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Bitcoin: Optimising the regulatory approach


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MSc Business Economics

Competition Law & Economics

Master Thesis

Bitcoin: Optimising the regulatory approach

A decentralised approach for a decentralised asset


Ethan Moynihan 11423757

July 2021 15 EC


Mw. prof. dr. B.E. Baarsma


Statement of Originality

This document is written by Ethan Moynihan who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document are original and that no

sources other than those mentioned in the text and its references have been used in creating it.

UvA Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.



Traditional regulation relies on the assumption that an asset can be easily classified into a single use-case. With the creation of cryptocurrencies such as Bitcoin, regulators are faced with a new asset class that serves multiple use-cases simultaneously. Rather than force a classification that may fail to capture all benefits and risks inherent to the new cryptocurrency asset class, this paper sought to form an optimal approach to the regulation of Bitcoin, by applying regulation on a use-case basis.

Three use-cases for Bitcoin were considered: as a reserve currency, as a means of day-to-day exchange, and as an investment or store of value. Two policy goals were selected from each use-case and the effects of existing regulations on said policy goals were quantitatively evaluated through regression analysis of panel data.

The resulting three sub-baskets of regulation were then qualitatively evaluated in order to assess how they may interact across use-cases and with Bitcoin itself. The final optimised basket of regulation contained three regulations:

- Reserve requirements (central bank, from use-case 1)

- A Countercyclical capital buffer (central bank, from use-case 1 and 2) - A Market Abuse Directive (SEC or equivalent, from use-case 3)

The success found by this paper in applying the use-case regulatory approach indicates that determining regulation on a use-case basis is a legitimate approach to regulating multi-use- case assets. This finding suggests that such an approach could form the basis of a framework for regulating future multi-use-case assets.


Table of Contents

Statement of Originality 2

Abstract: 3

1. Introduction: 6

1.1 Topic introduction 6

1.2 The 3 use-cases considered for Bitcoin: 8

1.3 What does ‘optimal’ mean, and why are we interested in optimising the regulatory

approach? 9

1.4 Research Questions: 9

1.5 Research aims: 9

1.7 What other characteristics must regulation fulfil? 10

1.8 Additional regulatory concerns: 11

1.9 Limitations: 12

1.10 Paper Layout: 13

2. Literature review: 14

2.1 Core research papers 14

2.1.1 Nabilou (2019) 14

2.1.2 OECD papers (2012): 18

2.1.3 Additional Bitcoin Literature 20

2.2 Non-specific Regulatory Literature: 21

2.3 Literature relating to use-case 1 (reserve currency regulation): 22 2.4 Literature relating to use-case 2 (means of exchange regulation): 23

2.5 Literature relating to use-case 3 (store of value investing/wealth building

regulation): 24

2.6 Conceptual framework 25

3. Methodology: 27

3.1 Explaining the methodological approach 27

3.2 Gathering data 29

3.2.1 Determination of the 3 primary use-cases for Bitcoin 29


3.2.2 Discovery of the policy goals of regulators for each use-case 30 3.2.3 Determining the regulations that are typically employed by regulators, in pursuit of the policy

goals 34

3.2.4 Regressions and quantitative evaluation on the effects of the different regulations on the policy

goals on a case-by-case basis 42

4. Results: 46

4.1 Use-case 1: As a reserve currency (regressions 1 & 2) 46

4.1.1 Regression 1: Liquidity of reserves 47

4.1.2 Regression 2: Return on reserves 51

4.2 Use-case 2: as a means of day-to-day exchange (regressions 3 & 4) 53

4.2.1 Regression 3: Inflation 54

4.2.2 Regression 4: Volatility of exchange rate 58

4.3 Use-case 3: As an investment or store of wealth (regressions 5 & 6) 60

4.3.1 Regression 5: Economic growth 61

4.3.2 Regression 6: Sustainable development 62

4.4 Final sub-baskets of regulation: 64

5. Discussion: 66

5.1 Consolidating sub-baskets in a Bitcoin context: 66

5.2 The optimised basket: 70

5.3 Evaluation of the methodological approach 71

6. Conclusion: 75

References 77

Appendix 84


1. Introduction:

1.1 Topic introduction

The global bubble of the early 2000s, culminating in the financial crisis of 2007/8 spawned a new form of asset, specifically designed to avoid the perceived weaknesses of traditional fiat currencies and the institutions that they flowed through.

With the ongoing exponential growth in interest from both institutional and retail investors, its influence is undeniable. Bitcoin may be here to stay.

Whilst Bitcoin, the currency, is the primary area of interest for investors, the true innovation is the underlying technology, blockchain, and the way in which it is implemented through Bitcoin. It is undeniable that such technological advancements should be promoted, however it is still necessary to ensure that the perceived benefits are not outweighed by unforeseen novel threats. Such caution finds merit in recent history. In the early years of the internet, a lack of clear regulation allowed firms to operate in grey areas that ultimately harmed consumers and market participants.

Having learned from these past shortcomings, governments have expressed significant

interest in the development of an effective regulatory approach to Bitcoin, and the entire class of cryptocurrencies.

The number and scope of cryptocurrencies has grown since their inception, with over 6000 acknowledged cryptocurrencies as of July 2021. Despite this fact, this paper will focus solely on the first and largest of the cryptocurrencies, Bitcoin (Statista, 2021). There are several reasons for this decision, the primary one being that, unlike traditional currencies, the underlying characteristics of cryptocurrencies vary dramatically based on their goal.

Although the innovative technology behind Bitcoin, the blockchain, is a core component of almost all alternative coins, colloquially referred to as ‘altcoins’, its implementation varies dramatically. These differences can be best represented by comparing Bitcoin to Ether, at present the second largest cryptocurrency by market cap. Ether is the currency linked to a blockchain network called Ethereum, run by an entity called the Ethereum Foundation.

Unlike Bitcoin, whose creator’s identity is unknown, with changes to the core programming almost impossible, Ether takes a more centralised approach, with the Ethereum foundation having the power to make changes to fundamental characteristics of the currency, from the block reward to the way that new currency is minted (Buterin, 2021).


Whilst they fall under the same name, cryptocurrencies vary significantly from each other. As this paper seeks to prove a conceptual approach to regulation, the unnecessary complication of considering all cryptocurrencies would only hinder the research. Furthermore, Bitcoin is the only cryptocurrency seeing adoption outside of individual and institutional investors, with El Salvador passing a law to adopt Bitcoin as a domestic currency in June of 2021 (Solomon, 2021).

Whether a critic or a proponent of Bitcoin, regulation is an undeniable necessity. Many that are cynical of Bitcoin are critical of regulation due to the view that it provides a degree of legitimation for cryptocurrencies. On the contrary, as the value of the Bitcoin network grows, so too does the risk it poses of knock-on instability resulting from large spikes in volatility.

