Drivers and risks of the cryptocurrency boom

This could be enough to appease regulators enough to delay or stop the introduction of heavy regulation. This assumes that the self-regulation goes far enough and proves to be effective. By removing the threat of heavy regulation and replacing it with self-regulation, a high level of uncertainty is removed, bringing back confidence in the market and allowing organisations to plan effectively with a renewed focus on innovation.

Fit for purpose and industry specific Industry driving self-regulation will ensure that this regulation is not only fit for purpose, allowing innovation in the space to continue, but also adaptable and able to evolve according to need or market changes. Additionally, rather than a one size fits all approach, separate and specific regulations could be developed for different types of cryptocurrencies such as privacy coins, smart contracts and settlement networks amongst others.

The following graph provides an example of how cryptocurrencies may be differentiated, although this could be split even further. A global solution Self-regulation also combats one of the drawback of every country potentially having different regulation, which makes it increasingly difficult for companies to operate on a global scale. Self-regulatory bodies have more opportunity to collaborate with each other and introduce global regulations that are consistent and meet the needs of investors and cryptocurrency companies.

Beneficial to Government Self-regulation can often be useful for governments too. It is not only faster to implement, but the burden of costs falls on the industry rather than the government. This is a major selling point of self-regulation and as long as governments are involved and are kept informed, they may be happy to leave it in the hands of self-regulatory bodies.

Influence Another aspect that should be considered as being highly desirable to the industry is that it allows them to lobby, interact with and educate regulators and legislators. This can ensure that any future regulation introduced is not detrimental to the industry and is developed in conjunction with businesses in the space.

Effective self-regulation: Whilst the benefits of self-regulation are clear, the regulatory body in place needs to be strong, fit for purpose and effective. Some key areas for consideration by newly formed self-regulatory bodies are covered below. Government supported and backed by law In order to remove the introduction of government regulation, the industry needs to ensure that the self-regulatory body is backed by law and has a government regulatory partner.

A positive relationship needs to be built with them in order to have successful self-regulation. Unfortunately, there is a widely held view within the cryptocurrency space that the government and banks are enemies of cryptocurrency and are looking for every opportunity to shut the industry down.

This view needs to change if self-regulation is going to work and if they want the industry to flourish. Industry support Another critical success factor will be industry support and involvement in the creation of regulation. This helps the buy-in process and also ensures well thought out and extensive regulations are put in place that have been agreed by all members.

The more participation the better as self-regulation can have little effect if companies are not involved. Accountability With self-regulation, members need to be prepared to accept that there will be penalties and sanctions for non-compliance. Therefore, a strong accountability program that includes transparent reporting to stakeholders, should be implemented and committed to in writing by members with annual certified compliance submissions.

It should focus on sound financial and non-financial practices with oversight and transparency and members should expect for information to be shared with government regulators as appropriate. Detection A key challenge with self-regulation is that of detection. There needs to be a system in place for detection from audits and reviews to incentivise the detection and deterrence of manipulative and fraudulent acts and practices, including partnering with regulators and particularly the CFTC to share or refer information, as appropriate.

Conversely, several papers rebut the statement that there are properties that Bitcoin shares with gold. Klein et al. They compare the conditional variance properties of Bitcoin and gold and find differences in their structures. Dissimilar results are reported by Ennis Using a GARCH analysis, he reports that Bitcoin returns are statistically independent of equity and bond markets, while it acts as a hedge for the euro, supporting the idea that Bitcoin is an alternative monetary asset.

They conclude that Bitcoin does not hold any of the attributes of the stock market index or gold has. Indeed, recent studies have focused on the tail risk of Bitcoin, which consists of two main strands of literature. The first strand addresses tail risk dependence among cryptocurrencies. Borri use CoVaR to estimate the conditional tail risk for cryptocurrencies.

He finds that cryptocurrencies, including Bitcoin, are exposed to tail risk within cryptocurrency markets, while they are not exposed to tail risk with respect to other assets, such as the US equity market or gold.

