Is cryptocurrency a hedging tool during economic policy uncertainty? An empirical investigation
Recently, the fascination with cryptocurrencies has been growing, and Bitcoin has emerged as the most notable (Kristoufek & Lunackova, 2015). Cryptocurrency, in its broadest sense, refers to a form of digital currency that operates on the Internet and independently of any central governing body (Zohuri et al., 2022). Whether cryptocurrencies can serve as a medium of exchange has been the subject of some research, and the results have been mixed (Ammous, 2018). Due to the dramatic surge in cryptocurrency values in 2017, investors worldwide began pouring much of their investment capital into these relatively new forms of financial assets. However, the inflated prices could not be maintained, and the cryptocurrency market experienced a price bubble bust before the year’s conclusion. The enormous volatility in the value of cryptocurrencies demonstrates the risk involved in investing in this kind of asset.
Cryptocurrencies are established through various cryptographic algorithms and are exchanged in a digital realm. The ongoing development of this system, which aims to replace existing currencies, payment instruments, and even traditional monetary theory and practices, has increased the significance of this system over time (Alpago, 2018). In contrast, there is a debate among scholars and experts about whether cryptocurrency is a type of money or a volatile asset. Opinions differ on this phenomenon. Global financial markets have seen a rapid increase in cryptocurrency popularity (Białkowski, 2020; Deepa et al., 2022; Liu et al., 2021). As a result, regulators, the media, and individual and institutional investors have all taken an interest in them. Academic cryptocurrency research has also become significant (Almeida & Gonçalves, 2022). A feature of both gold and US dollars, Bitcoin’s potential to hedge is known as a medium of exchange or digital gold (Su et al., 2023). Because a positive link exists between the prices of gold and Bitcoin, according to (Selmi et al., 2022), gold and Bitcoin are more likely to complement than compete against one another. A short position in the Bitcoin market enables hedging the risk when investing in various other financial assets Guesmi et al., (2019). In particular, the portfolio’s risk from holding gold, oil, and stocks is lower when holding Bitcoin than when not. However, because of restrictions on anti-money laundering and terrorist funding legislation, Bitcoin cannot replace gold
Cryptocurrency markets can be affected in various predictable ways. Existing studies have examined how different uncertainty metrics affect cryptocurrency. Some prevailing studies on Bitcoin have examined the impact of uncertainties and risks on cryptocurrencies’ profits and price volatility. In their research, Doumenis et al. (2021) discuss the correlation between the volatility index (VIX) and the volatility of cryptocurrencies. The findings of their analysis reveal that cryptocurrency market volatility tends to increase in response to heightened investor apprehension. In their study, Fang et al. (2020) examine the influence of the News-based Implied Volatility index (NVIX) on the volatility of cryptocurrencies over an extended period. The researchers discovered that the NVIX has an adverse impact on the long-term fluctuations of cryptocurrencies. In their study, (Gozgor, Tiwari, et al., 2019) examine the correlation between the returns of Bitcoin and the uncertainty in trade policies (TPU) in the United States. Their research findings demonstrate a negative impact of TPU on the returns of Bitcoin. In a study by Shaikh (2020), the researcher examines the impact of the economic policy uncertainty (EPU) index on Bitcoin returns in many countries, including the US, the UK, Japan, China, and Hong Kong. The study reveal that uncertainty had a detrimental effect on the Bitcoin market in the US and Japan. Because the modern, financially connected world is more vulnerable to economic policy risk than ever, researchers are currently concentrating on finding an appropriate shelter to protect assets.
Previous studies have been conducted on cryptocurrency, mainly on Bitcoin as a single entity with different uncertainty-related measures. To our knowledge, no earlier studies on cryptocurrency with economic policy uncertainty or on the asymmetric effect of EPU on cryptocurrency returns have been done. The study’s goals are twofold: first, to better understand the academic literature already available on crypto investor behavior, compile its knowledge, and identify knowledge gaps to support future studies; and second, to present significant research findings for investors, academics, policy-makers, businesses, professionals, and society. Existing studies have traced the relationship between cryptocurrency and other different factors. To our knowledge, this study is the first to analyze the nexus between cryptocurrency and economic policy uncertainty after Covid-19. We select the top three cryptocurrencies based on their market share—Bitcoin, Ethereum, and Tether. The period is from 1 January 2021 to 1 April 2023. The time selected is after the COVID-19 pandemic, which affected every sector of the world economy. Therefore, we acknowledge the importance of time.
Interestingly, no pandemic or event of more significant uncertainty, including the Spanish Flu, the Global Financial Crisis, and the European Debt Crisis, has ever worsened the stock market and driven down the EPU as much as COVID-19. Because investors are predominantly concerned about losing their investments, often referred to as reflecting risk-averse behavior, increased economic policy uncertainty frequently hinders the flow of investments. Therefore, during financial crises, political unrest, or other periods of substantial uncertainty, such as the COVID-19 pandemic, investors and fund managers are drawn to risk-reduction strategies. Conversely, in China, we observe a beneficial effect of uncertainty on the Bitcoin market (Chen et al., 2021). Their study examines the correlation between Bitcoin returns and Chinese EPU. Their research findings indicate a favorable impact of Chinese EPU on Bitcoin returns. Similarly, (Wu et al., 2021) examine the effect of Twitter-based EPU on the cryptocurrency market. Their results suggest that Twitter-based EPU has a favorable influence on cryptocurrency returns. The Cryptocurrency Uncertainty Index (UCRY) is a novel proxy for measuring uncertainty. UCRY was created by (Karim et al., 2023) and relies on examining textual content.
