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Cryptocurrency Market Development: The Role of Institutions and Financial Openness
A surge in cryptocurrency trading has led to increased attention on its potential impact on financial markets. A recent study by Nee and Opper (2009) suggests that the quality of state bureaucracy can significantly contribute to financial market development. In this context, we investigate whether de jure financial openness and institutional strength are related to policy decisions on cryptocurrency.
The Role of Institutions
Our research posits that countries with a more liberal capital flow policy may be more open to developing new financial instruments, including cryptocurrency. This is because financial innovation offers new opportunities for countries to keep up with international market developments and compete globally. In fact, studies have shown that capital account liberalization contributes to financial development by introducing international standards, promoting financial stability, and increasing access to foreign capital (Chinn and Ito, 2006).
The Role of Financial Openness
On the other hand, institutional factors also play a crucial role in shaping cryptocurrency market development. A well-functioning legal framework and strong governance institutions can foster trust among investors, promote transparency, and reduce regulatory uncertainty. Our study uses the Worldwide Governance Indicators’ government effectiveness index as a proxy for institutional quality.
Methodology
Our study uses a dataset of 43 countries from 2015 to 2020. We employ the Chinn-Ito index for financial openness and the Worldwide Governance Indicators’ government effectiveness index as proxies for institutional quality. The de jure openness to cryptocurrency variable is constructed based on national laws, regulations, and policies related to cryptocurrency trading.
We estimate a linear regression model using the following specification:
cc_i = δ0 + δ1 ka_open_t-3i + δ2 bureau_quality_t-3i + X_t-3iτ + v_i
where cc_i represents de jure openness to cryptocurrency in country i, ka_open is the Chinn-Ito index for financial openness, bureau_quality is the Worldwide Governance Indicators’ government effectiveness index, and X is a vector of macroeconomic control variables.
Results
Using a sample of 43 countries, we find that financial openness and institutional strength are positively related to de jure cryptocurrency market development. Specifically, our results suggest that a one-standard-deviation increase in financial openness is associated with a significant increase in cryptocurrency market development. Similarly, a one-standard-deviation increase in institutional quality is also linked to increased cryptocurrency market development.
Conclusion
Our study contributes to the growing body of research on the intersection of institutions and financial markets. By highlighting the importance of institutional strength and financial openness in shaping cryptocurrency market development, we provide policymakers with valuable insights for promoting the growth of these markets. As the cryptocurrency landscape continues to evolve, our findings offer a nuanced understanding of the complex interplay between institutions, markets, and economic outcomes.
References
- Chinn, D., & Ito, T. (2006). What matters for financial development? Capital controls, institutions, and interactions. Journal of International Economics, 69(2), 349-362.
- Nee, V., & Opper, S. (2009). The role of bureaucracy in financial market development: Evidence from transition economies. Journal of Comparative Economics, 37(3), 453-466.
ADBI Working Paper 978 Rico Shirakawa and Korwatanasakul