Huynh investigates the contagion risks among cryptocurrencies. Xu et al. They find that a significant risk spillover effect exists in cryptocurrency markets. The second strand focuses on the relationship between Bitcoin and traditional assets in the tail sense. Feng et al. Similar to Feng et al. Conversely, Hussain Shahzad et al. A few studies have investigated the distinct drivers of Bitcoin tail risk. Using the measure of crash risk suggested by Chen et al. Using the same measure of crash risk, Anastasiou et al.

Thus, I seek to contribute in this respect. Conditional autoregressive value at risk This section presents the estimation method of the series of conditional VaR via CAViaR specifications using daily returns on the Bitcoin price index and explanatory variables, following Engle and Manganelli The key idea of CAViaR is the recognition of the persistent quantile of the return. CAViaR is obtained by modeling the quantile of the daily return directly with the specifications.

Footnote 11 By incorporating an explanatory variable into the specification directly, the CAViaR model has the ability to capture complex tail dynamics via a parsimonious parameter structure. In the asymmetric slope specification, two terms are needed for each lagged return and driver to allow the response to positive and negative returns and driver to be different.

Both specifications are mean-reverting in the sense that the coefficient of the lagged VaR is not constrained to 1. The unknown parameters are estimated using regression quantiles, as introduced by Koenker and Bassett Note that the only assumption in the model is that the quantile process is correctly specified. No assumption on the distribution of the error terms is required, thereby reducing the risk of misspecification.

I use a consistent estimator of the variance-covariance matrix and the statistic of the dynamic quantile DQ test to evaluate the performance of potential drivers. Second, the DQ test is a type of specification test for the accuracy of a VaR model. Because VaR is usually reported as a positive number, the estimated VaR is set to be positive.

A high value of the estimated VaR indicates a high tail risk. Data The data employed are daily and cover the period from August 1, , to December 31, The dependent variable is always the VaR of the return on Bitcoin. Following Panagiotidis et al. Before the first boom in late , the Bitcoin price index was characterized by low volatility. Between and , the price remained near zero. The price index was below 50 until March , and then it went over in April for the first time.

Bitcoin trade started to become more active as Bitcoin grew in popularity since To address this, the US authorities began a full-scale investigation into Bitcoin trade and its exchanges. During , the price of Bitcoin showed a gradual upward movement, as the second Bitcoin halving event occurred in July. It is well known that Bitcoin prices respond positively to the Bitcoin halving event. Interestingly, the price action in was dramatic. After the period of moderate growth between and , the price index consistently soared by early and showed high fluctuations afterward.

This is considered to be the result of self-fulfilling phenomena. In October , the CME group announced the launch of Bitcoin futures, and its first contract began in December In January , Bakkt, a cryptocurrency exchange, announced the launch of bitcoin futures contracts, and Facebook said it was loosening its ban on advertisements related to blockchain and cryptocurrency.

I follow prior researchers to select candidates of drivers trying to make the most extensive dataset examined in the literature. These potential drivers can fall into several categories: Bitcoin-specific variables, variables related to commodity, macroeconomy, currency, stock market, uncertainty, sentiment, and internet search intensity.

The Bitcoin trading volume is simply the sum of all Bitcoins traded in a selected period. The motivation for including Bitcoin trading volume is based on the work of Balcilar et al. Following Demir et al. Considering the viewpoints of Bitcoin users, variables related to sentiment and Internet search intensity are investigated.

Additionally, because Bitcoin has been receiving more attention in the news, I follow Panagiotidis et al. The data for Wikipedia trends are available till the 21st of January The most recent data are available from tools. Table 2 provides summary statistics. Values for variables that are not in daily frequency have been linearly interpolated. Footnote 14 These findings, therefore, call for the analysis of the tail risk of Bitcoin which seems to be relatively more important than focusing on the return and volatility.

