In traditional stock markets, researchers have long known that certain patterns can predict future returns. For example, stocks that have performed well recently often continue to do well (momentum), and less liquid stocks tend to offer higher returns to compensate for their trading difficulties. What’s particularly interesting is that these patterns often interact – their combined effect can be greater than the sum of their parts.

But what about the cryptocurrency markets? Despite the explosive growth of crypto trading, we still don’t fully understand how these digital assets behave. Do they follow similar patterns to stocks? Do these patterns interact in any meaningful way? These questions aren’t just academically interesting – they’re crucial for investors trying to navigate this new asset class.

A new study by Aleksander Mercik, Barbara Będowska-Sójka, Sitara Karim and Adam Zaremba colleagues tackles these questions head-on, analyzing over 500 major cryptocurrencies from 2017 to 2023. The researchers examined 40 different market characteristics, ranging from basic measures like trading volume and price momentum to more sophisticated metrics like blockchain network activity and investor attention.

Key Findings:

Patterns Do Interact: The study found evidence that different market signals reinforce each other in crypto markets. For example, when measures of liquidity (how easily a crypto can be traded) were combined with measures of risk (how volatile the price is), the effect on future returns was often stronger than either signal alone. This suggests that crypto markets are more complex than simple single-factor models might suggest.

Size Creates Opportunity (and Challenge): Most of these interaction effects were concentrated in smaller cryptocurrencies rather than giants like bitcoin. When the researchers weighted their analysis by market capitalisation, many of the effects disappeared. This suggests that while smaller cryptos may offer more opportunities for sophisticated trading strategies, they also present greater practical challenges in terms of trading costs and liquidity.

Trading Strategy Potential: The researchers developed trading strategies based on these interactions and achieved impressive results. A strategy that bought cryptos with the strongest positive interactions and sold those with negative interactions generated strong risk-adjusted returns. However, these returns were significantly reduced when realistic trading costs were taken into account.

Market Efficiency Insights: The study provides important insights into the efficiency of cryptocurrency markets. The presence of these interaction effects, especially in smaller cryptos, suggests that crypto markets may not be fully efficient. However, the fact that many effects disappear when trading costs are taken into account suggests that market forces are at work – it’s just that practical constraints prevent traders from fully eliminating these patterns.

Why This Matters:

This research is important for several reasons:

• For investors, it provides a more sophisticated framework for analyzing crypto investments, suggesting that looking at multiple factors in combination might be more valuable than focusing on single indicators
• For market observers, it helps explain why certain patterns persist in crypto markets despite being well-known
• For academics, it provides evidence that crypto markets share some fundamental similarities with traditional financial markets while also having unique characteristics

The study represents a significant step forward in our understanding of cryptocurrency markets, bridging the gap between traditional financial theory and this new asset class. While the findings suggest potential opportunities for sophisticated trading strategies, they also highlight the practical challenges of implementing such strategies in markets that can be expensive and difficult to trade.

This more nuanced understanding of how cryptocurrency markets work is crucial as these assets continue to mature and attract institutional interest. The research suggests that while crypto markets might offer unique opportunities, they’re governed by many of the same fundamental forces that drive traditional markets – just with their own distinctive twists.

Full paper: https://www.sciencedirect.com/science/article/abs/pii/S1057521924007415?via%3Dihub

Mercik, A. R., Będowska-Sójka B., Karim S., Zaremba A. (2025). Cross-sectional interactions in cryptocurrency returns. International Review of Financial Analysis, 97. https://doi.org/10.1016/j.irfa.2024.103809