The dizzying rise of cryptocurrencies, from Bitcoin to Ethereum to Dogecoin, and their underlying technologies are signaling potential disruptions to the traditional world of finance. Cryptos and blockchain are decentralizing finance in ways that were difficult to imagine only a few years ago. Today, the crypto market itself is about to experience a new set of disruptions and, this time, by a different type of technology, artificial intelligence (AI). AI and machine learning (ML) can dramatically improve predictions or the decision making process, supporting traders in developing superior strategies that can in turn help generate more alpha.
The Current State of Crypto
Bitcoin was first introduced to the world in 2009 and, as of the time of this writing, more than 6,700 alternative coins (“altcoins”) have followed. Over the past 12 years, the crypto market has grown substantially. Recently, the Chairman of the U.S. Securities and Exchange Commission, Gary Gensler, publicly stated that “this asset class purportedly is worth about $1.6 trillion, with 77 tokens worth at least $1 billion each and 1,600 with at least a $1 million market capitalization.”
According to a 2021 study by Fidelity Digital Assets, seven out of ten institutional investors surveyed already hold investments in digital assets, with investors in Asia and Europe outpacing the U.S. in terms of investment rate. Bitcoin and Ethereum both have been key drivers in growing adoption in Europe. However, more than half of the investors surveyed globally consider “price volatility” as one of the greatest barriers to investment in this area.
The popularity of cryptocurrencies has grown to such an extent that certain governments are considering adopting them officially. In fact, in September 2021, El Salvador became the first country in the world to make Bitcoin legal tender. And, other governments may be following suit. Even countries such as China are considering creating their own digital currencies.
AI in Finance
Over the years, AI has been a powerful weapon that is rapidly transforming the global financial services industry. Its wide-ranging applications span from fraud detection and compliance to robo-advisors, algorithmic trading, and much more. In the investment sector, firms that have effectively leveraged AI have been able to generate superior returns, far outperforming the S&P. Medallion Fund for example “has returned an astonishing 71.8% per annum (or around 38% net of fees) over its [first] 29 years, versus about 10% for the S&P 500.” Machine learning has the power to help companies quickly analyze large quantities of data to uncover valuable patterns, trends, and other insights that would be otherwise impractical, either too time consuming or too laborious, for people to extract on their own.
Predicting trading patterns is exceptionally difficult because there are myriad explanations as to why a particular stock price can fluctuate on any given day. For example, in the field of behavioral finance, research has shown how psychological factors, like sunshine and weather, can influence a human trader’s investment decisions. Additionally, global catastrophes, new regulations, political changes, inflation, and other factors impact stock prices. All of this showcases the butterfly effect, where small changes in initial conditions can lead to drastic changes in the results. In stock trading, the results are stock prices, and any change to the global environment, from something as simple as sunny weather in New York on a particular day can have real implications on the market. With the diversity and abundance of data available today, AI can be utilized to make advanced predictions.
Crypto trading with machine learning
The crypto ecosystem is transforming rapidly as digital adoption increases worldwide. As more people buy into these digital assets, more channels are created for individuals to trade them. Now, in many places, you can purchase a cryptocurrency almost as readily as you could a public stock. It’s as simple as reaching into your pocket, grabbing your smart phone, downloading a cryptocurrency investment app, and making your first purchase.
In the U.S., it is estimated that 15% of consumers already own either Bitcoin or an altcoin. 70% of institutional investors also own crypto assets. However, for an investor, whether individual or institutional, it is difficult to keep pace with the volatility and the volume of information created in the world of crypto every minute. And keep in mind that, unlike the traditional stock markets that are highly regulated and active only part of weekdays, the crypto market is largely unregulated and active 24/7, 365 days a year. This persistent activity, places unrelenting pressure on traders, leaving them feeling overwhelmed, causing tremendous stress and fatigue. A mere tweet from a celebrity can send crypto prices to the moon or bring it crashing down to earth.
Here is where machine learning can be of value when properly designed and implemented. By continually analyzing voluminous and diverse data, using large computing clusters, advanced ML models can forecast changes to cryptocurrency prices in ways unfeasible for traditional human analysts or traders. To generate better returns in the crypto market, you need a solid investment strategy, suitable for a volatile and speculative asset class, augmented with sophisticated AI capable of analyzing pricing trends, news articles, social posts, and diverse technical indicators. At Entefy, our team has added new machine learning models and capabilities to our multimodal AI platform specifically for the crypto market, providing machine intelligence including price forecasting, volatility analysis, market sentiment analysis, and more to help traders develop superior strategies.
In little more than a decade, cryptocurrency has evolved from a single nascent digital coin, into a vast cohort of global altcoins that is collectively disrupting the traditional world of finance. Making sense of the rapidly moving market and forecasting prices is an insurmountable challenge for any investor. Fortunately, technology is evolving quickly, with AI at the forefront to meet this challenge and support this decentralized community.
Be sure to check out our previous blogs on 6 other creative uses of AI and the differences between traditional data analytics and machine learning.