Thus, regulation can serve as a means of insulating other industries from risks resulting from price fluctuations of Bitcoin. The threat of this is real and present, the market cap of Bitcoin exceeded $1 trillion for the first time in early 2021. In May of the same year however, the Bitcoin market saw a retracement of 50%. In US Dollar terms this is the equivalent of all global airlines going bankrupt almost twice over (Companiesmarketcap, 2021). With unrealised losses of $500 billion, such huge declines in the price of Bitcoin will inevitably lead to financial instability and bankruptcies. Regulation has many goals; however, the primary theme is to provide stability (Vives, 2016). Stability that may minimise the growing risks from the volatility that has thus far been prevalent throughout Bitcoin’s history. On the other end of the spectrum, many proponents of Bitcoin view regulation as an infringement upon the core characteristics of Bitcoin, specifically regarding the anonymous and

decentralised nature of the blockchain technology. On the contrary, regulation is designed to provide security for participants, and the stability that regulation may bring could see a new influx of users to the platform. Bitcoin’s security outside of regulation relies on the total compute power of Bitcoin ‘miners’; individuals that solve complex algorithms in order to be rewarded with Bitcoin. Under the laws of supply and demand, the increase in demand for Bitcoin, in conjunction with its fixed supply, should increase the price per Bitcoin, making Bitcoin mining more profitable. This should increase the number of Bitcoin miners and thus the compute power of the network, increasing the overall security.

The unique advantages of the Bitcoin technology, alongside the unique threats that said technology poses to participants, significantly complicate the jobs of regulators. This is


compounded by the multi-use-case spanning nature of Bitcoin. Traditional assets can easily be classified into a single use-case based on their applications. These use-cases are overseen by independent regulatory bodies that consistently apply regulation to all assets within that case. The advent of Bitcoin has exposed weaknesses in this centralised approach to

regulation, with no frameworks in place for cross-case regulation or collaboration between regulatory bodies when faced with an asset that sees application in multiple use-cases at once.

Thus far this has severely limited the extent of Bitcoin regulation discussions, with most regulators at a deadlock on the topic of how best to classify Bitcoin.

External research into solving the regulatory deadlock has however found inspiration in one of the core characteristics of Bitcoin itself, its decentralisation. A 2019 research paper revealed that the European Central Bank was legally unable to impose regulation on Bitcoin unless it could be deemed to be a threat to the monetary system (Nabilou, 2019). Instead, it was proposed that the regulatory approach should be based on the prevailing use-case of Bitcoin, with use-cases representing the current asset classes. At present, research into Bitcoin regulation only extends to the above determination.

1.2 The 3 use-cases considered for Bitcoin:

There are three primary use-cases for Bitcoin that are considered in this paper:

- As a reserve currency

- As a means of day-to-day exchange (liquid currency) - As an investment or store of value

Whilst it is not feasible to determine which purpose bitcoin will ultimately fulfil; it is possible to independently analyse the optimal regulatory approach for each individual use-case and then consolidate these sub-baskets into a single optimal basket of regulation.

To achieve this, this research paper quantitatively evaluated the approaches to regulation that are currently in place for each of the use-cases that Bitcoin spans. This enabled the creation of an optimal basket of regulation for each use-case, independent of the others. From these three sub-baskets of regulation, it was then possible to remove any regulations that were incompatible across use-cases or that threatened to cripple core aspects of Bitcoin. This approach left a single, optimal basket of regulation, with each regulatory body implementing their own portion of the regulation, in aggregate providing the optimal regulatory approach.


This overcomes the issue of having to wait for a dominant use-case to prevail so that a single regulator may determine their regulatory approach.

1.3 What does ‘optimal’ mean, and why are we interested in optimising the regulatory approach?

Optimisation is the formation of a basket of regulation that provides full achievement of regulatory policy goals, whilst maximising the preservation of Bitcoin’s unique advantages.

As outlined previously, the current centralised approach to regulation falters when faced with non-traditional assets. The traditional approach to regulation first requires classification of an asset into a single use-case, which determines the regulatory body that oversees it, and by extension the regulation that applies to it.

Within each of these traditional use-cases there are policy goals that the regulators

consistently strive to achieve. At the same time, innovative assets bring new strengths that regulators seek to preserve wherever possible. Thus, optimisation in this paper can be considered as a regulatory equilibrium between achieving the policy goals of regulators and protecting the innovative strengths of Bitcoin.

1.4 Research Questions:

Research Question:

Based on the demonstrated need for regulation of Bitcoin, and the challenges posed by its multi-class spanning nature for regulators, there is a valid need for the development of a new approach to the regulation of Bitcoin. This will be explored in this paper by answering the following question:

What is the optimal regulatory approach for Bitcoin?

With the sub-question: How does the optimal approach vary, depending on the prevailing use-case of Bitcoin?

1.5 Research aims:

This research does not have the intention of suggesting the best use-case for Bitcoin. On the contrary, this paper aimed to outline the optimal regulatory approach based on the fact that Bitcoin serves multiple-use-cases at once.


The central argument of this paper is that the current centralised approach to regulation is incompatible with Bitcoin. Anticipating that future multi-use-case assets may similarly face incompatibilities with the centralised regulatory model, this paper aims to demonstrate that the decentralised approach to regulation proposed by Nabilou (2019) is an effective tool for these untraditional multi-use-case assets. Furthermore, this paper seeks to translate Nabilou’s qualitative analysis into a practical quantitative assessment, in conjunction with aspects of the regulatory chain used by the OECD, wherein policy goals are determined and then

regulations are assessed based on their effect on the policy goals (Parker & Kirkpatrick, 2012).

In pursuit of this, the research will first curate 3 sub-baskets of regulations. These sub-baskets represent the optimal regulatory approach for a specific use-case of Bitcoin, treating it as if Bitcoin had been classified into that use-case. From these 3 sub-baskets, a single, optimised basket of regulation will be consolidated, creating a set of regulations that simultaneously covers all use-cases, with each regulator implementing the regulations that they have contributed from their own sub-basket.

Consequently, it is expected that the final optimal basket will contain only the few regulatory tools that are most compatible with Bitcoin on the whole, whilst the sub-baskets will be less selective due to the fact that they do not consider aspects relevant to other use-cases.

This paper combines two currently separate forms of analysis that have not presently been applied together in the context of Bitcoin regulation; a quantitative evaluation of existing regulations and their effect on the policy goals of the implementing regulator, and a

qualitative analysis on the compatibility of these regulations across the use-cases of Bitcoin.

