Global Bitcoin Markets and Local Regulations

Cyn-Young Park, Asian Development Bank;

Shu (Grace) Tian, Asian Development Bank;

Bo Zhao, Asian Development Bank

-- Bitcoin prices have soared on inflation fears as global central banks eased monetary policy to fight against COVID-19. Like gold, Bitcoin attracted investors who seek safe havens while traditional financial assets suffer from the prospect of weaker economic growth and monetary easing that will lead to higher inflation. But unlike gold, Bitcoin—designed as a decentralized digital currency to offer an alternative to a state-controlled currency subject to deteriorating national budget and central bank monetary policy uncertainty—offers additional allure to be particularly relevant to the coming of age of digital currency and fintech applications ushered in by the COVID-19 pandemic.

Since the launch of Bitcoin in 2009, however, significant volatility and speculation in the cryptocurrency market have raised concerns over investor protection and financial stability. The volatile prices of many cryptocurrencies have sparked considerable attention among investors, policy makers, and researchers over its asset nature and trading behaviors. Many national authorities and regulatory agencies have started to regulate the local Bitcoin market through either policy communication or direct intervention. Meanwhile, there is an emerging debate on whether regulators should intervene and, if so, what approaches would be appropriate given a major tradeoff between protecting investors and encouraging financial innovation.

While the same Bitcoin is traded globally, Bitcoin prices in local markets vary across different markets, driven by market frictions such as local market structure, trading infrastructure, information asymmetry, transaction costs, and so on (Figure 1). Such market frictions can limit arbitrage opportunities across different markets, causing market segmentation, where each market forms its respective pricing dynamics subject to local market demand and supply.

Bitcoin Prices in Six Major Markets

cny = yuan, eur = euro, gbp = British pound, krw = Korean won, jpy = Japanese yen, usd = US dollar.

Source: Park, Tian, and Zhao (2020).

In the global Bitcoin market, since cryptocurrency supplies are tightly controlled in the short run, day-to-day price variation of cryptocurrencies is mainly driven by changes in local market demand and trading conditions for cryptocurrency. When an individual market introduces a regulation or signals an authority stance, local trading activities may be affected, and local price dynamics could be influenced.

Our recent Asian Development Bank Economics Working Paper “Global Bitcoin Markets and Local Regulations” explores how bitcoin prices and trading activities were affected by local regulations. We find that the impact of local regulations on Bitcoin prices is very short-lived, only on the announcement day and the day after the announcement. However, local regulations seem to have a lasting repressive impact on trading in the local market as local trading volume continued to decline over a longer period after the regulation announcement.

As investors in Bitcoins need to move across markets to trade, financial openness of a local market matters for the investors. Our paper further finds that financial market openness can mitigate the repressive impact of local regulation, especially on Bitcoin trading activities. This may be because investors in a relatively free and open market tend to face lower trading barriers to make investment internationally.

The study supports the view that it is challenging for national authorities alone to effectively regulate the highly speculative trading activities and prices in the global Bitcoin market. Instead, local regulations may drive the speculators out of the local market and move their funds to invest in other markets. International and regional regulatory cooperation would be essential to better foster the healthy development of the cryptocurrency market, safeguard financial stability and protect investors.

Disclaimer: The views expressed in this blog are those of the authors and do not necessarily represent the views and policies of the Asian Development Bank or its Board of Governors or the governments they represent.

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