sentiment extracted from social media predicts cryptocurrency returns, while sentiment derived from news media does not.”

Reflections laid out in the paper, titled “An Anatomy of Cryptocurrency Sentiment,” show smaller cryptocurrencies — which don’t get as much media attention — are more influenced by the overall sentiment of the market, as filtered by social media.

“… We observe that both crypto specific and market-wide sentiments matter, but the predictive power of the latter is economically and statistically stronger,” they said.

“This finding may be counter-intuitive as it would be natural to expect that only sentiment tied to fundamental events would have predictive power, but it turns out that in the cryptocurrency market, sentiment, even when decoupled from fundamental events, does matter for returns.”

The study included 267 cryptocurrencies, excluding stablecoins, covering the period between Jan. 1, 2018 to April 4, 2021. Market caps for all tokens were under $1 million.

Emotions influence crypto prices

Anecdotal evidence cited for social media’s potential impact on crypto prices included Dogecoin’s 10,000% rally after a string of supportive tweets from Elon Musk and other celebrities in 2021. 

Another incident was FTX’s token, FTT, collapsing 70% in one day after Binance CEO Changpeng Zhao tweeted that Binance would liquidate its holdings. FTX would declare bankruptcy only two weeks later.

In showing more scientific proof that social media sentiment was linked to crypto prices, the researchers noticed a trend: positive events like code updates, crypto adoption and innovation generally boost sentiment, while negative events like regulatory crackdowns or scams tend to dampen it.

Both social and news media generally expressed positive attitudes toward cryptocurrencies throughout the duration of the study, researchers said. The team used sentiment data from Refinitiv MarketPsych Analytics. 

Per the paper, social media discussions have a significant impact on shaping sentiment, with emotions influencing how people perceive cryptocurrency value, and thus, actual returns.

Unlike discussions and posts on social media, journalistic articles tend to provide more factual information and may appear less emotionally charged, they found.

Researchers wrote: “… While events that may be considered ‘fundamental’ to cryptocurrency value, such as news on transaction speeds, code upgrades, anonymity, currency adoption, and technological innovations, impact market sentiment, they do not fully explain it.”

“Importantly, we observed that it is the unexplained sentiment, which we refer to as ‘exuberance,’ that consistently and significantly predicts cryptocurrency returns.”

Read more: ‘Crypto Doesn’t Care About Fundamentals.’ Is That Sustainable?

‘Momentum’ strategy pays off when sentiment is high

The team studied daily returns of a long-short crypto portfolio with a holding horizon of one week.  

By comparing data during periods of both positive and negative sentiment, it was possible to calculate the profitability of short-term “momentum” strategies based on social media chatter and the like. 

The momentum strategy effectively boiled down to quantifying market sentiment for individual cryptocurrencies and “longing the winners, shorting the losers.”

The researchers found that the momentum strategy wasn’t significantly profitable on average — but it was when market exuberance was high. And when market sentiment was low, the strategy wasn’t really effective.

Overall, increased crypto prices (or “perceived cryptocurrency value”) were associated with increased market exuberance.

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

“This finding suggests that market participants might be reacting to a general mood of optimism or pessimism, reflected in market exuberance, rather than reacting to any tangible changes in the fundamentals.”

Yale University academics recently conducted a separate study examining the influence of social media on crypto returns. Their research uncovered that crypto projects with a greater volume of posts from Twitter bots tended to have lower long-term returns.

David Canellis contributed reporting.


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