INVESTIGATION OF THE CBN CRYPTOCURRENCY BAN POLICY IN NIGERIA AND PUBLIC PERCEPTION

CHAPTER TWO

LITERATURE REVIEW

2.0 INTRODUCTION

Our focus in this chapter is to critically examine relevant literature that would assist in explaining the research problem and furthermore recognize the efforts of scholars who had previously contributed immensely to similar research. The chapter intends to deepen the understanding of the study and close the perceived gaps.

Precisely, the chapter will be considered in two sub-headings:

• Conceptual Framework
• Theoretical Framework
• Chapter Summary

2.1 CONCEPTUAL FRAMEWORK

CRYPTOCURRENCY

The year of 2007 set a new rhythm when it comes to the financial sector and how much people were willing to trust the system. After the crisis, many people who had lost everything, or almost everything, had to turn the page and look for new possibilities. The end of the last decade opened the door for new opportunities, and cryptocurrencies were right around the corner when it happened, which led to a great opportunity for many people who wanted to invest their money on something totally different and with a good growth margin. “In the 19th century, you could find a dollar coin made of silver and a paper dollar that in those days could be exchanged for the same silver coin. More than 100 years ago paper dollar bills were backed by silver, a precious metal that theoretically should always have value. However, today that has changed, a modern dollar bill is backed by nothing but the word of the U.S. government.” (Rose, 2015: 617). Nowadays, cryptocurrencies are a daily topic. But what are exactly cryptocurrencies? The first thing we need to understand is how to settle the difference between a virtual currency, a digital currency and a cryptocurrency, because these are often used interchangeably. The European Central Bank released an article about “Virtual Currency Schemes” in October 2012, where virtual currency was defined as a” type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among members of a specific virtual community”. A digital currency can be defined as a form of virtual currency that is electronically created and stored. A digital currency can or cannot be a cryptocurrency. And last, a “cryptocurrency can be defined as a subset of digital currencies, however, it uses cryptography for security so this makes it extremely difficult to counterfeit” (Gilpin, 2014).

When referring to cryptocurrencies, it is precisely all about a certain type of virtual currencies. Rogojanu and Badea (2015) stated that “virtual currency continues to maintain the main features of a traditional currency, in other words, virtual money is a symbol or synonym for a value, a payment system technology which continued to grow over the past 20 years”. However, due the newness of this phenomenon and its rapid growth, suggesting a universal definition of cryptocurrency is still a challenge. Abboushi (2016), from Duquesne University tries to explain it according to four core dimensions: (1) virtual currency is a form of digital currency which is digital representation and measurement of economic value for an object or transaction; (2) it is issued by non-government party and remitted for the exclusive use by another private party; (3) it is denominated in units of account of its own system that may or may not be exchangeable to real currency; (4) it is used as a medium of exchange similar to real currencies but does not have legal tender status in any jurisdiction in the world. Sauer (2016), describes cryptocurrency as money which does not exist in reality as coins, banknotes or bank deposits, but rather exists in digital form. The author also makes clear that cryptocurrencies are not e-commerce or e-payment systems or other ways of transferring money such as credit card systems or online banking. According to Sauer (2016), the first cryptocurrencies, or virtual currencies, were first seen in online gaming where it could be used to buy new equipment or characters. With time, the online gaming operators began to exchange their virtual currency for real money. The problem was that this market didn’t work both ways, it was a one-way market as the players were unable to swap the virtual currency into real money. In 2015, Edward V. Murphy, a specialist in Financial Economics published an article with questions and answers about cryptocurrencies to allow everyone to understand what was this new emerging market. According to him, “a cryptocurrency is a medium of exchange such as the US dollar” (Murphy, Murphy and Seitzinger; 2015: 1). Later in the same article, Edward clarifies that “like the US dollar, cryptocurrency has no intrinsic value and that it is not redeemable for another commodity, such as gold. Unlike the US dollar, however, cryptocurrency has no physical form, is not legal tender, and is not currently backed by any government or legal identity. In addition, its supply is not determined by a central bank and the network is completely decentralized, with all transactions performed by the users of the system” (Murphy, Murphy and Seitzinger; 2015: 2). “Cryptocurrency is based on the idea of exchanging value without the approval of an institution” (Maftei, 2014: 55). While being aware of a broad developments of various payment mechanisms and creation of alternative currencies, the bold question of what cryptocurrency is should be answered. Legislative acts of United States explain cryptocurrency to be a medium of exchange that operates like a currency in some environments, but does not have all the attributes of real currency, which points the absence of legal tender status in any jurisdiction. So, cryptocurrencies can be described as a digital asset with the intention to function as a medium of exchange, based in the concept of cryptography, which refers to “techniques for secure communication in the presence of third parties called adversaries.” (Rivest and Ronald, 1990).

