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Authored By: Saurav Kumar (M.B.A. (Finance) & Co-Authored By: Dr. Jayanti Srivastava, Assistant Professor, Amity Business School, Lucknow,
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ABSTRACT:
“This study examines the effects of the presence or absence of effective regulatory bodies on the volatility and liquidity of cryptocurrencies. Following the 2008 financial crisis, the rise of cryptocurrencies sparked significant interest within academic and professional circles, with cryptocurrencies now representing over 25,000 options, of which over 40 have exceeded $1 billion in market valuation as of June 2023. Despite limited outright prohibitions by central banks, concerns regarding market risks, illicit activities, and inadequate consumer protection persist. This research aims to clarify the relationship between regulatory oversight and the market dynamics of cryptocurrencies”.
Keywords: Bitcoin, Regulation, Algorithm, Decentralization, Blockchain, Cryptocurrency
I. OBJECTIVES OF THE STUDY:
• To analyse the existing regulatory frameworks for cryptocurrency in key global markets and their evolution over time.
• To assess the impact of regulatory measures on the liquidity of cryptocurrency assets across different exchanges and platforms.
II. INTRODUCTION:
“Bitcoin is not unregulated. It is regulated by algorithm instead of being regulated by government bureaucracies.” Andreas M Antonopoulos. On the one hand, the 2008 financial crisis’s devastating impact on the banking industry and, on the other, the instabilities within financial institutions, prompted the rigorous development of cryptocurrencies. Academics and professionals have taken notice of the rise in cryptocurrencies. They are traded between users via a decentralized (peer-to-peer) system built on blockchain technology, and they are not influenced by any outside parties, including the central bank. Of the more than 25,000 different cryptocurrencies available on the market as of June 2023, over 40 have a market valuation of more than $1 billion. In recent years, cryptocurrency has garnered a lot of interest and offers both opportunities and threats in the financial markets. Few central banks have prohibited the use of cryptocurrencies as financial assets, despite the fact that several have warned against their usage and categorically disputed that they are a form of money. The use of leverage, market risks from volatility, insufficient liquidity, and operational hazards of cryptocurrencies are issues that policymakers are worried about. According to the Global Research Centre’s (2018) research on cryptocurrency regulations, cryptocurrency can be traded lawfully in nations where it is permitted as long as it complies with current financial instrument laws and regulations. Policymakers are concerned that cryptocurrencies could be used for illicit purposes including money laundering, the trading in illegal or controlled substances, or the financing of terrorism, regardless of the regulatory position. The possible absence of protection for investors and consumers is another issue that policymakers are aware of. In this study, we investigate whether the existence or lack of reliable monitoring and regulatory bodies affects how much the volatility and liquidity of cryptocurrencies.
III. LITERATURE REVIEW:
Researchers, investors, and legislators are paying more and more attention to the connection between legal frameworks and the volatility and liquidity of cryptocurrencies. Although cryptocurrencies provide advantages like decentralization and cross-border transactions, their volatility and liquidity problems continue to be major roadblocks. With varying results depending on different jurisdictions and market conditions, an expanding corpus of work has attempted to investigate how alternative regulatory methods impact these elements. One of the most important studies in this field looks at how regulation might lessen the volatility of the cryptocurrency market (Zohar, 2020). According to Zohar, one of the main causes of volatility in digital asset markets is uncertainty, which can be lessened with the support of clear and uniform regulatory frameworks. The study analysis of market data from nations with well-established regulatory frameworks, including Switzerland, revealed that cryptocurrencies in these areas typically have less volatility in price than those in economies with unclear or non-existent regulations. Zohar specifically highlights the significance of investor protection laws, such as know-your-customer (KYC) and anti-money laundering (AML) measures, which boost market confidence and curb speculative activity, resulting in increased stability.
However, research such as that conducted by Wang and Yu (2021) examines the potential effects of regulatory actions on liquidity. Their study looks at trading volumes and market depth using secondary data from bitcoin exchanges in various regulatory contexts. The results imply that strict laws, particularly those pertaining to KYC/AML compliance, may decrease liquidity by making trading more expensive and complicated. Srivastava J. (2016) analyses the Sahara mobilization of funds from over 3 crore investors without complying with SEBI regulations,
highlighting the group strategy to circumvent regulations and the subsequent legal battle and Supreme Court intervention on the other hand, markets with less regulation, like those in Estonia and Japan, typically have more liquidity since more people are drawn to these markets due to the lower entry barriers. However, the report also points out that since less regulation can encourage speculative trading and market manipulation, this boost in liquidity frequently comes at the expense of more volatility. The body of research indicates that regulatory frameworks are essential in determining the volatility and liquidity of cryptocurrency markets. Regulation effects are complex, though; strict standards may reduce volatility but also limit liquidity, whereas loose regulations may encourage liquidity but raise price volatility. These research use of secondary data technique offers insightful information about how cryptocurrency markets behave under various regulatory frameworks, emphasizing the necessity of well-rounded and cogent regulatory strategies to promote stable and liquid markets. In order to further investigate these dynamics, this study expands on previous research by examining secondary data on market trends and regulatory actions.
