How Crisis Affects Crypto: Coronavirus as a Test Case

67 Pages Posted: 23 Mar 2020 Last revised: 23 Mar 2022

See all articles by Hadar Yoana Jabotinsky

Hadar Yoana Jabotinsky

Tel Aviv University - Cegla Center for Interdisciplinary Research of the Law; The Hadar Jabotinsky Center for Interdisciplinary Research of Financial Markets, Crises and Technology (HJC)

Roee Sarel

Institute of Law and Economics, University of Hamburg

Date Written: February 15, 2022

Abstract

Everybody is talking about Cryptocurrencies. These digital tokens, which began as a one-asset market, have swiftly ballooned into a massive and diverse “cryptomarket”. The cryptomarket is still mostly unregulated, but this is about to change, as a presidential executive order on “crypto strategy” reportedly lurks ahead. In light of the expected regulatory changes, two important questions emerge: is there a clear rationale for legal intervention in the cryptomarket? And if so, what type of regulation would be optimal?

We take a two-step approach to answer these pivotal questions: First, we analyze empirical evidence from the early days of the Covid-19 pandemic in order to better understand the risks posed by the cryptomarket when a crisis emerges. Second, we apply a law and economics approach to identify which market failures are consistent with the data and derive novel regulatory lessons.

Our empirical analysis reveals an interesting pattern: investors initially shifted funds to the cryptomarket when the pandemic erupted but then made a U-turn, which led to a plunge in the market. We maintain that this behavior of investors can have both rational and behavioral explanations, which, in turn, affects the optimal choice of regulation.

Accordingly, we map each explanation onto potential market failures by surveying different possible interpretations of our findings, such as substitution effects between traditional markets and the cryptomarket, exploitation of investors in the form of pump-and-dump schemes, and other criminal activities. We then discuss how each type of failure can serve as justification for regulation and derive regulatory lessons on how to best intervene in the cryptomarket, depending on the source of the market failure.

To the best of our knowledge, this is the first paper dealing with regulation that analyzes how the Covid-19 pandemic affected the cryptomarket.

Keywords: Coronavirus, Covid-19, Cryptocurrencies, Blockchain, Financial regulation, Securities Law

JEL Classification: E44, E52, G01, G14, G18, K22

Suggested Citation

Jabotinsky, Hadar Yoana and Jabotinsky, Hadar Yoana and Sarel, Roee, How Crisis Affects Crypto: Coronavirus as a Test Case (February 15, 2022). Hastings Law Journal, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3557929 or http://dx.doi.org/10.2139/ssrn.3557929

Hadar Yoana Jabotinsky

Tel Aviv University - Cegla Center for Interdisciplinary Research of the Law ( email )

Ramat Aviv
Tel Aviv, IL
Israel

The Hadar Jabotinsky Center for Interdisciplinary Research of Financial Markets, Crises and Technology (HJC) ( email )

29 Ha'Oren St.
P.O Box 80
Timrat, 23840
Israel

Roee Sarel (Contact Author)

Institute of Law and Economics, University of Hamburg ( email )

Johnsallee 35
Hamburg, 20148
Germany

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