CHARACTERISTICS OF CRYPTOCURRENCIES

Cryptocurrencies have several different characteristics when compared to the “traditional currencies”. Some of these characteristics are: intrinsic value, legal tender, medium of exchange, how can it be used as a storage method, its structure, supply, cost of production and risk of inflation. It is obvious that neither cryptocurrencies or the US dollar have intrinsic value. However, there are several differences when it comes to the rest of them. These new cryptocurrencies are still unregulated, and that means that they do not have, yet, legal tender. Also, the US dollar can be used as a medium of exchange with any other currency, while cryptocurrencies work as a medium of exchange with the limited number of participants who also own it. While the US dollar has a public supply source, the cryptocurrencies have a private one. The cost to produce a US dollar bill is relatively low, while producing another cryptocurrency unit has an attached cost, the cost of the computer utility power, through a process called mining. Another major characteristic of cryptocurrency is the fact that they are decentralized, which means that they are not backed by any governmental authority. And last, while the US dollar or any other real currency is subject to inflation, cryptocurrencies are not. Even though they are highly volatile and their value can go “zero to hundred” in a couple of days or even hours.

With this, we can say that cryptocurrencies have four completely new characteristics when compared to real currencies: they are unregulated, they are decentralized, they are highly volatile and they are “born” through a mining process that is available to every user, which will be explain forward. When we describe cryptocurrencies as being decentralized, we mean that they are not controlled. Every currency in the world, apart from cryptocurrencies, is governed by some kind of authority. Every transaction goes through a bank, where people are charged enormous fees, and it normally takes a long time for the money to reach the recipient. Cryptocurrencies, on the other hand, are not controlled by anyone. It’s a decentralised network and it’s built on the cooperation and communication of all the people taking part in it. Because of that, even if some part of the network goes offline, transactions will still be coming through. Cryptocurrencies are also unregulated. Ever since their first appearance, cryptocurrencies are still a skeptical topic to many people. While some believe that they are the future and investing on it is a really good opportunity, a lot of people are still uncertain about trusting something that is still unregulated and is only now being adopted by the financial authorities, and not by many. Franklin (2016) states that the lack of regulation is one of the biggest issues when talking about cryptocurrencies: “One significant issue of virtual currency such as the Bitcoin is the lack of regulation and lack of bank or governmental control. Without the regulation, there is opportunity for investors, some of which are already taking advantage of opportunity, but also the risk that comes from the speculation that comes with investment around such an uncharted territory.” (Franklin, 2016: 83). The lack of currency regulation is, as much as over regulation, a burden to many. When dealing with currency and market opportunity, basic regulation is needed to control markets from taking unfair advantage of arbitrage opportunity. Varriale (2013) discussed how should a cryptocurrency be regulated because in that same year, The New York Banking watchdog issued subpoenas to twenty-two cryptocurrency companies. The biggest concern with this currency is the ease that it can be used for illegal activities due to the anonymous nature of the transactions. Drug trade and terror funding are two significant concerns.

Tu and Meredith (2015) looked at the possible consequences of unregulated cryptocurrencies, as they currently are. The authors understand that the lack of regulation can create issues, like the opportunity to foster funds transfers for illegal activities. Slay, Kim-Kwang, and Lui (2014) alert that money laundering and terrorism funding can easily take place in the cyber environment, as a result of the high levels of anonymity, low levels of detection and ease to transact. Another important characteristic of cryptocurrencies is its volatility. Ever since 2009, after the appearance of the first cryptocurrency, Bitcoin, the price had a lot of ups and downs. By being subject to so many speculation, the price of cryptocurrencies goes up and down every day, based on what people say, read and believe. From 2009 on, when Bitcoin started operating, the price has raised more than 8000%. Dibrova (2016), state “… interesting how a digitally created code that has no back-up from any central government, nor financial institution or is ensured by any commodity could ever hit a price as, for instance, 1.145 USD, in January 2013”. This concerns many investors, experts and Central Banks, due to its volatility, which leaves no suspicion about the absence of economic reasons to those. According to Coindesk4 , cryptocurrency carries a lot of uncertainties. The volatility of Bitcoin against the dollar on a Bitcoin exchange is about five to seven times the volatility of traditional foreign exchange trading. Gavin Anderson5 , a cryptocurrency enthusiast, consider that these new currencies are going to be the future, and presented us with the pros and cons of cryptocurrencies. The pros are:

• Freedom: cryptocurrencies where designed with freedom in mind, freedom from governing authorities controlling transactions, imposing feed and being in charge of people’s money;
• High portability: it should be easy to carry and use. Cryptocurrencies are completely digital, which means the money can be easily stored online, in a wallet;
• Safety and control: cryptocurrency users are able to control their transactions. No one can withdraw money from your account without you knowing and agreeing it;
• Transparent and neutral: one of the most unique aspects of cryptocurrencies, and mainly Bitcoin, is the Blockchain technology. This technology allows every single transaction, every single bit of information to be always available to everyone, which can be checked online;
• Cannot be counterfeited: one of the most popular ways of counterfeiting in the digital world is using the same money twice – the double spending situation. Due to technologies like Blockchain, this cannot be done.

The cons are:

• Legal parameters: obviously that the legal questions concerning cryptocurrencies is the most important aspect for some people to still doubt about it, and until they are not regulated, this dubious question will remain unanswered. However, there are already some countries where cryptocurrencies, or some of them, are encouraged. While in other countries they are being banned or remain outlawed;
• Level of recognition: in some countries, cryptocurrencies are perfectly legal, however some governments still do not have regulations regarding them, while others are trying to ban them;
• Volatility: probably the most concerning aspect about cryptocurrencies for those who are holding them. The price of several cryptocurrencies like Bitcoin has been up and down, going through various cycles of skyrocketing and plummeting, being referred by some agents as bubbles and busts.
• Development: the continuous development of cryptocurrencies is not a con, per se. This is referred by the author because cryptocurrencies are still evolving, and governments are trying to regulate it more and more, and when that happens, the cryptocurrencies as we know it nowadays, might change completely.

CRYPTO TECHNOLOGY

For better understanding of crypto currencies is essential to be aware of certain facts related to thefield of cryptotechnology. Crypto technologiesare technologies thatare based on cryptography. Cryptographyhas a longtradition in humanhistory. However, modern mathematical cryptography has been developed only over the last few decades. Public key cryptography, that will be mentioned below, was introduced for the first time in 1976 and first attempts to createa cryptocurrency weremade in thebeginning of 1980´s(Omohundro, 2014:19). Crypto-technology is a class of software systems that use cryptography. Generally, these software systems can implement a system to transfer virtual goods and at the same time they can implement complex agreements between parties. There are various kinds of virtual goods such as songs, online documents, or pieces of software. However, there are other kinds of virtual goods that might notbe that obvious such as ownership ofalmost anything, an approval, notarization or verification of almost anything or aunit of currency (Eckersley, 2004:87).There are threemain problems, relevant for thepurpose of thiswork that are addressed by crypto technologies. First of all, it is counterfeiting in other words, assurance of the parties that the original virtual good was transferred, not a copy. Secondly, it is trust. This means that the trust of the counter-party is not required to transfer the virtual goods. This is because thetransfers are verified.Last but notleast, another problemaddressed by the technology is central authority, meaning that it enables absence of such an authority in order to process transactions or maintain the ledger – there is no middleman involved (Boneh, 2015, lecture 1). All crypto-technology is underpinned by the two main ideas: Public Key Cryptography and the blockchain. The first one – public key cryptography – is a sophisticated math concept that allows an individual toencode a virtual good thatcan only be decodedby the intended recipient. Even the sender cannot decode it once the good has been encoded. In this concept there are two numbers deployed:a private key and apublic key. The second idea isthe blockchain which can be described as a special form of ledger that keeps track of evidences who holds what, and that is extremely hard to be deceitfully modified (Antonopoulos, 2014, lecture 3). Also, one of the important properties of the blockchain is its pseudo-anonymity. In the next chapters, these ideas will be described more into details.

CBN's Ban on Cryptocurrency

The CBN prohibited the facilitation of cryptocurrency transactions by commercial banks and other financial institutions in the country. This prompted the Securities Exchange Commission to pause its plans to formalize cryptocurrencies as securities under its remit. The CBN is particularly concerned about the high risk of the digital asset class and the use of the currency for money laundering, terrorism financing and tax evasion. However, these financial crime concerns existed in the country long before the crypto market rose in popularity. In addition, only 1.1% of the total $1 trillion global crypto transactions in 2019 were illicit.