IV. CRYPTOCURRENCY AND ITS POLICY ENVIRONMENT:
According to Peters et al. (2015), cryptocurrency is an electronic token that was created in response to the demand for peer-to-peer online payments. Bitcoin is the most popular and well-known cryptocurrency. It was created by an unidentified developer or group of developers using the pseudonym Satoshi Nakamura. It records ownership and value transfers using a decentralized public ledger. In order to confirm who owns the cryptocurrency and the following transfer, a number of “miners” must solve a challenging cryptographic puzzle. This is the innovation underlying bitcoin. The public can access the mining process as it is an open-source program. Peer-to-peer verification eliminates the need for conventional, reliable third parties like banks and credit card companies. In its current form, cryptocurrency is not regarded as a cash substitute. The fact that it is not issued by a sovereign body raises doubts about its inherent value, which is one of the main grounds of disagreement over it. As cryptocurrencies became more well-known in the financial industry, market participants started using it as a speculative investment tool. Bitcoin started to be exchanged on cryptocurrency exchanges, just like other financial assets. At the moment, more than 200 exchanges worldwide facilitate cryptocurrency trading . Among other nations, the US, the Republic of Korea, and Samoa are some of the main exchanges. The Global Legal Research Center (2018) offers a thorough analysis of the regulatory and legal environment pertaining to cryptocurrencies. While some nations (such Nepal, Pakistan, Vietnam, etc.) have explicitly banned cryptocurrencies, the majority do not regulate or support them. Countries like Italy, Australia, and Japan, among others, demand that cryptocurrency activities be registered and licensed. The Isle of Man and Mexico, on the other hand, permit the use of cryptocurrencies as payment methods, according to the report. Policymakers adopt their attitudes and policy posture toward cryptocurrencies as the opportunities and hazards associated with them become more apparent as news about bitcoin operations develops. For example, according to the Global Legal Research Centre (2018), Japan updated its cryptocurrency laws in response to growing market speculation. Japan updated the Payment Services Act in April 2017 to include a clear definition of cryptocurrencies and to mandate that dealers who exchange them for legal cash, like yen, register. On the other hand, some legislators choose to leave cryptocurrency unregulated and let its use be governed by the regulations that already apply to financial instruments or commodities. The Global Legal Research Centre’s (2018) regulations offer a number of instances. Cryptocurrency is categorized as another intangible commodity in Austria and is regarded as a corporate asset. Under the current securities regime, Anguilla regulates cryptocurrencies that act as securities. In the meantime, a few other nations, like the Bahamas and Bermuda, do not yet have any particular laws pertaining to cryptocurrencies and are presently investigating their legislative or regulatory alternatives.
V. EU’S CRYPTOCURRENCY REGULATION:
In May 2023, the European Union introduced the Markets in Crypto-Assets Regulation (MiCA), the first comprehensive cryptocurrency legislation in history. The public is now being consulted on a number of initiatives by the European Security and Markets Authority. A license will be required for any business that issues or trades cryptocurrencies, and starting in January 2026, all service providers will need to collect the names of senders and recipients, regardless of the amount being transferred. Additionally, any transactions using self-hosted wallets with more than 1,000 euros will require wallet ownership verification. By setting common rules across all EU member states, MiCA reduces the regulatory fragmentation that can hinder cross-border trading of crypto assets. This harmonization could lead to more efficient and liquid markets, as exchanges and crypto service providers can operate across the entire EU without needing to comply with multiple national regulations. By addressing some of the speculative behaviours seen in the market, MiCA could reduce wild price fluctuations and lower extreme volatility in certain areas of the market.
VI. ASIAN DIGITAL CURRENCY LAWS:
Although Asia is a global leader in cryptocurrency adoption, regional laws differ greatly from one another. Since it acknowledges cryptocurrencies as legal property and a kind of money, Japan is open to their use. Citizens are therefore free to possess or invest in cryptocurrency, and the Financial Services Agency of the nation oversees both cryptocurrency and yen transactions. To combat money laundering, the nation has tightened its regulations on the movement of consumer data between cryptocurrency exchanges. South Korea is making strides in regulating cryptocurrencies and other virtual assets by including standards for record keeping and openness, after the Virtual Asset Users Protection Act passed in 2023. One of the most stringent nations regarding cryptocurrencies is China, which has outlawed trade, exchanges, and cryptocurrency mining. In India, the Supreme Court has overturned the country’s cryptocurrency ban in 2020.
VII. BRAZIL CRYPTOCURRENCY RULES:
The government of Brazil established a law governing cryptocurrency use in December 2022. Legal certainty for the bitcoin market is the goal of this regulation. Some of the features of this law includes consideration of cryptocurrency as private assets and its use as a mode of payment. Under this law, crypto service providers are required to register with the Brazilian Securities and Exchange Commission. Brazil’s law provides guidelines for the issuance and use of stablecoins. The regulatory framework aims to ensure that stablecoins are properly backed by reserves and adhere to financial regulations, ensuring their stability and minimizing risk to investors.