It is important to note that there is limited data available on Bitcoin and how it interacts with regulation. Therefore, the effects of different regulatory approaches will be estimated by use- case, through regressions on existing assets within the use-cases. Using these effect

estimations, the different regulatory approaches will then be judged for feasibility.

1.7 What other characteristics must regulation fulfil?

It is necessary to consider what constitutes effective regulation. These are the criteria that regulation must fulfil in order to be considered successful. Furthermore, forming a regulatory proposal for Bitcoin is more than simply optimising the overall approach. There are two


stages, the individual regulation, which must meet a specific criterion, and the overall regulatory approach taken as a whole, which too must meet criteria.

Explicitly, for the overall regulatory approach to be considered as optimised it should be a number of things:

● Easy to implement

● Not hamper innovation

● Protect consumers/prevent bad actors

● Mitigate the significant risks posed by Bitcoin

● Fulfil regulators’ policy goals

1.8 Additional regulatory concerns:

There are further concerns that must be acknowledged when considering the optimal regulatory approach.

Firstly, inconsistencies between countries or regions could lead to the creation of regulatory havens, possibly becoming areas where criminal use of Bitcoin becomes rampant. It is observed that in less politically stable regions, the governments have a tendency to act immorally (e.g., through corruption) (Hussain, 2014). How then does one apply the appropriate degree of regulation in the more stable nations, whilst ensuring that this is not negated in less stable regions? Is this even something that developed nations should be concerned about, so long as their own citizens are protected?

Secondly, regulation must be proportionate to the risks it seeks to mitigate, whilst also avoiding fundamentally crippling the advantages that come from an innovative new asset, in this case, Bitcoin.

Bitcoin also faces challenges to its use as a means of day-to-day exchange in the form of Central Bank Digital Currencies (CBDCs). This is a digital version of a fiat currency and functions almost identically to fiat currency held in an online bank account, only that this account is with the central bank itself, rather than a private bank. The weakness of these CBDCs in regard to Bitcoin is that they share almost all of the same characteristics as traditional fiat currency, with the exception of their non-physicality. The act of digitising a fiat currency does not ultimately change the way it functions. The supply limitations of


bitcoin, mediated through its decentralisation are what make it unique, not the fact it is digital. Furthermore, CBDCs are already classified as currencies, so there is little similarity with Bitcoin with regard to the multi-use-case argument that forms the foundation of this research paper.

Additionally, there is also concern that Bitcoin transactions are too slow for it to function as a global currency. This issue can be broken down into two parts.

Firstly, for day-to-day transactions there exists a second layer network called lightning. This offers virtually instantaneous transactions in bitcoin (Poon & Dryja, 2016). Whilst it is still emerging, it is recognised as being the future of instant bitcoin transactions for small purchases requiring fractions of a Bitcoin. Transactions performed through the lightning network are still settled on the first layer primary bitcoin blockchain later, but the lightning network allows for instant confirmations.

The second case is more related to inter-governmental, very large transactions. These

transactions can be performed on the first layer of the bitcoin network; it is possible to ensure that transactions are confirmed in the next block, within 10 minutes, if a high enough fee is set. For such large transactions a sufficient fee would be negligible, with $400 million worth of Bitcoin being transferred in a single transaction in May 2021 for only $2.50 USD (Terzo et al., 2020).

1.9 Limitations:

As outlined previously, this paper takes a predictive approach to evaluating the viability of different regulations. This is because Bitcoin regulation is largely non-existent and therefore it is not possible to specifically observe the actual effects of different regulations. As with any predictive models there is the threat of omitted variables, with the potential that the model will fail to effectively represent a real-world outcome. This is especially relevant for Bitcoin regulation, where information is rapidly priced into the market, having potentially large effects on the price in a short period of time. This suggests that price may not be a good indicator for regulation performance or would require significant controls if used.


1.10 Paper Layout:

Following the Introduction this paper will comprise 5 further sections, outlined below.

Literature review:

The Literature review section is divided into 6 sub-sections and will evidence the need for this research paper based on existing literature. This will be further developed using literature on the specific use-cases of Bitcoin and will conclude with the introduction of the conceptual framework for this paper.


The Methodology section will include a description of the modelling methods that were employed in gathering data on policy goals of regulators, obtaining advantages and

disadvantages of Bitcoin for each use-case, and evaluating the effectiveness and implications of different regulatory approaches to Bitcoin under the adjusted OECD guidelines.


The Results section will present the findings of the quantitative data analysis described in the methodology section, in order to compile the three sub-baskets of regulation, allowing for further analysis of the sub-baskets in the discussion section so that the final optimised basket of regulation can be determined.


The Discussion section will qualitatively evaluate the regulations from each of the sub- baskets of regulation, as indicated by the quantitative analysis results. This will provide the final optimised basket of regulation. Following this, the research method will be evaluated and weaknesses and recommendations for future research will be presented.

will provide a contextual evaluation of the method and findings of the paper, alongside additional considerations for further research or improvements.


The Conclusion will restate the goal of the research, what the final outcome was and how this compares to the expected result.


2. Literature review:

With Bitcoin’s increasing infamy comes growing discourse surrounding the appropriate regulatory approach that should be employed in order to ensure that the best interests of all relevant parties are maintained. Borne of this concern, many papers exploring regulation of cryptocurrencies like Bitcoin have arisen. As there are fundamental differences between Bitcoin and other cryptocurrencies, with this paper focusing exclusively on the former, only cryptocurrency literature that explicitly relates to Bitcoin regulation will be considered.

This paper will build upon arguments raised in existing literature, whilst taking a novel approach to regulatory discussion, namely, separating the debate into the 3-primary use-cases for Bitcoin and evaluating them independently, before consolidating the most appropriate regulations from the separate use-cases into a single optimal approach.

The literature review is divided into 6 sections, with the first covering the core papers upon which the research methodology is based, followed by a section on non-specific regulatory literature. This is succeeded by 3 sections covering research into the asset classes for each of the 3 use-cases of Bitcoin as laid out in the introduction section. Finally, the conceptual framework will be introduced alongside a brief breakdown of how this will be applied in the research.

2.1 Core research papers

This research relies on two primary literature sources that together form the foundation for the methodological approach employed in this study. The first is a qualitative study by Hossein Nabilou (2019), titled ‘How to regulate bitcoin? Decentralized regulation for a decentralized cryptocurrency’, which proposes a non-traditional approach for regulating multi-use-case assets such as Bitcoin. The second source is a collection of three research papers by the OECD that describe a quantitative approach to evaluating the effectiveness of regulations at achieving policy goals.

2.1.1 Nabilou (2019)

In a 2019 paper, Hossein Nabilou provided a number of points in favour of tackling

cryptocurrency regulation on a use-case basis. The primary argument that Nabilou raises is


that Bitcoin’s decentralised nature and lack of a clear single use-case is not compatible with traditional centralised forms of regulation. Nabilou provides 3 main justifications for this claim: competence limitations of public authorities, challenges in adequately identifying the regulated entities, and regulatory arbitrage arising from inconsistencies between geographic areas. These points will be further discussed below.

