Cryptocurrencies such as Bitcoin or Ethereum have attracted much attention, because of both meteoric price swings and their advocates’ claim that they represent a new model of decentralised trust. Many are analysing the validity of such claims and the economics of the underlying technology (Biais et al. 2018, BIS 2018, Carstens 2018a, 2018b, CPMI 2015, Huberman et al. 2017, Landau and Genais 2018). Concurrently, many national authorities and international bodies have expressed concerns about market integrity and consumer protection issues, as well as the scope opened up for illicit activities such as money laundering and terrorist financing (e.g. G20 Finance Ministers and Central Bank Governors 2018, Financial Stability Board 2018, Carney 2018).
Cryptocurrencies are often thought to operate beyond the reach of individual national authorities, as they can function without institutional backing and are inherently borderless. Yet, a number of jurisdictions have announced at various points in recent months that they are considering whether and how to respond, and some have already responded. In a recent paper, we examine whether and how regulatory actions and communications about such actions have affected cryptocurrency markets (Auer and Claessens 2018). We do so using an event study approach, i.e. we use the market reactions to these regulatory statements and decisions to assess the anticipated effects on cryptocurrency markets.
To illustrate our methodology, consider two events. One is the decision by the United States Securities and Exchange Commission (SEC) in March 2017 to turn down a proposal to alter stock exchange rules so as to allow the creation of an ETF for bitcoin. In the five minutes around the announcement, the price of bitcoin dropped by 16% (Figure 1, left-hand panel).1 Another event is the Japanese Financial Services Agency (FSA) ordering six cryptocurrency exchanges to improve their money laundering procedures (June 2018). Again, prices tanked – although it seems to have taken several hours, until the start of the US trading day, for this measure to have its full effect (right-hand panel).2
Figure 1 Bitcoin intraday price reaction to two news events (US dollars)
Notes: 1 The vertical line indicates 21:04 on 10 March 2017 (news headline: “US SEC rejects application to list Bitcoin ETF”). 2 The vertical line indicates 07:17 on 22 June 2018 (news headline: “RPT – Japan FSA says ordered 6 cryptocurrency exchanges to improve business, over lax money laundering measures”).
Source: Auer and Claessens (2018).
We then proceed to assemble a systematic database of regulatory news events, which can be accessed herealong with replication material, and classify news events into three categories: legal status; anti-money laundering/combating the financing of terrorism (AML/CFT) and interoperability; and unspecific general warnings.
Legal status news
Figure 2 examines returns surrounding four specific categories of legal news. News pointing to an outright ban and non-recognition of the instruments as currencies is associated with negative returns, and strongly so for bans. News suggesting that cryptocurrencies could be treated as securities also leads to negative returns, probably reflecting the expectation that cryptocurrencies would be regulated more stringently. In contrast, the introduction of a specific, non-security legal framework generates positive returns, most likely as those frameworks generally come with oversight rules that are milder than those under securities law.
These effects are large and persist over time. The responses are qualitatively consistent between the one-day (left-hand panel) and the ten-day impact (right-hand panel), with the latter generally more pronounced. We also examine the response to other news events.
Figure 2 Legal status news and bitcoin returns (%)
Notes: The box plots show minimum, lower quartile, median, upper quartile and maximum. 1 Other than a security legal framework.
Source: Auer and Claessens (2018).
We find that regulatory news regarding anti-money laundering/combating the financing of terrorism (AML/CFT) measures and limits on the interoperability of cryptocurrencies with the regulated financial system adversely impacts cryptocurrency markets.
In contrast, general warnings about cryptocurrencies, including about the risk of loss, have little discernible effect on prices. In this sense, moral suasion alone does not seem to work in stemming speculative markets.
Why do news events about national regulations have such an impact on crypto-assets that have no formal legal homes and are traded internationally? Part of our interpretation is that cryptocurrencies rely on regulated institutions to convert regular currency into cryptocurrencies. After all, it is the price of cryptocurrencies in terms of conventional money that hogs the headlines and generates speculative activity. Their cumbersome setup also means that many consumers hold and transact in cryptocurrencies through more interfaces, such as online crypto-wallets that are often regulated, or can be regulated in principle. And international arbitrage is still limited. Agents cannot easily access cryptocurrencies’ markets offshore – because they may need to have a bank account in the foreign jurisdiction. Factors such as these create market segmentation and fragmentation, which currently make national regulatory actions bind to some degree.