VIII. UNITED KINGDOM’S CRYPTOCURRENCY REGULATION:
Britain is working to create regulations for the cryptocurrency industry. Particularly, it has required that the Financial Conduct Authority (FCA) of the nation authorize any business that offers digital money. Additionally, the Bank of England and the FCA have suggested rules pertaining to stablecoins. Because stablecoins are linked to the value of another asset, their value is intended to be more stable than that of cryptocurrencies. The Financial Conduct Authority (FCA) is the primary regulatory body overseeing the cryptocurrency industry in the UK. It has been responsible for regulating specific areas, such as crypto asset activities and anti-money laundering (AML) rules, as well as ensuring the protection of consumers.
IX. INDIA’S CRYPTOCURRENCY REGULATION:
The RBI published a circular in April 2018 that prohibits banks and other regulated organizations from offering services to people or companies that trade in cryptocurrency. The Supreme Court of India declared the RBI circular to be illegal and excessive in March 2020. The RBI stated that the circular was no longer relevant after the Supreme Court’s ruling, allowing banks to offer services to people and companies that trade in cryptocurrencies. The RBI has still voiced concerns about the dangers of cryptocurrencies, even after the circular was revoked. The central bank has warned people and investors about the possible risks of cryptocurrency investing in public notifications.
X. IMPACT OF REGULATORY FRAMEWORK ON ITS VOLATILITY AND LIQUIDITY:
The volatility and liquidity of cryptocurrencies are significantly impacted by the regulatory framework in place. A well-structured regulatory environment can provide stability, reduce uncertainty, and promote trust in the market, while the lack of regulation can increase risks and create market inefficiencies. Here’s how regulation can influence both the factors:
• Regulatory framework reduces uncertainty and speculative behaviour, thereby reducing the volatility of the currency. When set of clear guidelines for participants is provided, it ensures that they act with more caution.
• Regulations that require cryptocurrency platforms to disclose information about their working, helps improve market transparency. Transparency can reduce the chances of unexpected market dynamics and volatility.
• Restrictions on leveraged products help reduce excessive risk taking and short term speculation. This can reduce the potential for sudden swings in prices caused by large margin calls or forced liquidations.
• A clear regulatory framework often leads to greater institutional involvement in the cryptocurrency market. Institutions such as banks, asset managers, and pension funds are typically hesitant to enter markets that lack a clear legal structure due to the risks involved.
• Institutional investors find it simpler to enter the bitcoin market when laws are clear. Strict regulatory frameworks that mandate adherence to rules pertaining to trading, reporting, and auditing sometimes bind financial organizations. Regulation of cryptocurrency markets makes it simpler for financial institutions to include crypto assets in their holdings, which greatly improves liquidity.
XI. CONCLUSION:
Cryptocurrency provides a fresh, appealing, and efficient payment option that can increase profits for businesses and operators. In addition to real money, it offers other payment options that let customers conduct financial transactions like purchasing, selling, transferring, and exchanging with ease. Despite offering a new form of currency with many procedures and methods, as well as opening several channels for digital financial transactions, cryptocurrency platforms are not given the proper control and regulation. The primary issue with cryptocurrency systems is thought to be the absence of laws. Until cryptocurrency is properly regulated and monitored, consumers must exercise extreme caution when utilizing virtual currency. Liquidity, volatility, and cryptocurrency regulation are intricately and multidimensionally related. Significant volatility and liquidity limits have been exacerbated by the lack of regulation, but these problems can be lessened with the support of a well-designed regulatory structure. Governments and regulatory agencies are essential in influencing how bitcoin markets behave because they offer stability and transparency, which lessens speculative activity and market manipulation. By drawing in institutional investors and boosting market confidence, clear and encouraging regulations—like those in Japan and Switzerland—have shown the ability to lower volatility and boost liquidity. However, by pushing market participants to less regulated jurisdictions, excessively stringent regulations—like those in place in China and South Korea—may hinder innovation and reduce liquidity. The creation of a well-balanced regulatory framework that safeguards investors, fosters innovation, and upholds market integrity is ultimately necessary for the cryptocurrency industry to thrive sustainably. It will be essential to keep an eye on how these developments affect volatility and liquidity as the global regulatory landscape develops further in order to provide a more safe and stable market environment for all players.
Cite this article as:
SAURAV KUMAR & DR. JAYANTI SRIVASTAVA, “A Study of The Impact of The Regulatory Framework on The Volatility and Liquidity of The Cryptocurrency” Vol.5 & Issue 6, Law Audience Journal (e-ISSN: 2581-6705), Pages 419 to 427 (16th April 2025), available at https://www.lawaudience.com/a-study-of-the-impact-of-the-regulatory-framework-on-the-volatility-and-liquidity-of-the-cryptocurrency-2/.
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