Competence limitations

The relative infancy of Bitcoin, in conjunction with the originality of the blockchain network upon which it is built, pose a significant risk of regulatory competence limitations. Nabilou explains that “regulators need to exercise the utmost caution in the legal categorization of cryptocurrencies, as a legal categorization is not simply a description of reality. In effect, such categorizations prescribe the legal nature of objects” (Nabilou, 2019). He continues, stating on traditional regulation, that “putting one object into a specific legal category often triggers a whole host of legal consequences, such as the determination of who should regulate that cryptocurrency” (Nabilou, 2019).

For Bitcoin, an asset that serves multiple use-cases simultaneously, the danger of premature classification is significant. It is logical that regulators that enforce the assets that fall under the purview of each of the use-cases would seek to classify Bitcoin under their relevant use- case, with evidence being available that supports their claims. Indeed, Nabilou notes that the hybrid nature of cryptocurrencies, “which allows them to be used as a means of payment, investment and access, have led to a surge of interest in studying the potential venues for regulating cryptocurrencies among regulators ranging from financial crime enforcement agencies to banking, securities and commodity markets regulators” (Nabilou, 2019). There is a tangible threat therefore that the first regulator to provide a logical justification for

classifying Bitcoin under their use-case may be granted their request. Nabilou concludes that

“legal categorization should only be sought after the full appreciation of the object and its complexities” (Nabilou, 2019).

The threat of competence limitations goes beyond this. Nabilou calls for caution with regard to the Hayekian knowledge problem, stating that “traditional centralized regulation assumes that the government has the perfect knowledge to identify the causes of the problems and would have the complete knowledge and mastery of the regulatory instruments to design the best solutions to achieve its goals''. Whilst this may hold true in traditional regulation, the


infancy and complexity of Bitcoin relative to traditional assets mean that regulators are almost certain to lack sufficient knowledge to fully appreciate the impacts of new regulations, designed for Bitcoin. Returning to Nabilou’s earlier conclusion, that “legal categorization should only be sought after the full appreciation of the object and its complexities'', it is clear that whilst regulators seek to urgently implement regulatory approaches to Bitcoin, caution is required, as a premature classification of Bitcoin may lead to a later discovery that not all nuances of Bitcoin had been considered prior (Nabilou, 2019).

This paper attempts to account for the threat of competence limitations by assessing only pre- existing regulations, to determine their suitability for implementation on Bitcoin, rather than attempting to develop entirely new regulations for each of the individual threats posed by Bitcoin. Through this approach, regulators’ competence is safely assumed, as they have prior experience implementing said regulations effectively.

Identifying regulated entities and lack of regulatory direction:

The second argument that Nabilou provides for a decentralised approach to Bitcoin regulation is the current lack of an existing institution towards which regulation could be directed. This is of particular concern for regulators, because “traditional methods of

financial regulation are mainly reliant on either the direct regulation of activities, entities and instruments or the regulation of the middlemen and gatekeepers” (Nabilou, 2019). As

Nabilou further explains, “from a regulatory perspective, policymakers have taken different stances on the nature of cryptocurrencies. Tax authorities have designated cryptocurrencies as property.Commodity markets authorities have viewed them as a commodity.Securities regulators have seen some of them as security, and regulators and supervisors in charge of money or financial crime have designated them as currency” (Nabilou, 2019). This once again clearly demonstrates the primary issue of applying a centralised regulatory approach to a decentralised, multi-use-case asset; each regulator can justify classifying the asset in a different way. Furthermore, these regulatory bodies have no authority over assets outside of their classifications. This naturally poses issues for the regulation of Bitcoin, seeing as there is no progress towards a general classification consensus.

This multi-use-case characteristic of Bitcoin means more than just a lack of classification.

For instance, “in multi-layered constitutional arrangements such as that of the European Union (EU) and the euro area, the principles of conferral, subsidiarity and proportionality


impose additional limitations on the powers of the EU institutions, agencies, and bodies”

(Nabilou, 2019). This means that “the ECB can only intervene in the cryptocurrency markets if the cryptocurrencies threaten the stability of the payment or the banking systems”

(Nabilou, 2019).

This illustrates the extent to which existing, centralised regulatory approaches lead to a hand- tying effect, where regulatory bodies are legally prevented from imposing necessary

regulations due to the incompatibility with the decentralised nature of Bitcoin.

Whilst the decentralised approach to regulation proposed by this paper does not entirely solve the issues of identifying regulated entities or hand-tying in multi-layered constitutional arrangements, it does provide regulatory recommendations that can be implemented without significant legal structural changes, as each regulatory body applies regulation to the use-case of Bitcoin that falls under their jurisdiction.

Regulatory Arbitrage:

Finally, there is the issue of regulatory arbitrage, wherein inconsistencies in regulation between areas lead to flows of capital from areas with greater regulation to those with less.

For an intangible, digital asset such as Bitcoin, the threat from regulatory arbitrage is

significant. This further justifies the need for a decentralised approach to Bitcoin regulation, as the ability for regulators to use existing regulatory approaches as the basis of the

decentralised regulatory framework ensures a rapid and consistent application of regulation, minimising the time discrepancy between countries’ implementations and therefore also minimising the threat of regulatory arbitrage.

Conclusions from Nabilou’s paper:

It is possible to draw a number of conclusions from Nabilou’s paper. Primary of these is that, in their current form, regulatory bodies’ hands are tied until Bitcoin is either classified under one of the existing asset classes, a new branch of regulatory body is created specifically for cryptocurrencies, or, as this paper advises, regulatory bodies are permitted to collaboratively regulate a single asset, with each regulatory body applying regulation related to the use-case of the asset that falls under their jurisdiction. By optimising each of these use-case baskets of regulation, both independent from each other and then by considering them in aggregate, it is possible to provide an optimal approach to regulating Bitcoin, under a framework that could be applied to future as-of-yet non-existent multi-use-case assets.


2.1.2 OECD papers (2012):

The OECD has a set of 3 published papers outlining their methods for quantifying the effects of different regulatory approaches (Coglianese, 2012; Parker & Kirkpatrick, 2012; Radaelli &

Fritsch, 2012). The OECD approach focuses primarily on the impact of improving regulation on economic and welfare gains. Whilst this is somewhat different to the goal of this research paper, which in the first stage seeks to first evaluate the effect of different regulations on regulators’ policy goals, the OECD makes a number of recommendations for evaluating regulations that can be applied to this research.