As Quartz explains, laundering money using cryptocurrency is like stealing from a jewelry store but leaving the map to your house at the crime scene.4 This is because all cryptocurrency transactions may not carry your real name but there is an ID reference and the details of all transactions made with that ID can be traced. The pseudonymous nature of cryptocurrency somewhat validates the CBN's concerns. But the truth remains that cryptocurrency is an emerging market with a huge potential for job creation and investment which is being undermined by arbitrary policy regulations.

CRYPTOCURRENCY AND NIGERIA ECONOMY

The creation of cryptocurrency as a cybernetic currency has been generating reactions in the global economy such as a country like Nigeria. There has been countless advantage and disadvantage discourse on cryptocurrencies' importance on the Nigerian economy. However, the Nigeria government through its governing agencies such as the Central Bank of Nigeria and the Securities and Exchange Commission has tried to place a ban on cryptocurrency. However, its legal status remains unclear, unlike in countries like Morocco and Algeria where there is an explicit prohibition on trading in Bitcoins such that a breach attracts hefty fines (Dierksmeier & Seele, 2016). The cautions are primarily designed to educate the citizenry about the difference between genuine currencies issued and guaranteed by the state and cryptocurrencies, which are not. Following the moves taken by the Central Bank of Nigeria and the Securities and Exchange Commission, lawmakers have also advised the regulatory authorities to speed up efforts in presenting a legal framework for cryptocurrencies in Nigeria.

Economic Implications

Investment

The recent ban on cryptocurrency transactions could taper investment flows into the country as global investors are beginning to heavily eye the cryptocurrency space. Just recently, Jay Z and Jack Dorsey announced a $23.6mn investment to fund Bitcoin development in Africa. In addition, there is a fast growing interest from Wall Street and the big players in the financial industry, such as JP Morgan and Morgan Stanley. This signals a huge potential for the crypto market in the coming years. There are high expectations of reduced volatility as investors could begin to increase cryptocurrency investments in emerging markets. This is good news but with the largest consuming market in Africa banning cryptocurrency transactions, this could limit potential investment in-flows that would boost economic growth.

Shadow Economy

Bitcoin was created for the sole purpose of reducing bottlenecks in financial transactions, particularly across borders. The ban is unlikely to completely stop all transactions. What is more likely is the rise of a crypto shadow economy in Nigeria, which could now increase the chances of money laundering and illicit financial flows. There would be no more advertisements by popular exchanges on social media platforms and no transactions using financial institutions.

Capital Flight

The move by the CBN may fuel the pessimism of existing and potential investors (domestic and foreign) who were already skeptical about the uncertain policy environment. The attendant effect could be an increase in capital outflows, which is risky for the naira and infrastructure development.

Poverty and Unemployment

The fast expansion of the Nigerian crypto market has created numerous jobs especially for the youths. The ban will affect individual home-based traders and these traders often have employees of their own. Stopping the operations of the emerging crypto market means more job loss, and this could trigger a faster increase in the rate of unemployment which is already at 27.1% (Q2'20).

Impact on Monetary Policy

At the moment, cryptocurrencies operate alongside official currencies. The current volumes are small and do not challenge the position of official money as the main currency. But as algorithms improve to limit the volatility of cryptocurrencies, their popularity and use tends to increase. This would lead to a coexistence with other official currencies. The fundamental question here is, could the central bank lose its grip on the economy as a result? The interaction between cryptocurrencies and central bank monetary policy is treated in detail by Fernandes-Villa Verde and Sanches (2018). Their theoretical model predicts that the coexistence of central bank and private money depends on the type of monetary policy the former follows. In particular, privately-issued currencies would be used if the official currencies do not ensure price stability, but would lose their value as a medium of exchange when the central bank credibly guarantees the real value of money balances. The ramifications are two-fold. First, the coexistence of government money and cryptocurrencies that are valued as mediums of exchange is not a theoretical impossibility. Second, the central banks have the advantage by choosing a specific type of monetary policy they can prevent cryptocurrencies from being valued as a medium of exchange (but they could still be valued for other reasons, for instance as a pure speculative asset). From this perspective, rather than posing a threat, the coexistence of government money and cryptocurrencies can have a positive effect by acting as a disciplining device on central banks. Currency competition can succeed in calming inflation and preventing the sort of manipulation of interest rates and prices to which government have historically been prone. This is a partial vindication of Hayek (1976), who argued in favour of breaking the state monopoly on money as a way to ensure the stability of the official currency. Nevertheless, from a more practical standpoint, central banks could face some risks from the emergence of cryptocurrencies as relevant mediums of exchange with stable purchasing power due to its high level of volatility.

