What has happened?
The Bank for International Settlements (BIS) has released a report, in which it makes the case that the cryptocurrency market is swayed by news about regulatory actions.
What does this mean?
In its report, the BIS, which represents a coalition of 60 central banks, has examined the relationship between regulatory announcements and price variations.
"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," the report said.
The authors of the report, Raphael Auer and Stijn Claessens, created a "global cryptocurrency news index" for quantifying the effect of regulatory actions on cryptocurrency prices.
The two researchers decided on five types of regulatory news: general information and warnings, authorities' statements of central bank digital currencies, cryptocurrency exchange regulations, the interoperability with regulated financial entities and the legal status of cryptocurrencies.
All the news events between the beginning of 2015 and the end of June 2018 as reported by news agency Reuters were included, amounting to 151 items.
The researchers then correlated regulatory actions (and their news reporting) with the prices of seven cryptocurrencies: Bitcoin, Bitcoin Cash, Ether, Litecoin, Monero, Zcash, and XRP.
The report found that news relating to general bans on cryptocurrencies or to their treatment under securities law had the greatest adverse effect on valuations.
This was followed by news on combatting money laundering and terrorism financing and on restricting the interoperability of cryptocurrencies with regulated markets.
One example given in the report was the decision in March 2017 by the US Securities and Exchange Commission to turn down a proposal, from investors Cameron and Tyler Winklevoss, 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%. 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," the report explained.
However, news about the establishment of legal frameworks tailored to cryptocurrencies and initial coin offerings coincided with strong market gains.
One example included "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'".
In this regard, the report concluded that the price responses signalled a market preference for a defined legal status, but under a light regulatory regime.
What is behind the fluctuations?
The report then asked why news about national regulations have such an effect on cryptoassets, which have "no formal legal homes" and are traded internationally.
The report contended that this is partly because of the reliance on regulated exchange institutions when converting regular currency into virtual currencies.
"Part of our interpretation is that cryptocurrencies rely on regulated institutions to convert regular currency into cryptocurrencies. 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," the researchers wrote.
"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."
In conclusion, the researchers said:
"Our analysis shows that despite the entity-free and borderless nature of cryptocurrencies, regulatory actions as well as news regarding potential regulatory actions can have a strong impact on cryptocurrency markets, at least in terms of valuations and transaction volumes. This suggests that at the current juncture, authorities around the globe do have some scope to make regulation effective."
If you want to take advantage of blockchain's huge potential and disruptive impact, while avoiding falling foul of ever-developing regulatory and legal requirements, visit our Hogan Lovells Engage Blockchain Toolkit.
For more news and analysis that is tailored to you, as well as access to Hogan Lovells' cutting-edge interactive Lawtech tools, register for free on Engage.
You can also keep track of all the Engage content by following our LinkedIn page.