The OECD methodological approach prescribes a hindsight effectiveness evaluation on the impact of different regulations. This paper seeks to adapt the application of the OECD methodology from a purely hindsight effectiveness evaluation to an extrapolative prediction, in order to quantitatively determine which regulatory approaches provide the greatest benefits for the specific policy goals of each of Bitcoin’s three use-cases. Following the quantitative analysis, it will be possible to qualitatively evaluate the regulations that were found to have desirable effects on the policy goals, by considering how they may interact with the unique advantages and disadvantages posed by Bitcoin, as well as other regulations being


The third of the three OECD papers includes a causal chain model, an adaptation of which is used in this research paper. According to Parker & Kirkpatrick (2012), the OECD defines good regulation as regulation that “occurs only when it does improve social welfare and that regulatory changes do so with the minimum net cost or maximum net benefit to society”.

Whilst the OECD focuses on a regulation-by-regulation basis, this paper takes a similar approach to defining what a good, or optimal approach is. Specifically, the approach to optimising regulation set out in this paper, is defined as a basket of regulations that provide full achievement of regulatory policy goals, whilst maximising the preservation of Bitcoin’s advantages.

The key similarity between the OECD approach and that of this paper is therefore the view that regulation should be implemented only when it leads to a desirable outcome, but not at the detriment of other factors. In the case of this paper, regulations must mitigate the disadvantages posed by Bitcoin, however this should be achieved whilst simultaneously satisfying regulators’ policy goals.


(Causal chain, Parker & Kirkpatrick, 2012)

The OECD paper states, “the impact attributed to a particular policy intervention is commonly estimated by comparing the observed outcome with the hypothetical

counterfactual” (Parker & Kirkpatrick, 2012). This means that the OECD approach advises observation of the effect of implementing a regulatory approach and compares this to a model-prediction of what would have happened, had the regulation not been implemented.

This paper adapts this methodology by taking a simplified approach, performing multiple linear regressions, using dummy regressors for the relevant regulations in panel data format, grouping by country. Through this approach, it is possible to evaluate the effect of

implementing specific regulations over time, controlling for fixed or random effects where necessary.

The unique advantages and disadvantages that Bitcoin presents mean that certain regulations may not behave in the same way when applied to Bitcoin as they do when applied to

traditional assets in the use-case (such as US dollars in use-cases 1 and 2). Therefore, once a predictive value for each regulation is obtained, this can be qualitatively evaluated against the advantages of Bitcoin to assess for incompatibility, before being approved or denied as a regulatory tool for the use-case-basket.

The OECD paper specifically notes a reliance on core indicators, as a means of gauging the impact of different regulations. This paper will therefore evaluate the effect that different relevant regulations have on the key policy goals of regulators for each use-case, as a means


of acquiring tangible estimates on the impact of policy goals. The OECD paper draws focus to the potential for spill-overs when performing cross-national comparisons between OECD countries (Coglianese, 2012). Whilst on a Macro-scale, this could pose a threat to regulation effect measuring, through in inability to account for regulatory arbitrage, this should not be of significant concern to this paper, as the majority of regulatory arbitrage issues arise from inconsistencies between regulation implementation, rather than differing effects of the same regulation between countries. To control for any remaining spill-over effects, Hausman tests can be performed to test for random or fixed effects and then the appropriate model applied accordingly (Hausman, 1978).

The OECD paper also discusses the weaknesses of their modelling approach, specifically an inability to employ aggregate indicators that combine the benefits and the costs in one indicator. This paper will overcome this issue by separating the effectiveness evaluation into two sections. The first, qualitative section, focuses on the impact of regulations on a policy goal. Following this, the regulations that are significant can be qualitatively evaluated by comparing the potential impact of the regulation to the advantages and disadvantages of Bitcoin for that use-case application. Consequently, a lack of aggregate indicators is not of significant concern.

2.1.3 Additional Bitcoin Literature

Nabilou’s second argument in favour of a use-case basis for Bitcoin regulation, namely that there are challenges with appropriately identifying regulated entities and a lack of regulatory direction related to Bitcoin, is consistent with arguments made in other papers that discuss the regulatory approach to Bitcoin. Specifically, in a 2015 paper, Mitchell Prentis discusses how

“The IRS stated that it considered bitcoins to be "property," and would tax them like any other appreciable property” (Prentis, 2015), however Prentis notes that on a separate occasion

“The IRS's guidance also notes that bitcoins may be capital property in the hands of some Bitcoin users, and, if held for the necessary amount of time, may enjoy capital gains treatment” (Prentis, 2015). From the above it is clear that regulators face significant

roadblocks through the requirement to classify Bitcoin into a single use-case or asset class.

Nabilou’s recommendation is that Bitcoin is considered separately for each potential use- case, a proposal that this paper expands upon by performing quantitative analysis on


regulations on a use-case basis, in order to determine which regulations are optimal for regulating Bitcoin on a use-case basis.

One of the purposes of regulation, in addition to protecting participants, is to ensure that those participants are correctly reporting their activities to prevent fraud, tax evasion, or criminal activities. This is especially key for Bitcoin, due to the anonymity of transactions.

Whilst Nabilou’s first point, competence limitations, is aimed at the competence limitations of regulators in the face of new asset classes like Bitcoin, attention should also be paid to the competence limitations of those involved in the markets. An article posted by the Federal Trade Commission in 2021 relating to cryptocurrency scams, stated that “Since October 2020, reports have skyrocketed, with nearly 7,000 people reporting losses of more than $80 million” (Fletcher, 2021). Furthermore, Prentis’ research paper, noted above, discusses challenges faced by taxpayers when attempting to report Bitcoin transactions; “Because of the anonymity of Bitcoin transactions, it may be difficult for a taxpayer to know whom to send the 1099 to, and whom the taxpayer should list as the payee, when he reports the payment to the IRS'' (Prentis, 2015).

2.2 Non-specific Regulatory Literature:

There are multiple possible approaches for evaluating the effectiveness of different

regulations at achieving policy goals. Qualitative studies, such as that of Nabilou (2019) face limitations in the inferences that can be drawn from their analyses, as they are only able to provide exploratory conclusions. In the case of Nabilou, it was possible to determine that the optimal approach to regulating multi-use-case assets such as Bitcoin was by applying

regulation on a use-case basis. However, qualitative studies are not able to determine which specific regulations should be applied to the regulation of Bitcoin in each use-case. This paper therefore applies Nabilou’s use-case recommendation through quantitative regression analysis in order to overcome the inability of qualitative approaches to evaluate individual regulations.

