There are two fundamental things about cryptocurrencies that need to be understood. Firstly, they do not pose a global financial stability risk and, secondly, their price reacts to news on regulation and classification of the asset. That’s according to the Bank for International Settlements (BIS), founded in 1930 and currently owned by 60 central banks, which has released a 15-page report entitled “Regulating cryptocurrencies: assessing market reactions”.
“Cryptocurrencies such as Bitcoin have attracted much attention because of their meteoric price swings, but have also raised concerns for regulatory authorities,” says the BIS in the report signed by economists Raphael Auer and Stijn Claessens. “While cryptocurrencies are often thought to operate out of the reach of national regulation, in fact, their valuations, transaction volumes and user bases react substantially to news about regulatory actions.”
Good news, bad news
One way to better predict where the price of cryptocurrencies is headed is to monitor news. “News events related to general bans on cryptocurrencies or their treatment under securities law have the greatest adverse effect on valuations,” reads the report.
Other news that drives the price of crypto is on “combating money laundering and the financing of terrorism, and on restricting the interoperability of cryptocurrencies with regulated markets”. An example of this 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 to allow the creation of an ETF for Bitcoin”.
“In the five minutes around the announcement, the price of Bitcoin dropped by 16%. 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.”
Auer and Stijn, on the other hand, found that “news pointing to the establishment of legal frameworks tailored to cryptocurrencies and initial coin offerings coincides with strong market gains”.
An example of favourable news was in February 2018, when officials from the SEC and the Commodity Futures Trading Commission (CFTC) issued statements before the US Congress that news agencies interpreted as “putting crypto-currencies on a relatively long leash”.
“We find that favourable events coincide on average with a 0.33% return in the 120 minutes around the events, and a 1.52% return in the 24-hour window around them”, they explain. “Unfavourable events are associated with a 0.32% and 3.12% lower return over similar windows, respectively.”
Both agree that events appear to affect the prices of cryptocurrencies several hours before the news release, “suggesting the news is in fact released gradually, and information flows via other channels”.
Crypto within reach of national regulation
As they rely on regulated financial institutions to operate and markets are still segmented across jurisdictions, Auer and Stijn believe “cryptocurrencies are within reach of national regulation”.
Both agree that “many of the regulatory concerns raised would also apply to other asset classes and emergent technologies”.
They say that what sets cryptocurrencies apart from other asset classes is that they function without institutional backing and are intrinsically borderless. This issue raises questions of whether one can expect regulation – specifically national – to be effective.
Recapping market reactions
The economists reiterate that the crypto “market responds most strongly to news events regarding the legal status of cryptocurrencies. Besides general bans on their use for financial transactions, news events related to their possible treatment under the securities market law have strongly adverse impacts, as do events explicitly signalling that cryptocurrencies will not be treated as a currency”.
However, when news indicates possible new legal frameworks for cryptocurrencies and ICOs, the market shows considerable gains. “Authorities’ unspecific general warnings have no effect, nor does news regarding the likelihood of central bank digital currency (CBDC) issuance”.
Lastly, “large price differences sometimes prevail across jurisdictions, suggesting some market segmentation”.
The report says the cryptocurrency industry would welcome regulations, which in itself doesn’t necessarily have to be bad news for the market as the price response clearly signals a preference to a defined legal status.
Authorities should begin by determining the regulatory classification of crypto-related activities, applying criteria based on economic functionality rather than the underlying technology. They also believe national regulations must ultimately be coordinated and enforced across the globe, although the absence of international cooperation “need not be an impediment to effective intervention”.
The pair conclude that “a loss of public trust in crypto asset markets could translate into distrust in the broader financial system and its regulators. While crypto assets thus do not, at this point, pose a global financial stability risk, it is important to remain vigilant, monitor developments and respond to potential threats”.