Is cryptocurrency a hedging tool during economic policy uncertainty? An empirical investigation

Recently, the fascination with cryptocurrencies has grown, 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 is independent 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). As a result of 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 sustained, and the cryptocurrency market had a price bubble before the year ended. The enormous volatility in the value of cryptocurrencies demonstrates the risk associated with investing in this type of asset.

Cryptocurrencies are established by various cryptographic algorithms and are exchanged in a digital realm. The continuous development of this system, which aims to replace existing currencies, payment instruments and even traditional monetary theory and practices, has increased the importance of this system over time (Alpago, 2018). In contrast, there is a debate among scholars and experts as to 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 all took an interest in it. Academic cryptocurrency research has also become significant (Almeida & Gonçalves, 2022). Bitcoin’s potential to hedge, a feature of both gold and US dollars, is known as a medium of exchange or digital gold (Su et al., 2023). Because a positive relationship exists between the prices of gold and Bitcoin, according to (Selmi et al., 2022), gold and Bitcoin are more likely to complement each other than to compete against each other. A short position in the Bitcoin market makes it possible to hedge the risk when investing in various other financial assets Guesmi et al., (2019). In particular, the portfolio risk of holding gold, oil and stocks is lower when you hold Bitcoin than when you don’t. However, due to restrictions on anti-money laundering and terrorist financing legislation, Bitcoin cannot replace gold

Cryptocurrency markets can be affected in several predictable ways. Existing studies have investigated how different uncertainty metrics affect cryptocurrency. Some prevailing studies on Bitcoin have examined the impact of uncertainties and risks on cryptocurrency 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 show that the market volatility of cryptocurrencies tends to increase in response to increased investor fear. In their study, Fang et al. (2020) investigate the influence of the News-Based Implied Volatility Index (NVIX) on the volatility of cryptocurrencies over a long period of time. 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 show 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, UK, Japan, China and Hong Kong. The study shows that uncertainty has had an adverse 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 have been conducted on cryptocurrency with economic policy uncertainty or on the asymmetric effect of EPU on cryptocurrency returns. The study’s objectives are twofold: first, to better understand the academic literature already available on cryptoinvestor behavior, synthesize its knowledge and identify knowledge gaps to support future studies; and second, to present meaningful research findings to investors, academics, policy makers, businesses, professionals and society. Existing studies have traced the relationship between cryptocurrency and other various factors. To our knowledge, this study is the first to analyze the relationship between cryptocurrency and economic policy uncertainty post-Covid-19. We pick the top three cryptocurrencies based on their market share—Bitcoin, Ethereum, and Tether. The period is from January 1, 2021 to April 1, 2023. The time chosen is after the COVID-19 pandemic, which has affected every sector of the global economy. That is why we recognize 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 the EPU as much as COVID-19. Because investors are predominantly concerned about losing their investments, which is often cited as a reflection of risk-averse behavior, increased economic policy uncertainty often impedes the flow of investments. Therefore, during financial crises, political unrest or other periods of material uncertainty, such as the COVID-19 pandemic, investors and fund managers are drawn to risk reduction strategies. Conversely, in China, we see 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) examines 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 new proxy for measuring uncertainty. UCRY was created by (Karim et al., 2023) and relies on examining textual content.

Importance 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 significantly improves and moderates traditional financial services. The current state of cryptocurrency developments is usually characterized by abnormal behavior and unexpected events that affect people’s views, market behavior and public legislation (Treiblmaier, 2022). The transmission of fiscal and monetary policies in financial markets has been significantly affected by uncertainty, which has grown in importance in modern economies (Kang & Yoon, 2019). The regulation of cryptocurrency is necessary as it changes “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 previous literature has mainly concentrated on this topic; few research publications have examined other cryptocurrencies. In line with these concerns, we aim to summarize the literature that has focused on the economic implications of crypto. We carefully searched for existing studies on cryptocurrency in the growing academic literature to conduct this analysis. We use a quantile regression approach to examine the data. The quantile regression methodology is beneficial because it helps us make sense of outcomes that are not normally distributed and have non-linear relationships with predictor variables by enabling us to understand the relationships between variables beyond the mean of the data. We aim to examine cryptocurrencies with global economic policy uncertainty. So 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 hedge to cryptocurrency. In addition, the individual country analysis is also tracked in this study. The US and China are known as the two key countries of the world economy, and their shares in cryptocurrency are the highest. Therefore, we select these two countries and perform the same analysis.

Growing global EPU has a detrimental effect on Bitcoin’s long-term returns. The falling EPU, on the other hand, has a favorable impact, showing that once a concern eases, investors regain confidence in the Bitcoin market. Arguably, these investments do not serve as long-term safe havens. Tether benefits from rising EPU due to its stable currency status and long-term position as a haven asset. Harbor assets such as Bitcoin, Ethereum and Tether are expected to benefit and show potential in the short term.

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 non-essential economic activities. These COVID-19 containment measures have been a tremendous shock to micro-firm 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 operating primarily offline expected to maintain their cash flow for no longer than three months. Cryptocurrency is in a unique position as a pioneer in a technology that can fundamentally change conventional financial institutions (Marella et al., 2020). Disagreement still exists as to whether cryptocurrencies fulfill the three functions of money exchange, unit of account and store of value despite the exponential growth in the number of companies accepting Bitcoin payments (Harb et al., 2022). The roles of stable and unstable cryptocurrencies affect 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 example, (Karim et al., 2023) points out that factors including volatility, trading volume, transaction volume, VIX and Google searches cannot predict bitcoin returns. While (Huang et al., 2019) suggests that high-dimensional indicators can predict bitcoin returns, (Balcilar et al., 2023) demonstrates that volume can predict returns using non-linear models. Therefore, in this study, we analyze the relationship between economic policy uncertainty and cryptocurrency returns.

The results of the country-specific EPU-bitcoin nexus show that the United States EPU, which dominates the global economy, has a persistent negative influence on bitcoin returns. However, China’s EPU has little to no long-term impact on Bitcoin. Because of its significant role in the global economy, the United States is vulnerable to these and other global consequences (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 province-wise 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 share of 50%, followed by Sichuan and Yunnan with 21% and 7% respectively.