CAI0069

Written evidence submitted by Professor Andros Gregoriou

Introduction

I am a Professor of Finance at the School of Business and Law, University of Brighton. I previously worked at Brunel University, Bournemouth University, University of East Anglia and the University of Hull. I have published over one hundred research papers in internationally leading journals and successfully supervised 10 PhD students to completion.[1][2]

I believe that digital currencies will shape the future of government policy and financial markets. It is vital that ground breaking research is created on the factors that determine returns of digital currencies and how they can be regulated. I have developed through a consultancy project (Evai), the world’s first cryptocurrencies financial ratings system free from human bias using AI and ML techniques.[3] The financial ratings platform is based on multiple factors that were developed in Florackis, Kostakis and Gregoriou (2011) and in Gregoriou, Healy and Le (2019). In particular we establish our own liquidity risk measure for digital assets and also a sentiment variable from the peak-end technical analysis trading tool.[4]

Overview of Cyrptocurrencies based on my research

Cyrptocurrencies could in principle replace paper money in the future. This is because quantitative easing creates inflation, which in turn reduces the value of paper money. Digital currencies have a fixed supply, so they do not have this problem.[5] This is one of the greatest advantages of Cyrptocurrencies over paper money. The other advantage of digital currencies is from an investment perspective. As shown by Gregoriou (2019) investors are able to obtain abnormal returns by trading cryptocurrencies daily from 2014-2017. Excess returns persist once they account for systematic risk, size, value, momentum, profitability and investment. In addition, cyrptocurrencies have been good at reacting to negative shocks in the market. For instance, according to Zhang and Gregoriou (2020) the digital currency market reaction to china prohibiting initial coin offerings on the 4th of September 2007, had a negative but temporary impact on cryptocurrency returns and liquidity. Furthermore, Zhang and Gregoriou (2021) examine diversification when cryptocurrencies are included in investment portfolios, around China prohibiting initial coin offerings on 4 September 2017. They discover, once they account for liquidity, that all portfolio diversification benefits of cryptocurrencies are eliminated. Finally, there is very little diversification within the digital currency market. This is because most digital currencies are pegged against the USD, Bitcoin or Ethereum. Therefore, when Bitcoin or Ethereum go down (up) in price, most of the digital currency market reacts in a similar manner.[6]

Inquiry Issues

Query

To what extent are crypto-assets when used as digital currencies (such as Stablecoin) likely to replace traditional currencies?

Response

I believe they can replace traditional currencies in the future. This can be seen by the establishment of Bitcoin ATM machines. However, before this can happen on a larger scale gas fees need to be reduced to make digital currencies cheaper to do business with. Renewable energy needs to be used for the data mining of digital currencies. Also, regulation is vital for this to occur. Regulation will provide individuals with the confidence to invest in this market. It will also eliminate the excess volatility in this market and not support digital currencies that have no fundamental value. I have undertaken empirical research on this and would be delighted to share it with you.

Query

What opportunities and risks would the introduction of a Bank of England Digital Currency bring?

Response

This would be a great idea as this could peg the digital currency on the value of the GBP. This will give individuals the confidence to invest and eliminate excess volatility in the market. The risks involve having enough liquidity to ensure that trades can occur with little price impact. Setting up liquidity pools is very important to make this a viable investment opportunity. It is also important to provide UK individuals with the knowledge of this market. I believe involving universities, online and face to face short courses would be very useful for providing the education and knowledge for this market.

Query

What impact could the use of crypto-assets have on social inclusion?

Response

This is a great opportunity to include all people in the digital currency world through the development of the central bank digital currency. I believe the government could reach out to the universities, to provide the knowledge and education to individuals. This could be established in a similar vein to the Help to Grow Small Business Charter.[7]

Query

Are the Government and regulators suitably equipped to grasp the opportunities presented by crypto-assets, whilst at the same time mitigating against the risks?

Response

I believe that more can be done here. A committee needs to be set up to deal with regulation of digital assets. This should involve government officials, financial regulators and academics. They need to identify value of digital currencies. For example, ownership of the digital assets is vital. If owners have a large holding of tokens, they can simply sell when they list and the price falls to zero. These need to be identified and eliminated from the market, or at least not supported by the regulator. Also, digital currencies need to be financially rated. This is because if they are simply driven by sentiment, then they have no real fundamental value. Regulation is vital and needs to be undertaken with immediate effect, so as the digital currency market grows, individuals can be safe when they invest their money.

