1 INTRODUCTION

As the economy and society become more digital, it is reasonable to argue that digital assets will become more important over time and Bitcoin could be the replacement of gold in such a digital world. One of the best features of bitcoin is its ultimate digital scarcity that becomes even more apparent in light of the substantial monetary expansion in major economies seeking to stimulate the real economy during the Covid-19 pandemic. Bitcoin is viewed as a scarce digital asset in which its value will grow in tandem with its network users who trust and want to hold Bitcoin as a hedge against the monetary expansion diluting the existing stocks of currencies. In a sense, bitcoin is a project or company which is fuelled by the work of all the people in its network and similar to those investors who hold stocks around the globe, bitcoin users and investors are always on the lookout for an increase in bitcoin price.

The pricing of bitcoin (and cryptocurrencies in general) is an issue that has attracted the attention of finance academics and traders who strive to make money out of price volatility. Many studies have examined the determinants of bitcoin price movement or its fundamental value, including Bolt and van Oordt (2016), Li and Wang (2017), Hayes (2017) and Ciaian et al. (2016), Luther and Salter (2017), and Hazlett and Luther (2020). Several other studies investigated the efficiency of the bitcoin market. Cheah et al. (2018), for instance, find that the bitcoin market is fractionally cointegrated and that uncertainty has a negative impact on the cointegration relationship. Furthermore, Chan et al. (2018) examine the usefulness of bitcoin for diversifying risk against the EURO STOXX index, Nikkei, Shanghai A-Share, S&P 500 and the TSX index. By using a pairwise GARCH process on daily, weekly, and monthly return data, they find that the hedging abilities of bitcoin are less significant for daily and weekly data. Another study by Baur et al. (2018) finds that traditional crisis events—such as natural disasters, terrorist events and economic crises—do not affect the price of bitcoin.

We suspect that the price of bitcoin does not follow traditional extreme events, but rather it follows crypto extreme events such as hacking. One of the most important features of bitcoin is its blockchain has a low probability of being hacked. However, this feature does not apply to the cryptocurrency exchanges as the exchanges (where most bitcoins are traded) are more susceptible to security threats. The 2014 Mt.Gox Hack, for instance, is a typical example of how hackers can tamper the transactions and steal bitcoin from the exchanges. In this relatively new literature, the empirical evidence on the efficiency of the bitcoin market is relatively weak, and this is why we want to embark on this endeavour to investigate the effect of hacking events on the price of bitcoin. Furthermore, we attempt to find out if investors can formulate an investment strategy to take advantage of those events. The paper is organised as follows: Section 2 describes the data and methodology used in this study, Section 3 presents the empirical results, and Section 4 concludes the paper.

2 DATA AND METHODOLOGY

We use daily data, covering the period between 9 August 2013 and 9 August 2018, on bitcoin price, collected from WinkDex, exchange rates (CNY/USD, JPY/USD and CAD/USD) and the S&P500 index from Thomson Reuters Eikon. Table 1 presents the hacking events examined in this study, covering Bitcoin, Ethereum and NEM between 2014 and 2018.1 We adopt and modify the models proposed by Baur et al. (2018) and, Ranaldo and Soderlind (2010) to analyse the bitcoin return against FX returns and the S&P500. In addition, we create a dummy variable (hack) for all hacks that takes a value of 1 on the day the hack and zero otherwise. We then multiply the dummy variable by the FX and S&P500 returns to find out how hacking events affect the bitcoin return. The models are specified as follows:

(1)

where is the bitcoin returns at time t, calculated as the first log difference of the bitcoin price between time t and t−1, is the FX returns at time t, calculated as the average returns of the three currency pairs, and is the S&P500 returns at time t, calculated as the first log difference of the S&P500 index.

Joo et al. (2019) suggest that the new information is not fully reflected in bitcoin price immediately after the events during the event window of (0, 6). We suspect that the effects of hacking events may persist over the few days following the event day—therefore, we create a persistence dummy variable (hacklong) that takes a value of 1 for 7 days from the event day and zero otherwise. We then replace the hack dummy variable with the hacklong dummy variable in Equation (1) to form a modified equation that captures the persistence of the effect and the modified model is as follow:

(2)

To ensure the robustness of the results, we incorporate the lagged variables into Equations (1) and (2) and the models are then specified as follow:

(3)

(4)

where , and are the lagged variables of FX, S&P500 and BTC return respectively.

In addition, we separate the BTC-related hacks from other non-BTC hacks such as DAO or Coincheck to test if BTC price is only driven by BTC-related hacks by creating a dummy variable (hackbtc) for BTC-related hacks and readjusting Equation (1). The model is then specified as follow.

(5)

3 RESULTS

Table 2 displays the descriptive statistic of the variables used in this study. We find, on average, that investing in bitcoin yields significantly higher return than the S&P500 but the bitcoin return is lower than the FX return of the CNY/USD and JPY/USD. Table 3 presents the correlation matrix of the variables, showing a lack of correlation between bitcoin and other assets. This observation is consistent with those made by Yermack (2015) and Baur et al. (2018).

The results of Equation (1) indicate that past bitcoin returns, FX returns and S&P500 returns do not affect bitcoin returns (Table 4). When a hacking event occurs, however, a positive relationship appears between bitcoin returns and FX returns. A plausible explanation for this relationship is that investors might increase their trading activities and make a profit during a hacking event, which requires a substantial amount of foreign currencies pouring into the crypto exchanges, which is, in turn, beneficial for the FX market. On the other hand, we observe a change in market sentiment towards the bitcoin market and the stock market (as proxied by S&P500) when a hack takes place. Our results also show that these effects are limited to BTC-related hacks (see Table 5). For robustness check, we incorporate the lagged variables into the model and the results are consistent with those of Equation (1) as shown in Table 6. The results also show that investors tend to switch their investment to the stock market when the bitcoin price decreases, and vice versa. In addition to the results of Baur et al. (2018), our findings create an opportunity for investors to formulate an investment strategy that takes into account hacking events.

In addition, we examine the long-term effect of these hacking events using Equation (2) that incorporate the hacklong dummy variable to find out if the effect persists in the long term. Our results show that there is no evidence of a persistent effect of a hacking event on bitcoin return and the results are consistent across different models (see Tables 7 and 8).

4 CONCLUSION

The rise of cryptocurrencies, particularly bitcoin, has drawn significant attention from cryptocurrency users, miners and investors as well as the scientific community (Ciaian et al., 2018). Since bitcoin is usually used for investment purposes, it is important to find out if investors can benefit from bitcoin and other financial markets during crypto extreme events.

This paper examines the effects of hacking events on bitcoin returns, producing evidence for a positive relationship between the FX market and the bitcoin market during the hacks. Moreover, the results reveal a negative relationship between the S&P500 and bitcoin returns. Investors can take advantage of the observation that the characteristics of bitcoin are extremely different from those of other financial assets (Dyhrberg, 2016; Katsiampa, 2017). We also find that BTC-related events have significant impact on BTC price while other non-BTC hacks such as DAO or Coincheck have minimal impacts on BTC price. Our results can be used to formulate an investment strategy utilising hacking events and suggest that investors must act quickly to benefit from hacking events since the effects do not last long.