Significance of the study
Global financial markets are in a revolutionary phase (Johnson, 2020), and digital finance plays a significant role in how financial services are organized worldwide (Johnson, 2020). According to (Hosen et al., 2022), cryptocurrency is considerably improving and moderating traditional financial services. The current state of cryptocurrency developments is usually marked by anomalous behavior and unanticipated occurrences that influence people’s views, market behavior, and public legislation (Treiblmaier, 2022). The transmission of fiscal and monetary policies in financial markets has become significantly impacted by uncertainty, which has grown in importance in modern economies (Kang & Yoon, 2019). Regulating cryptocurrency is necessary since it alters “typical” financial transactions (Hossain, 2021); however, keeping up with the legislation in many jurisdictions is challenging (Mohsin, 2022). Since their inception, cryptocurrencies have been popular in the financial industry (Jiménez-Serranía et al., 2021), and the associated markets have a history of volatility (Chokor & Alfieri, 2021).
The prior literature has concentrated mainly on this topic; few research publications have examined other cryptocurrencies. In line with these concerns, we seek to summarize the literature that has focused on the economic implications of crypto. We carefully searched for existing studies on cryptocurrency in the expanding academic literature to perform this analysis. We use a quantile regression approach to examine the data. The quantile regression methodology is advantageous because it helps us make sense of outcomes that are not normally distributed and have nonlinear relationships with predictor variables by allowing us to understand the relationships between variables outside the mean of the data. We aim to investigate cryptocurrencies with global economic policy uncertainty. Thus, we chose the top three cryptocurrencies (Bitcoin, Ethereum, and Tether) as a variable since they are well-known cryptocurrencies. To check the robustness of the results, we use gold as an alternative hedging for cryptocurrency. In addition, the individual country analysis is also traced in this study. The US and China are well-known to be the two key countries of the world economy, and their shares in cryptocurrency are the highest. Therefore, we select these two countries and run the same analysis.
Growing global EPU has a detrimental effect on Bitcoin’s long-term returns. The declining EPU, on the other hand, has a favorable impact, showing that once a concern has eased, investors recover trust in the Bitcoin market. Arguably, these investments do not serve as long-term safe-havens. Tether benefits from rising EPU because of its stable currency status and long-term position as a haven asset. Haven assets such as Bitcoin, Ethereum, and Tether are expected to benefit in the short-term and show potential.
Motivation of the study
Significant downward pressure was placed on economic growth in 2020 due to the pandemic containment measures taken by authorities at all levels. These measures include home isolation, social distancing, travel and transport restrictions, and the temporary suspension of nonessential economic activities. These COVID-19 curtailment steps were a tremendous shock to microfirm capital networks, making it challenging to maintain general operations; according to a poll conducted in February 2020, 72.87% of internet businesses and 68.39% of businesses that primarily functioned offline anticipated being able to maintain their cash flows for no longer than three months. Cryptocurrency is in a unique position as a pioneer in a technology that might fundamentally alter conventional financial institutions (Marella et al., 2020). Disagreement still exists about whether cryptocurrencies fulfill the three functions of money medium of exchange, unit of account, and store of value despite the exponential growth in the number of companies that accept Bitcoin payments (Harb et al., 2022). The roles of stable and unstable cryptocurrencies impact the dynamics of the Bitcoin market (Qiao et al., 2023). Several studies on cryptocurrency economics (Almeida & Gonçalves, 2023) have attempted to determine why cryptocurrency markets go through bubbles. For instance, (Karim et al., 2023) point out that factors including volatility, trading volume, transaction volume, VIX, and Google searches cannot forecast bitcoin returns. While (Huang et al., 2019) suggest that high-dimensional indicators can predict bitcoin returns, (Balcilar et al., 2023) demonstrate that volume can predict returns using nonlinear models. Therefore, in this study, we analyze the nexus between economic policy uncertainty and cryptocurrency returns.
The results of the country-specific EPU-bitcoin nexus demonstrate that the United States EPU, which dominates the global economy, has a persistently negative influence on bitcoin returns. However, China’s EPU has little to no long-term impact on Bitcoin. Due to its significant role in the global economy, the United States is vulnerable to these and other global effects (Chowdhury & Abdullah, 2023). EPU had a favorable and significant impact on cryptocurrency returns, except for oil prices. Figures 1 and 2 in the appendix represent the state and provincewise hash rates in China and the US, respectively. Georgia has the highest, followed by Texas and Kentucky. After that, New York and California recorded the largest shares. For China, Xinjiang has the highest with a 50% share, followed by Sichuan and Yunnan with 21% and 7%, respectively.