Effect on Agriculture

Blockchain technology has immense possibility of solving significant difficulties in agriculture. The challenge for blockchain is connecting the technology to viable business models and compelling use cases. Blockchains have enormous possibility to create and increase access to finance in the agricultural sector, thereby addressing food scarcity and enhancing food security.

2.2EMPIRICAL STUDIES

Katsiampa (2017) estimated the volatility of Bitcoin through a comparison of GARCH models and finds that the AR-CGARCH model gives the most optimal fit. He underlined that the market is highly speculative. Umar (2017) argued that the proliferation of digital currency including Bitcoin has led to the partial disintermediation of banking system in Nigeria. Nnabuife and Jarrar (2018) examined online media coverage of Bitcoin cryptocurrency in Nigeria with focus on some selected online version of leading mainstream newspaper in Nigeria, using a qualitative and quantitative content research analysis method. Findings revealed that Nigerian online media gave negative slant to the coverage of Bitcoin. Sovbetov (2018) examined factors that influence prices of most common five cryptocurrencies: Bitcoin, Ethereum, Dash, Litecoin, and Monero over 2010-2018 using weekly data. The study employed ARDL technique and documented several findings. First, crypto market-related factors such as market beta, trading volume, and volatility appear to be significant determinant for all five cryptocurrencies both in short- and long-run. Second, attractiveness of cryptocurrencies also matters in terms of their price determination, but only in long-run. This indicates that formation (recognition) of the attractiveness of cryptocurrencies are subjected to time factor. In other words, it travels slowly within the market. Third, SP500 index seems to have weak positive longrun impact on Bitcoin, Ethereum, and Litcoin, while its sign turns to negative losing significance in short-run, except Bitcoin that generates an estimate of -0.20 at 10% significance level. Lastly, error-correction models for Bitcoin, Ethereum, Dash, Litecoin, and Monero show that co-integrated series cannot drift too far apart, and converge to a long run equilibrium at a speed of 23.68%, 12.76%, 10.20%, 22.91%, and 14.27% respectively.

In Yanuar and Yoda (2018) work on the effect of cryptocurrency on investment portfolio effectiveness, modern portfolio theory approach was adopted using bitcoin, ripple and for investment portfolio, the result showed that the portfolio increased as the cryptocurrencies increased the effectiveness of the portfolio in two ways; to minimize the standard deviation and the second, to create more allocation options for investors to choose from. The optimum allocation of Cryptocurrency was from 5% to 20% depending on the risk tolerance of the investor.

Mwangi (2014) examined the impact of digital currencies on ecommerce landscape in Kenya, adopting a descriptive research design. The study showed that Bitcoin use has increased substantially, though still remains small in comparison to traditional electronic payments systems such as credit cards and the use of dollars as a circulating currency. Bouoiyour and Selmi (2016) studied daily Bitcoin prices using an optimal-GARCH model and show that the volatility had decreasing trend comparing pre- and post-2015 data. Even tough, they still observe significant asymmetries in the Bitcoin market where the prices were driven more by negative than positive shocks.

2.3 THEORETICAL FRAMEWORK

Mises Regression Theorem The regression theorem assumes that all money must ultimately derive their purchasing power from a historical tie to a commodity that was valued in a state of barter. The theory of the value of money is able to trace the objective exchange value of money only to that point where it is no longer the value of money but just the value of a commodity (Jeffrey, 2014). In this way one can continually go further and further back and must eventually get to a point where one can longer find any component in the objective exchange value of money which emanates from valuations based on the function of money as a medium of exchange. At this point, the value of money is nothing other than the value of an object that is useful in some other way than as money. Mises solved this circularity through the regression theorem. Mises further identified that people expect future purchasing power based upon current and previously observed purchasing powers. For the regression theorem to work, a medium of exchange must already have the attributes necessary for a medium of exchange, having a price and be accepted on the market.

CHAPTER SUMMARY

In this review the researcher has sampled the opinions and views of several authors and scholars on Cryptocurrency and its effect on Nigeria economy. The works of scholars who conducted empirical studies have been reviewed also. The chapter has made clear the relevant literature.