Query

What opportunities and risks could the use of crypto-assets—including Non-Fungible Tokens—pose for individuals, the economy, and the workings of both the public and private sectors?

Response

NFTs are a major opportunity for investment opportunities. Essentially most investments can be attributed to blockchain. For NFTs to be successful they need to be valued and regulated. If they add true value to the market, this could be a new way of investment in the future, for a large variety of products. Once again financial regulation of NFTs is the way forward for these investments.

Query

How can distributed ledger technology be applied in the financial services sector?

Response

I really like the distributed ledger technology, its very fast and it can be tracked very effectively throughout the blockchain. There are some issues, which need to be resolved in my opinion. First, it should be advised for investors to keep their tokens outside of exchanges for security reasons. Trust wallet and Safe wallet for example are safer for investors. Second, the security key should not be kept electronically, it should be in a cold wallet not connected to the internet. Finally, I think that KYC should be conducted more thoroughly, so if individuals lose their security key, they can still have access to their investments. This can be done using the technology for internet banking in current accounts.

Query

What work has the Government (and its associated bodies) done to understand, prepare for and, where relevant, encourage changes that may be brought about by increased adoption of crypto-assets?

Response

I believe it is encouraging that the government is gathering evidence from experts concerning digital currencies, also the central bank token proposal is a very good idea. I believe regulation is essential and a committee involving regulators, government officials and academics is the next step forward for the government.

Query

How might the Government’s processes – for instance the tax system - adapt should crypto-assets be adopted more widely?

Response

I believe the current tax system should remain in order to encourage investment in the digital currencies. As they grow, the government can react and introduce higher taxation, in line with the income tax rates.

Query

How effective have the regulatory measures introduced by the Government - for instance around advertising and money laundering - been in increasing consumer protection around crypto-assets?

Response

The advertising around money laundering and consumer protection has been very encouraging. I believe more needs to happen to determine true value of tokens and financial regulation, through the development of the committee, mentioned above.

Query

Is the Government striking the right balance between regulating crypto-assets to provide adequate protection for consumers and businesses and not stifling innovation?

Response

More needs to be done through the committee to enable tokens with true value to remain in the market, which will enable innovation for companies and investors to make good solid and safe investments.

Query

Could regulation benefit crypto-asset start-ups by improving consumer trust and resilience?

Response

Definitely, regulation is vital to the long-term success of crypto assets. Regulation will ensure that companies are set up in a proper manner to enable them to flourish and create a safe environment for investors.

Query

How are Governments and regulators in other countries approaching crypto-assets, and what lessons can the UK learn from overseas?

Response

Regulation of this market needs to be adopted worldwide. I believe this will happen in the same manner as the FCA. The UAE is very keen on regulation, the UK needs to follow suit by making regulation a priority.

Query

The environmental and resource intensity of using crypto-asset technology.

Response

The amount of electricity required to data mine digital currencies is very high. Renewable energy needs to be adopted to make this a viable investment vehicle in the future. This can be achieved in my opinion.

Conclusion

I have undertaken a significant amount of research on digital currencies including valuation, factors which determine them, response to shocks, excess returns and portfolio theory. I believe that they can play a vital role in investment in the future. I feel that a committee consisting of government officials, financial regulators and academics is required in order to determine value and to eliminate the poor projects not based on fundamentals. The adoption of renewable energy and financial regulation are the key to success in the digital currency space.

I very much hope this has been useful for the government. I would be delighted to support the government through my research and to be involved in the committee, if the opportunity was to present itself.

Kind regards

Professor Andros Gregoriou, University of Brighton.

References

Florackis, C., Gregoriou, A. and Kostakis, A., 2011. Trading frequency and asset pricing on the London Stock Exchange: Evidence from a new price impact ratio. Journal of Banking & Finance, 35(12), pp.3335-3350.

Gregoriou, A., Healy, J.V. and Le, H., 2019. Prospect theory and stock returns: A seven factor pricing model. Journal of Business Research, 101, pp.315-322.

Gregoriou, A., 2019. Cryptocurrencies and asset pricing. Applied Economics Letters, 26(12), pp.995-998.

Zhang, S. and Gregoriou, A., 2020. The price and liquidity impact of China forbidding initial coin offerings on the cryptocurrency market. Applied Economics Letters, 27(20), pp.1695-1698.

Zhang, S. and Gregoriou, A., 2021. Cryptocurrencies in portfolios: return–liquidity trade-off around China forbidding initial coin offerings. Applied Economics Letters, 28(12), pp.1036-1040.

September 2022