• International Journal of Technology (IJTech)
  • Vol 12, No 7 (2021)

A Study of Uncertainty Contribution to Cryptocurrency Investment Dynamics

A Study of Uncertainty Contribution to Cryptocurrency Investment Dynamics

Title: A Study of Uncertainty Contribution to Cryptocurrency Investment Dynamics
Polyakova Aleksandra, Zavyalov Dmitry, Kolmakov Vladimir

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Cite this article as:
Polyakova, A., Zavyalov, D., Kolmakov, V., 2021. A Study of Uncertainty Contribution to Cryptocurrency Investment Dynamics. International Journal of Technology. Volume 12(7), pp. 1529-1536

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Polyakova Aleksandra Plekhanov Russian University of Economics; 36, Stremyanny lane, Moscow, 117997, Russian Federation
Zavyalov Dmitry Plekhanov Russian University of Economics; 36, Stremyanny lane, Moscow, 117997, Russian Federation
Kolmakov Vladimir Plekhanov Russian University of Economics; 36, Stremyanny lane, Moscow, 117997, Russian Federation
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Abstract
A Study of Uncertainty Contribution to Cryptocurrency Investment Dynamics

We investigate the interrelation between the economic policy uncertainty index and composite cryptocurrency index to contribute to the contemporary discussion and verify the available results of other researchers. Our research objective is to verify the hypothesis about the positive correlation between uncertainty and cryptocurrency price with regard to the previously published results. We employ a trailing correlation and linear regression of data at different lags to find evidence of co-movement and, if found, to determine the nature of cryptocurrency investment—a safe haven or abnormal return-seeking venture. We employ the most recent data (ending May 2021) and come to a conclusion that requires revisiting the known findings, as our results at earlier levels in the time series follow the mainstream, while the most recent data prove them wrong. The major conclusion made upon completion of the analysis is that there is no reliable correlation between economic policy uncertainty and cryptocurrency exchange rates, which could have practical usability.

Cryptocurrency; Risk prediction; Trailing correlation; Uncertainty index

Introduction

The United Nations Organization denoted cryptocurrency as the new frontier in finance. According to the United Nations, cryptocurrency and blockchain technology can create breakthrough business models that eliminate or augment routines and significantly contribute to performance and efficiency, shaping the global “digital future” (Bencsik, 2020). As is well known, its practical implementations are spreading from decentralized finance products to corporate social responsibility management issues (see, e.g., Kulkova, 2020, or Berawi, 2020b), as cryptocurrency markets have developed significantly and provided many reasons to investigate their development drivers and factors.

One opinion holds that cryptocurrencies and related assets can provide investors with a powerful instrument of risk mitigation in periods of volatility and unpredictability, which has increased significantly under COVID-19 circumstances, causing many governments to take necessary actions and collaborate to enable robust global recovery (Berawi 2020a). Alternatively, one can assume that cryptocurrencies are not “safe havens” but are profit-seeking ventures that aim for maximum yields when major investors rebalance their portfolios in favor of conservative assets.

To formalize, we assume that an interdependence exists between cryptocurrency returns and economic uncertainty. Thus, we posit the following research hypothesis: Increases in economic uncertainty contribute positively to cryptocurrency returns; alternatively, decreases in uncertainty undermine investors’ faith in cryptocurrency in favor of traditional segments of the market.

This hypothesis is not a brand-new development in contemporary science. Several papers have employed the same methodological approach to test cryptocurrency responses to uncertainty changes. Namely, Wu et al. (2021) applied Twitter-based economic policy uncertainty measures to test the Granger causality presence in uncertainty influence on cryptocurrencies and found that the influence was positive. Haq et al. (2021) concluded that economic policy uncertainty implies different patterns of correlation with cryptocurrency market development, depending on national-specific features, such as regulation or financial market alternatives for risk mitigation.

Many researchers agree that the cryptocurrency market can respond to uncertainty change differently depending on the direction of the change. Colon et al. (2021) approached the issue from the reverse perspective; they proved that “the cryptocurrency market can serve as a strong hedge against geopolitical risks in most cases, but it could be considered a weak hedge and safe haven against economic policy uncertainty during a bull market.” In other words, they considered cryptocurrency to be a factor of instability. The variability of correlations between cryptocurrency and uncertainty was also demonstrated by Qian et al. (2021), who explored the economic policy uncertainty index as an external factor for possibly explaining correlations between the cryptocurrency index (CRIX) and the world stock market portfolio. Their findings demonstrate that “the correlation is influenced by the uncertainty stance of the economy and behaves differently in low-, medium-, and high-uncertainty periods.”

Concordant to the former and the latter, Koumba et al. (2020) found that “economic policy uncertainty affects exchange rates on cryptocurrency assets in times of financial turbulence characterized by low confidence in the financial stock markets, and tranquil periods where the financial stock markets behave smoothly.”

Developing on that, Yen and Cheng (2021) applied a country-specific approach to address economic policy uncertainty with regard to cryptocurrency volatility. They found that uncertainty can be a valid predictor of cryptocurrency volatility in China but not in the United States or Japan. They also showed in Cheng and Yen (2020) that national economic policy uncertainty indices are improper predictors of cryptocurrency returns, except in China. Notable is the evidence provided by Phan et al. (2018), whose findings also proved that economic policy uncertainty provides different contributions to financial market dynamics across different countries.

Given all the facts above, we aim to contribute to the theory by introducing an alternative analytical approach and means of results verification. 

Conclusion

    Despite our expectations, the analysis we made makes us reject our hypothesis. Fluctuations of economic uncertainty contribute to cryptocurrency returns not in a single manner and cannot be used to explain cryptoasset growth or downgrades. With respect to the quoted research papers we can give at least one plausible explanation of the differences we see: the time series we employed were more actual. Up to some periods, our findings did fit into the mainstream, but the most recent fluctuations in the cryptocurrency market do not allow us to conclude that there is a distinct uniform pattern of correlation that can be further employed for practical purposes.

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