Cryptocurrency Exchange Rates
Digital currencies (DC) represent one of the most disruptive innovations ever in consumer finance, and the Wall Street Journal refers to" one of the most powerful innovations in finance in 500 years." (Casey and Vigna, Jan. 23, 2015) DC have become the platform for a thriving community of venture-backed start-ups. Established banks and financial companies have searched for ways to integrate the technology into their older money transfer and payment systems. Regulators have struggled to adapt existing laws in the areas of banking and securities regulation to fit the novel problems associated with DC. Central banks around the world (Bank of England, Bank of Canada, U.S. Federal Reserve, Bank of China, ...) are even exploring issuance of their own DC, using the blockchain technology developed for Bitcoin, the most valuable and prominent digital currency to date. The distributed ledger technology underlying all digital currencies has many other potential applications in diverse areas such as property registration, accounting and auditing, and financial derivatives. On January 9, 2017, the Wall Street Journal announced joint efforts by IBM the Depository Trust & Clearing Corp., the New York-based utility that settles and clears all stock and bond trades in the U.S., to clear all credit derivatives clearing through blockchain technology (Demos, Jan. 9, 2017). These developments underscore the rapid transformation of the market for financial derivatives. The decision by the SEC to reject the request for listing of the first Bitcoin ETF in history certainly represents a setback for the development of financial securities tied to DCs (Michaels and Vigna, March 10, 2017). Yet, the fact that the corporate derivatives giant CME Group (Chicago Mercantile Exchange) officially launched its bitcoin price indices for transparent pricing and settlement on November 14, 2016, confirms the backing of the financial industry and strongly suggests that these innovative financial products are here to stay.
This project will undertake an in-depth study of the spot and derivative markets of financial securities tied to bilateral exchange rates with DCs. Despite a tremendous amount of research into the blockchain technology, and, to a lesser extent, into DC (primarily Bitcoin), there exists no academic research into DC derivatives, at least not to our knowledge. Thus, the primary objective of the suggested analysis is (i) to provide a systematic overview of the DC market, (ii) to describe the key risk and return characteristics of bilateral DC exchange rates (Lustig and Verdelhan, 2007; Lustig et al., 2011, 2013). (iii) to examine the pricing efficiency of the DC market, and to determine the location of price discovery (regular exchange vs. DC platforms), and (iv) to examine well-known anomalies in the foreign exchange market, such as the carry trade and the violation of covered interest rate parity. DCs are immune from monetary inflation, but not from price-level inflation. Thus, comparing the differences and similarities in anomalies and risk factors between standard bilateral exchange rates and those implied by DCs may be helpful in better understanding the sources of existing "puzzles." Thus, our analysis may potentially allow us to shed light on the debate about the economic source of the carry trade (Hassan, 2013; Ready et al., 2017; Richmond, 2017).
Patrick Augustin is Assistant Professor of Finance at the Desautels Faculty of Management at McGill University. He earned a PhD degree in Finance from the Stockholm School of Economics in 2013, a Master degree in Banking and Finance from the Luxembourg School of Finance, and a Master degree in Financial and Monetary Economics from the University Louis Pasteur in Strasbourg. He is also certified as Financial Risk Manager by the Global Association of Risk Professionals.
Professor Augustin’s research interests include derivatives, risk management, empirical asset pricing, sovereign credit risk and macro-finance. He has published in the Journal of Financial and Quantitative Analysis and in the Journal of Investment Management. His work on insider trading has been widely covered in the financial press, including The New York Times, The Wall Street Journal, The Washington Post, and The Globe and Mail. Before joining academia, he worked as a structured credit officer at Dexia and as attaché to the Luxembourg Ministry of Foreign Affairs.