This paper employs primarily panel data in the regression analyses. Hsiao (2003) describes a panel data set as “one that follows a given sample of individuals over time, and thus provides multiple observations on each individual in the sample” (Hsiao, 2003). In the quantitative analysis section of this research paper, the goal is to determine what the effect of


implementing different regulations is on the policy goals of the regulators implementing them. In order to achieve this, it is necessary to have data on these variables both prior and post-regulatory implementation. This need for having multiple observations for each of the countries included in the model is, as indicated by Hsiao, made possible through the use of panel data (Hsiao, 2003).

An interesting point of note that became clear when performing preliminary research for this paper, which resulted in a significant deviation from the initial planned approach to the research, was the realisation that the central bank is responsible for making regulatory policy decisions for both use case 1 and 2 (for reserves and means of exchange). This is due to the fact that both operate in the same unit, namely, currency. As the same regulatory body was responsible for implementing regulations for both use case 1 and 2, it was determined that the same regulations could be used for modelling regressions 3 and 4 (for use case 2) as were used for the modelling of regressions 1 and 2 (for use case 1).

This changed the structure of the analysis somewhat, as instead of considering that there are 3 separate regulators, 1 for each use-case, I am now considering 2 regulators, the central bank for use case 1 and 2, and the SEC (or international equivalent) for use case 3.

2.3 Literature relating to use-case 1 (reserve currency regulation):

Whilst this research aims to optimise the regulatory approach to multi-use-case assets, the asset in question, Bitcoin, has only existed for 12 years. As such it is important to note that the concept of cryptocurrencies has only been referred to in research since then. Although Cryptocurrencies are not explicitly referred to in research prior to 2009, prominent

researchers of the 1900s still hypothesised about alternatives to the inflation-plagued fiat money of their time. Of those writing on the topic of currency competition, the two of greatest significance are Milton Friedman and Friedrich Hayek.

Friedrich Hayek, in a 1986 article speaks of ‘paper money’, untethered from backing by gold as somewhat of a temporary solution to the inflation that plagued the Bretton Woods era (Hayek, 1986). He explicitly refers to what he perceives as the source of this inflation in his statement “So long as government is in charge of monetary policy, inflation is bound to continue” (Hayek, 1986). A clear trend in his work is the argument that governments will succumb to political pressures, resulting in monetary incontinence. In his 1976 book, The


Denationalisation of Money, Hayek proposes the establishment of privately issued currency and with a Laissez-faire approach to currency competition (Hayek, 1976). He later further developed this argument into the hypothesis that the world would progress towards a single or few dominant currencies (Hayek, 1978).

Following the discovery that the central bank was responsible for implementing regulations for both use-case 1 and 2, it was necessary to then find an appropriate set of regulations to evaluate for possible implementation for regulating Bitcoin. This was found in the Basel III banking regulatory framework. The Basel framework sets out 27 regulatory policies that can be implemented by central banks. The Basel framework was appealing as it already had widespread adoption, providing a relatively large sample size as well as avoiding the threat of inconsistencies posed by manually cultivating a collection of potential regulations.

Furthermore, the Basel framework is intended to provide a largely exhaustive list of regulations covering banking activities and therefore the risk of omitted variables is significantly lowered.

It should be noted that a more recent update to the Basel III standards was released in 2017, however the changes are not due to take effect until 2023 whilst the Basel III standards were agreed in 2009 and were implemented in the years following. Basel III, being almost

identical to Basel IV and already being largely implemented, makes it more appropriate for use in this paper (The Bank for International Settlements, 2020).

2.4 Literature relating to use-case 2 (means of exchange regulation):

Current regulation relating to the use of currency as a day-to-day means of exchange is primarily aimed at policing the transaction processors such as the Visa and Adyen platforms, rather than the underlying currency (Wilson et al., 2014). This naturally occurs because traditional currencies are controlled by the issuing government, who also then govern regulatory policy. This discrepancy is novel in Bitcoin as for the first time there exists a widely accepted currency that is not controlled by a government. As such, regulation of Bitcoin from the perspective of its use as a day-to-day means of exchange needs to also consider regulation of the underlying currency. An issue with this is the unchangeable nature of Bitcoin. This means that, even if a government were to implement laws that dictated an incompatibility with current Bitcoin protocols, there is nothing that could be done to change


Bitcoin to resolve this, something often seen as a strength of the Bitcoin protocol. This poses challenges for regulators, who instead have to influence how users of Bitcoin interact with it, rather than policing how Bitcoin itself behaves.

As mentioned in section 2.4, the Basel III banking regulatory framework also applies for use- case 2, as the central bank is also responsible for regulating day-to-day currency use. The same 27 regulations are therefore evaluated in the regression analyses of use-case 2.

2.5 Literature relating to use-case 3 (store of value investing/wealth building regulation):

Regulation in terms of store of value investing or wealth building investments typically focuses on time of sale regulation, largely relating to how and when taxes must be paid on any capital gains.

From the above points a few notes can be made. Firstly, regulation should not seek to force a fundamental change in the Bitcoin protocols, as this is virtually impossible. Attempting to do so would lead to either the disappearance of the currency, or more likely, the movement of its use primarily towards illegal underground transactions which directly contradicts the purpose of regulation.

Secondly, the need to independently review the optimal regulatory approach for each case is clear. The differing goals of each category bring with them different advantages that must be protected, as well as threats that must be mitigated. The overlap between these categories justifies the need to review each case independently, as otherwise appropriate regulation may not be possible to find without causing negative effects on one of the other use-cases.

Unlike use-cases 1 and 2, there does not currently exist a framework for regulating investments or stores of value. Whilst there is a degree of consistency between some countries on their approaches to regulating these assets, the lack of clear available data on when said regulations were implemented means that the panel data analysis that this paper employs is not possible. As a result, a smaller group of regulations had to be curated

manually. These 3 regulations, measured as dummy variables, cover whether a country had a carbon tax, whether they had joined the MAD (Market Abuse Directive) and whether they had joined the TPD (transparency directive). The MAD and TPD are both part of the ESMA


framework for European countries. Similar to the Basel III framework, this means that there is comparability for the effects of implementing the regulations across countries (Christensen et al., 2010).

2.6 Conceptual framework

(Conceptual framework)

This paper considers three possible use-cases for Bitcoin. Traditionally, assets are first classified, which determines the regulatory body responsible for applying regulation. Then, based on the existing regulatory approaches available to the class regulator, an approach to regulation for the new asset is then determined. A weakness of this traditional approach when faced with decentralised, multi-class spanning assets is that a single regulatory body may not have sufficient regulatory approaches at their disposal to properly regulate away all of the threats of the asset.

This paper employs a decentralised for decentralised approach, wherein multiple regulatory bodies regulate a single decentralised asset.