Note that the third and fourth moments of the corresponding variable are the components of tail behavior measure Groeneveld and Meeden ; Moors ; Kim and White Prior to the estimation of the VaR, all explanatory variables are standardized. This allows for a comparison of the performance of the explanatory variables. Considering the concern of potential structural breaks due to regime shifts or critical social events, two sample periods are considered.

I first estimate the models in a sample covering the period from August 1, to January 3, , and then I update the sample to include the period from August 1, to December 31, First, the WannaCry ransomware attack in used Bitcoin as the only payment method, and it represented a natural advertisement for Bitcoin. Market speculation activities quickly follow.

Second, numerous initial coin offerings were launched in , which raised the demand for Bitcoin and attracted considerable market attention. These correspond to the recently alleged Bitcoin bubble since The table presents the values of the estimated parameters, the corresponding standard errors, one-sided p values, the values of the regression quantile objective functions RQ , the percentage of times the VaR is exceeded Hits , and the p value of the DQ when computing the series of CAViaR of returns on Bitcoin.

CAViaRs of returns on Bitcoin show a significant autoregressive term, which is consistent with the persistence of tail behavior. Figure 2 plots the estimated time series of the VaRs. Their significance and performance are evaluated based on the coefficients of the variance—covariance matrix and DQ tests. The results of the first period are shown in the second column, and those of the second period are shown in the seventh column.

The values of the estimated parameters Beta , the corresponding one-sided p values in parentheses , the values of the RQ, the percentage of times the VaR is exceeded Hits , and the p value of the DQ test are reported. This is consistent with the intuition that the more the trading amount of Bitcoin fluctuates, the higher the tail risk of Bitcoin. This evidence contradicts that of Balcilar et al. The second highest value is EFFR.

This is related to the impact of monetary policy. When dramatic tightening and easing monetary policies take place, these affect the liquidity market participants hold to determine their participation in the Bitcoin market, and it is therefore likely that demand for Bitcoin will vary in turn. This evidence can also explain the positive relationship between the demand for Bitcoin and the short-term interest rate documented by De la Horra et al.

Footnote 15 The monetary policy effect is similarly investigated by Nguyen et al. It appears that Bitcoin can be a safe haven for commodities, especially OIL, in the tail sense because the tail risk of Bitcoin is reduced in response to a large swing in OIL.

These results are somewhat consistent with those of Glaser et al. Taken together with the evidence of Panagiotidis et al. Footnote 17 However, this quantity issue is diminished to some extent in the second period. This is because the Bitcoin market has been growing and maturing since , and thereby its tail risk is not heavily dependent on the variation in trading volume. The second period reveals the same effect of the variables related to commodities. The effects of commodity variables remain significant, with consistently negative signs.

This finding is consistent with the evidence from De la Horra et al. They show a negatively significant relationship between Bitcoin demand and the price of gold, and therefore, I conclude that Bitcoin serves as a substitute for gold, not a complement, even in the tail sense. It is a well-known fact that investors in the Chinese market today look for a safer destination for investment when the values of the Chinese stock market and currency are worried. This phenomenon, the so-called flight-to-safety, brings about the Chinese capital inflow to Bitcoin and helps the Bitcoin market to be healthy.

Interestingly, Glaser et al. A potential explanation might be that investors with speculative motives decide whether to enter or exit the Bitcoin market based on an internet search. These investors tend to foster herd behavior in the Bitcoin market, which is skittish about outside news due to shortsightedness, which leads to an increasing extreme risk.

By using asymmetric slope specification, the significance uncovered in Table 4 remains, but there are new implications. This is consistent with the view in Table 4 , where Bitcoin is asserted to be a safe haven for commodities. A degree of caution should be exercised when interpreting the results. In this paper, recall that explanatory variables enter the CAViaR specifications after taking absolute values.

The large absolute value in an information set of the specification is interpreted as a high risk in the corresponding variable. Footnote 18 The increasing absolute values in both boom and bust times are considered as indicators of risky conditions in the sense that the price of an asset deviates from the trend reflecting the intrinsic value.