One example of likely market segmentation is the ‘Kimchi premium’, i.e. the fact that the price of bitcoin in Korea regularly exceeds that in the US, at times by over 50% (Figure 3, left-hand panel). This suggests limits to cross-border arbitrage. Similarly, news about cryptocurrency regulation by authorities in China has led at times to price differentials compared with the US market (Figure 3, centre panel).
Figure 3 Premia and trading volume (%)
Notes: The vertical lines in the centre and right-hand panels indicate 19 January 2017 (“MEDIA-PBOC branch finds ‘hidden risks’ in bitcoin exchange BTCC-EID”) and 9 February 2017 (“China central bank says warned bitcoin exchanges of closure risk on rule violations”). 1 Premium of local BTC price (in USD) compared with BTC price in the United States. 2 AUD, CHF, CAD, GBP, HKD, ILS, INR, PHP and SGD.
Sources: Auer and Claessens (2018).
While arbitrage is imperfect, the markets are obviously interconnected. Accordingly, we also find that national regulatory measures do spill across borders. For example, when China hinted at the possibility of strict regulation of Bitcoin around the end of January 2017, bitcoin trading shifted massively towards other Asian currencies (Figure 3, right-hand panel).
Overall, our analysis suggests that, at the current juncture, there is scope for national financial authorities to apply regulations, if they choose to do so, in the sense that even unilateral actions have an impact on cryptocurrency prices. On the other hand, our results also suggest that not all regulation need be bad news for cryptocurrency markets. Price responses suggest that traders have a preference for a well-defined legal status, albeit a light regulatory regime.
To tackle regulatory concerns, authorities will first need to clarify the regulatory classification of cryptocurrency-related activities, and ideally to do so using criteria based on economic functions rather than the technology used. Related, the boundaries among national regulatory bodies may need to be redrawn to clarify responsibilities. Authorities will need to vigilantly monitor developments and address regulatory issues arising from the global dimension of cryptocurrencies. Our evidence suggests that at the current juncture, authorities around the globe do have some scope to make regulation have effects. For policies to remain effective, and especially in case the market further develops and international arbitrage increases, however, rules will need to be coordinated and enforced across the globe.
Authors’ note: We thank Giulio Cornellifor superb assistance in the development of the dataset and the analysis. The views expressed here are those of the authors and should not be attributed to the Bank for International Settlements.
Auer, R and S Claessens (2018), “Regulating cryptocurrencies: assessing market reactions”, BIS Quarterly Review, September: 51-65.
Bank for International Settlements (2018), Annual Economic Report 2018, June.
Biais, B, C Bisière, M Bouvard and C Casamatta (2017), “The blockchain folk theorem“, TSE Working Papers, no 17–817.
Carney, M (2018), FSB Chair’s letter to G20 finance ministers and central bank Governors, 13 March.
Carstens, A (2018a), “Money in the digital age: what role for central banks?”, lecture at the House of Finance, Goethe University, Frankfurt, 6 February.
Carstens, A (2018b), “Technology is no substitute for trust”, Börsen-Zeitung, 23 May.
Committee on Payments and Market Infrastructures (2015), Digital currencies, November.
Financial Stability Board (2018), Crypto-assets: report to the G20 on the work of the FSB and standard-setting bodies.
G20 Finance Ministers and Central Bank Governors (2018), Buenos Aires Summit communiqué, 19–20 March.
Huberman, G, J Leshno and C Moallemi (2017), “Monopoly without a monopolist: an economic analysis of the Bitcoin payment system“, Columbia Business School Research Papers, no 17–92.
Landau, J-P and A Genais (2018), Les crypto-monnaies, rapport au Ministre de l’Économie et des Finances, 4 July.
 Relatedly, the SEC’s reconfirmation of the denial of a bitcoin ETF fund listing on 26 July 2018 sent the price of bitcoin tumbling from $8,220 to $7,920 (–3.7%) within a short period.
 This event may have had a particularly profound effect as it contrasted with the previously held belief that the FSA was sympathetic towards cryptocurrencies compared with other financial supervisors.
 Another channel would be the reputation effect: the possibility that a decision by one government could encourage other governments to adopt an “anti-crypto” mind-set.