Market Reactions to Cryptocurrency Regulation: Risk, Return and the Role of Enforcement Quality

Abstract

We explore the risk–return trade-off in international regulation of cryptocurrency markets using a unique sample of regulations implemented between July 2018 and April 2023. Various regulation types have reduced risk in cryptocurrency markets while having differential impacts on raw and risk-adjusted returns. Given the legal challenges for national jurisdictions in regulating international markets, we develop a digital asset regulatory strength index (DARSI) and study the impacts of national regulatory enforcement quality on the risk and return effects of cryptocurrency regulations. We find that strong enforcement quality, measured based on the strength of formal institutions, amplified the regulations' intended effects. The amplification effect is more pronounced for regulations announced by a financial regulator and for more liquid tokens. Consistent with the view that normative compliance-seeking facilitates the adoption of norms, we also find that cultural uncertainty avoidance amplifies regulations' intended effects.