Can Government Regulation Affect Bitcoin Prices?

After skyrocketing to a record high, bitcoin, the world's most widely-used cryptocurrency, fell by more than 7% yesterday. Other cryptocurrencies followed suit. Bitcoin has staged a strong recovery this morning and is currently trading at $5,730.46. There is also talk that it is within range of breaching $6,000.

The rapid change and volatility in cryptocurrency prices has puzzled analysts and economists, especially as there are no fundamental reasons governing their price movements. So, what factors should traders and investors in cryptocurrencies consider to evaluate them? Government regulation might be one of them.

In a June note, analysts at Morgan Stanley suggested that government regulation might be a factor influencing bitcoin prices. According to them, “governmental acceptance would be required for this (bitcoin’s price) to further accelerate, the price of which is regulation.”

Can Government Regulation Control Cryptocurrency Prices?

There are a couple of ways in which government intervention can influence the price of cryptocurrencies. First, governments can regulate the price of assets, such as fiat currencies, through buying and selling actions in international markets. Second, they can tamp down excessive enthusiasm for an asset class by saddling it with regulations that increase the cost of doing business. An example of this approach is bitcoin regulation being considered across various states in the United States. Most states require surety bonds or an equivalent amount in fiat currency for cryptocurrency exchanges within their jurisdictions. Finally, governments can also make the asset scarce by imposing controls on it. An example of this is the case of gold, which has import restrictions in several countries.

All three types of actions have the potential to fail in the case of bitcoin and cryptocurrencies. This is because cryptocurrencies are extra-national and have decentralized ledgers that are spread across multiple countries. Their regulation will require a well-coordinated effort across several economies. This might be a difficult task, given varying levels of interest in cryptocurrencies and their impact on national economies in different places.

The differing reactions of China and Japan to bitcoin is an example of the difficulties in such an approach. China banned initial coin offerings, which use cryptocurrencies as a funding mechanism, to prevent capital outflow and money laundering. On the other hand, Japan considers cryptocurrencies legal tender and is reportedly developing its own currency.

Both actions have an impact on the price of bitcoin. The announcement of China’s ICO ban resulted in a price decline of as much as $500 in bitcoin’s price. (See also: NEO Cryptocurrency Suffers As China Bans ICOs.) But the currency bounced back soon enough and continued its upward march towards $5,000. In the immediate aftermath of the Japanese government’s announcement that the currency was legal tender, bitcoin’s price spiked up by 2.8%.

A Limited Effect?

Still, the effect of government regulation on bitcoin and other cryptocurrencies might be limited.   

In an essay on Project Syndicate, noted economist Kenneth Rogoff writes that bitcoin will never supplant government-issued money because that “would make it extremely difficult to collect taxes or counter criminal activity.”

“Would the price of Bitcoin drop to zero if governments could perfectly observe transactions? Perhaps not. Even though Bitcoin transactions require an exorbitant amount of electricity, with some improvements, Bitcoin might still beat the 2% fees the big banks charge on credit and debit cards,” he writes.

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