The approach:

Firstly, the asset, Bitcoin, is split into three possible use-cases. Under the assumption that Bitcoin would be classified into each of these classes separately, the relevant regulation that would be applied is considered. These regulations are quantitatively evaluated to gauge their impact on regulators’ policy goals, removing those that are found to be either insignificant or to have undesirable effects on the policy goals. Once the three optimal sub-baskets are compiled (one for each use-case), the sub-baskets will be evaluated to prevent overlap from similar regulations, as well as evaluate interaction effects between regulations, further trimming the potential regulatory approaches prescribed by each sub-basket. The remaining regulations are then combined in a single basket; the optimal approach to regulation for Bitcoin, with each regulatory body implementing their own regulations.

Something that distinguishes this approach from typical regulation is that typical regulation requires sufficient regulation of an asset entirely by a single regulatory body, and for a single use-case. The decentralised for decentralised approach provides what may appear as an incomplete approach for a single use-case, however when considered in aggregate it offers the overall optimal approach for assets that do not neatly fit into a single asset class.


3. Methodology:

The methodology section will be separated into 2 primary parts, with the second of these consisting of 4 sub-sections.

Initially, an explanation of the methodological approach will be provided, briefly outlining the core stages of the research and the types of data employed.

This will be followed by a detailed explanation of each of the core stages of the research.

This includes both an explanation of how the relevant data was sourced, and how it was implemented in the study. Following this, the method is evaluated, with additional points of consideration.

3.1 Explaining the methodological approach

This paper sought to provide an optimisation solution to the incompatibility between multi- use-case assets, such as Bitcoin, and the traditional one use-case, one regulator, approach of traditional asset regulation. The solution proposed in this paper involved first separating the regulatory approach into the three primary use-cases of Bitcoin, where the optimal basket of regulation is determined for each use-case separately. Following the optimisation of each of the sub-baskets of regulation, the sub-baskets were considered collectively, and the

regulations were consolidated into a single basket, removing any regulations that were found to be incompatible or that unnecessary.

Whilst this paper specifically aims to provide an optimal approach to the regulation of Bitcoin, it is intended that the framework that this paper employs could be used in the future for the formation of regulatory strategies for other non-traditional, multi-use-case assets.

In optimising the regulatory approach to Bitcoin regulation, the research was developed in five core stages:

1. Determination of the 3 primary use-cases for Bitcoin.

2. Discovery of the policy goals of regulators for each use-case (2 policy goals per use- case).

3. Determining the regulations that are typically employed by regulators, in pursuit of the policy goals.

4. Regressions and quantitative evaluation on the effects of the different regulations on the policy goals on a case-by-case basis.


5. Qualitatively evaluate the most effective regulations determined in the previous step to determine which are compatible with Bitcoin.

In the process of following this 5-step approach, multiple data sources were employed. As the regressions that were employed for the quantitative evaluation section sought to evaluate the effect that implementation of different regulations had on policy goals over time, the main data used in this study was secondary panel data from regulatory bodies and databanks.

Where necessary, this was supplemented with additional secondary data from external sources. Due to the fact that the paper employs panel data, with many of the variables of interest measuring whether a regulation was active in a given year, the majority of variables used in the regressions were in dummy variable format, taking the value 0 when a regulation was not yet implemented, and 1 for all years after and including the year of implementation.

In all cases, once a regulation was implemented it remained active until the end of the time period being evaluated (1989-2018, inclusive). Research decisions were based predominantly on recommendations from existing literature with some nuances based on common-sense justifications.

For this study an initial sample of 50 countries was used. These were the 50 largest economies as of 2018. Whilst this was not truly random sampling, it was determined that poor or inconsistent reporting standards were a significant risk to the validity of the study. It was concluded that the potential threat from sampling bias was outweighed by the benefits of having access to clear data. Furthermore, the 50 largest economies make up over 92% of the world’s GDP (World Bank, 2020a). It is therefore acceptable to assume that the 50 countries included in the study can be generalised to the total population. Whilst the study started with an initial 50 countries, depending on data availability for the regulations included in each regression the number of countries included varied. This is due to the way that panel data regressions work; where data is required on all regulations for a given country in order for it to be included in the model. In some regressions this led to less than 30 countries being included, which could lead to magnification of any errors. Following the selection of countries, a time period was chosen. A period of 30 years was adopted for this study; 1989- 2018. Whilst there was data available for them, the years 2019 and 2020 were not included due to potential shocks from the global Covid-19 pandemic. As this event occurs at the end of the dataset, it is possible to simply shorten the time frame without causing time-gaps in the data. Similarly, prior to 1989 a number of the countries included in the model did not have


data available and therefore expanding the time frame further into the past would only have reduced the number of countries with available data further.

The quantitative analysis was performed through 6 multiple linear regressions, with the dependent variable of each regression being one of the 6 policy goals. The independent variables are the regulations that are applied in each use-case, with additional control

variables such as whether a country is a member of the EU also included. Through evaluation of the coefficients of the regressors, it was possible to determine the effect that different regulations had on policy goals. The regulations that had the desired effect on the policy goals were included in the sub-basket of their relevant use-case. First, the regulations that had significant and desirable effects on each pair of policy goals from each pair of policy goals (one pair per use-case) were combined into separate baskets. Following the determination of the 3 optimal sub-baskets of regulation, the baskets were qualitatively evaluated together.

This allowed for collective assessment, to ensure that there was no policy overlap between use-cases and that the regulations were actually compatible with Bitcoin and its unique advantages and disadvantages. The remaining regulations form the optimal basket of regulation, with the implication being that each regulator would implement the regulations that were contributed by the sub-basket they oversaw.

3.2 Gathering data

In the following sub-section, the process of data collection will be fully explained. Alongside this, justifications behind data selections will be provided.

3.2.1 Determination of the 3 primary use-cases for Bitcoin

The first step in optimising Bitcoin regulation was to determine the 3 predominant use-cases for Bitcoin. These were found to be:

- As a reserve currency

- As a means of exchange (day-to-day liquid currency) - As an investment or store of value

To understand the justifications behind selecting these use-cases, it is necessary to first consider the Bitcoin whitepaper; the initial publication outlining the intent of Bitcoin at its point of inception. The paper itself is titled “Bitcoin: A peer to peer electronic cash system”


(Nakamoto, 2008). In the whitepaper, Nakamoto outlines the intention for Bitcoin to be used as a form of electronic cash that is easily transferable between individuals without the need for third parties. Whilst this is one of the use-cases of Bitcoin for which it is already actively used, the rising prices per Bitcoin have led to investors purchasing it as a speculative asset, in addition to those that treat it as a means of exchange. This is demonstrated by a metric known as ‘coindays’, representing the total number of days that Bitcoins have not been transferred for (Glassnode studio, 2021). If an individual sent a Bitcoin to another individual after holding it for 365 consecutive days, then 365 coindays would be destroyed and would begin to accrue again from zero. Whilst this metric is not actively tracked by the Bitcoin network itself, it is possible to view all historic transactions between Bitcoin wallets and therefore through analysis of this information it is possible to form a measurement of coin-days. This metric has revealed that the number of long-term holders of Bitcoin are increasing over time, indicating that there is a rise in Bitcoin’s use as an investment or store of value, in addition to daily use as currency.