For both the first and second periods, considerable responses

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VIP clienteling gets a tech makeover By Maghan McDowell Launching his own currency is a loyalty play that creates value for his fans, who feel like they're investing and have some form of ownership in his brand, says JVCKJ. She issues crypto tokens, also known as initial coin offerings ICOs , to her audience before a show, enabling viewers to crowdfund a design or collection. Opportunities and risks ahead Risks abound. Frauds, scams and other criminal activities are rampant, while it's not easy to store cryptocurrencies because of the risk of cyberattacks and theft, he adds.

But mainstream awareness and a willingness to try the technology are on the rise. Speculation fuels the cryptocurrency market, with some investors quickly buying and selling their holdings as soon as there's a sign of a price drop. A single negative popular tweet or news story about a cryptocurrency could cause its price to plummet quickly.

Large trading and investment firms have recently acquired significant stakes in most cryptocurrencies. Those cryptos may begin to exhibit healthy volatility thanks to the stabilizing influence of these major companies. Cybertheft and Hacks Cryptocurrencies are held in digital wallets and traded through digital currency exchanges.

Cryptocurrencies are particularly appealing to cybercriminals because of their online dependence and anonymity. To gain access to cryptocurrency wallets and trading platforms, criminals use a variety of phishing attacks. Individuals and companies interested in investing in cryptocurrency must adhere to strict internet security protocols to safeguard their assets. Being aware of the latest threats is also helpful, as is understanding how to protect your crypto assets and crypto-wallets.

Decentralization The lack of a central authority is arguably one of cryptocurrency's most appealing features. But, this absence has drawbacks, especially when things go south. For example, in most online financial transactions, electronic money transfer is usually backed and mediated by a financial institution.

So, if there's a problem with the transaction, you can easily contact them and resolve it. With a cryptocurrency transaction, this isn't possible. Its decentralized nature makes it difficult to pinpoint the correct entity with which to file a transaction dispute. As a result, most cryptocurrency investors are advised to trade through reputable digital currency exchanges. The majority of the top exchanges have excellent customer service that can assist with almost any problem. Still, the decentralized nature of most cryptocurrencies makes resolving legal disputes nearly impossible.

Risks Associated with Peer-to-Peer Transactions A peer-to-peer P2P platform is a cryptocurrency marketplace that connects crypto buyers and sellers directly. On a P2P exchange, any cryptocurrency transaction is paid directly between the two parties. These exchanges are one of the simplest ways to convert cryptocurrency into fiat money.

Yet, the human factor is where mistakes or negligence can cause your asset to be lost. Furthermore, there is always the risk of scams and fraudulent schemes, such as a buyer refusing to pay for cryptocurrencies received or a seller refusing to send the tokens, and so on. Finding a P2P platform that provides a digital asset escrow service is the best way to avoid most of these schemes.

The cryptocurrencies are held by the platform during the transaction using this service. The asset will be released to the buyer as soon as the buyer completes the payment process and the seller confirms receipt. This guarantees that both parties get what they want. If a disagreement arises, a platform representative will resolve it. Loss or Destruction of Private Keys Cryptocurrencies are built on a cryptographic system that uses pairs of keys to authenticate transactions.

One is a publicly available public key, and the other is a private key kept secret and used for identification and authentication. A private key is automatically generated when you open a crypto wallet and grants user ownership of funds in that wallet. Related: The Best Bitcoin Wallets in The loss of a private wallet key means losing control or access to any cryptocurrencies in that wallet. Therefore, it is crucial that you regularly back up your private keys , preferably on a secure and isolated computer.

Also, never store your private key online, especially if it is not in an encrypted format. As a result, picking an exchange has become more difficult. Cryptocurrency exchanges offer the same level of services to the financial market as traditional financial institutions. However, the lack of regulatory oversight has aided the growth of scam exchanges and market manipulation in crypto trading. Some trading exchanges have exorbitant trading fees and no policies to prevent manipulative or suspicious trading, while completely unregulated exchanges may employ predatory practices.

Exchanges may charge exorbitant commissions while also making withdrawals nearly impossible.