The third use-case, as a reserve currency, is the only one of the three that is not already widely employed. Despite this, in June of 2021 the El Salvadoran government signed a law that implements Bitcoin as legal tender, alongside the US Dollar (Solomon, 2021). As a result of this, the El Salvadoran government is purchasing $150 million worth of Bitcoin to hold in a trust, in order to facilitate payments for its citizens (Solomon, 2021). Whilst this is not exactly how reserve currencies are traditionally treated, with the El Salvadoran government’s Bitcoin reserves only being used to settle transactions within the country, it demonstrates that countries are beginning to see Bitcoin as a currency that has a place on their balance sheets.

In order to capture this potential future use-case for Bitcoin it is therefore considered alongside the two current use-cases.

3.2.2 Discovery of the policy goals of regulators for each use-case

Within each of the aforementioned use-cases, regulators have specific policy goals that they seek to achieve. For this research the 2 most important of these goals, indicated in literature, for each use-case were considered. These policy goals formed the dependent variables for the regression models, upon which the effects of different regulations were evaluated. Due to the fact that a qualitative evaluation followed the regression analyses, based on the advantages and disadvantages of Bitcoin in each use case, these advantages, and disadvantages were also considered on a use-case basis.


This is best visualised in tabular form, provided below:

Use-Case Policy Goals Advantages Disadvantages

1. As a reserve currency

● Adequate foreign exchange reserves are available for meeting a defined range of objectives (1).

● Liquidity, market, and credit risks are controlled in a prudent manner (1).

● Subject to liquidity and other risk constraints, reasonable earnings are generated over the medium to long term on the funds invested (1).

● Fixed supply (proponents argue protects against inflation).

● No transport risk (as Bitcoin is digital there is no need for

expensive transport and protection).

● Bitcoin’s

anonymity makes it desirable for use in criminal


● Governments that adopt Bitcoin as a portion of their reserves face the volatility that comes with Bitcoin’s price movements.

● Cyclical nature of Bitcoin price means that the real value of reserves fluctuates


2. As a means of exchange (day-to-day currency)

● Management of inflation or unemployment (2.i).

● Maintenance of currency exchange rates(2.i) (Standard deviation of moving average of exchange rates (2.ii))

● Very low transaction fees for merchants compared to traditional means.

● Self-

administered, so transactions do not rely on a third party.

● Traditional Bitcoin transactions can be slow and rely on a second-layer protocol for faster transactions that might be too complicated for those unfamiliar with blockchain technology.


Use-Case Policy Goals Advantages Disadvantages

● Irreversible transactions mean that scams or mistakes cannot be undone.

● Bitcoin’s

anonymity makes it desirable for use in criminal


3. As an investment or store of value

● Mobilise private investment that supports economic growth and sustainable development (3).

● Fixed supply (Scarcity brings value).

● Accessible from anywhere.

● Easy to transport.

● Bitcoin’s

anonymity makes it desirable for use in criminal


● Self-storage has a higher chance of destruction than traditional stores of wealth like gold.

● High energy use (primarily from non-renewable sources).

● Prone to price manipulation and abuse.

Table 1 (Regulatory policy goals by use-case with advantages & disadvantages of Bitcoin) (1) Guidelines for Foreign Exchange Reserve Management. (2001).


(2.i) Corporate Finance Institute. (2021).

(2.ii) (Serenis & Tsounis, 2012).

(3) OECD (2006).

These policy goals were sourced from a number of organisations. Primarily the IMF and the OECD, with additional consideration for the measurement of exchange rate volatility taken from a 2012 research paper (Serenis & Tsounis, 2012).

The above policy goals translate to the following:

Use-case 1: As a reserve currency

● 1. Liquidity of reserves

o Measured as the ratio between a country’s liquidity of reserves and GDP

● 2. Return on reserves

o The interbank interest rate, annual average (calendar year)

Use-case 2: As a means of exchange (day-to-day currency)

● 3. Inflation rate

● 4. Volatility of exchange rate

o Standard deviation of moving average of exchange rate

Use-case 3: As an investment or store of value

● 5. Economic growth

o Annual GDP growth rate

● 6. Sustainable development

o Measured using the % of energy sourced from fossil fuels, higher values therefore constituting a worse sustainable development performance

The numbers 1-6 above describe the regression number. Further in the paper, to avoid excessive repetition, regressions are in places referred to simply by their regression number.

For example, ‘Regression 4’ is the regression for the ‘Volatility of exchange rate’ policy goal. Below each of the policy goals, in bullet-points, the operationalised variable representing the policy goal is included, where relevant.


3.2.3 Determining the regulations that are typically employed by regulators, in pursuit of the policy goals

Following the determination of the policy goals for each use-case it was necessary to evaluate what regulation is currently employed for assets in each of the three use-cases. As this paper seeks to obtain estimates on the average effect that different regulations have at achieving policy goals, it was important to maximise the breadth of data included in the regressions. In pursuit of this, the 50 largest economies as of 2018 were chosen for evaluation in this


The initial plan for curating a list of potential regulations was to individually select

regulations based on existing literature. During the data gathering stage however, it became apparent that the data reporting standards were not consistent between countries when trying to cultivate this list of regulations, even within the 50 largest countries by GDP. Furthermore, it was impossible to determine whether independently enforced regulations were proportional across countries.

A solution to this for use-cases 1 and 2 was found in the Basel III banking regulation framework. The Basel committee, through the Basel III monitoring report, provided data on 27 regulations related to banking and currency, sorted by country. In implementing the Basel III banking regulatory guidelines, countries aim to execute consistent regulations such as capital requirements for equity investments in funds, monitoring tools for intraday liquidity management, and net stable funding ratios. The monitoring report provided data on the year that countries had issued rules, or whether a country was yet to make progress towards a regulation’s implementation. Furthermore, where countries already had similar regulations in place, the Basel committee had already assessed the existing regulations to determine

whether they were similar enough to the Basel regulations to be considered sufficient. This negated the issue of gauging similarity between countries’ regulatory approaches that was initially faced when cultivating a list of appropriate regulations.

Nonetheless, the downside to taking this approach is that the list of regulations included in the models is still not exhaustive, relying solely on the regulations included in the pre-set Basel III framework. This poses a threat of omitted variable bias in the models; it is difficult to account for all potential regulations and factors that could influence the policy goals,



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