Margaret Ryznar, law professor at Indiana University Robert H. McKinney School of Law, in her recent publication, A Coffee Break for Bitcoin, argues that cross-border listing regulation can offset some of the issues that Bitcoin has developed since its emergence a decade ago. Professor Ryznar draws a parallel between Bitcoin and international stocks situation nearly 30 years ago, when international companies cross-listed their shares on foreign exchanges in the 1990’s to subject themselves to regulation that lifted their value.
Since emerging as a cryptocurrency relying on new blockchain technology in 2009, a stereotype has developed of a major category of bitcoin users — men with libertarian tendencies who like its independence from any government. Another category is the illegal business because of the anonymity bitcoin provides. Unsurprisingly, neither group of users has welcomed regulation of bitcoin. As bitcoin becomes more popularized, however, criminals seem to be moving away from using bitcoin as their method of payment, and mainstream users are entering the bitcoin market.
Satoshi Nakamoto, a pseudonym for an unknown person, designed bitcoin and introduced it in a 2008 white paper titled “Bitcoin: A Peer-to-Peer Electronic Cash System.” At its essence, bitcoin is a cryptocurrency, which is a digital currency issued electronically by a computer program that has a predetermined cap of 21 million bitcoins. To implement bitcoin, Nakamoto devised the first blockchain database to solve the double-spending problem for digital currency so that people cannot spend the same money twice. There are two main ways to get bitcoin to buy it on an exchange such as Coinbase or to earn it by processing bitcoin transactions, called “mining.” Owners store their bitcoin in a “digital wallet,” which exists either in the cloud or on a user’s computer.
Without a central bank underlying cryptocurrencies, however, many people find it difficult to trust bitcoin as a currency. The volatility of Bitcoin’s price also makes it hard to trust. Bitcoin is neither intrinsically valuable, like gold, nor is it rooted in a commodity expressing a certain purchasing power. There might be some value resulting from its scarcity, but it is an artificial scarcity. Generally, bitcoin as a currency is not regulated like stocks and futures, and this lighter regulation allows price manipulation. Bad actors can manipulate the price of cryptocurrencies and then cash out before the rest of the investors catch on. There are also concerns about initial cash offerings of bitcoin, with the main reason for going public being for insiders to cash out. Additional concerns arise regarding a bitcoin bubble. This all contributes to its volatility.
As bitcoin has gained prevalence in the United States, it has drawn the attention of regulators. Transactions in bitcoin have drawn scrutiny from the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Financial Crimes Enforcement Network (FinCEN), the Internal Revenue Service, and the federal courts. These agencies have differed in their treatments of virtual currency, and confusion continues over whether the law considers bitcoin and its related products to be securities, commodities, currency, or property. Thus far, comprehensive regulation has been unsuccessful. Not only have many bitcoin users resisted regulation, but regulation has also stalled because it is unclear how to regulate. The challenges include bitcoin’s rapid growth and the anonymity surrounding bitcoin, but much literature has been written on these questions.
This Article offers another perspective on the regulation of bitcoin—a way to view its benefits. The next Part therefore examines the similar phenomenon of international stock regulation and its benefits for international companies. This Article concludes that bitcoin can similarly benefit from regulation.
International stocks & bonding theory
International stocks are shares in companies located internationally. However, with the location of these companies outside the United States, the result is often lighter regulatory standards. The potentially high risks make high rewards possible, and there is demand for it. In contrast, high regulatory standards and oversight in the United States have made it a secure place to invest.
For international companies, there is an opportunity to cross-list their shares on a foreign stock exchange, such as the New York Times or London exchange. In other words, international companies can list their shares on their domestic exchange as well as a foreign exchange, usually in the United States.
Although cross-listing has traditionally been explained as an attempt to break down market segmentation and to increase investor recognition of the cross-listing firm, the globalization of financial markets and instantaneous electronic communications render these explanations increasingly dated. Another prominent explanation put forth by Professor Coffee is “bonding”: issuers migrate to U.S. exchanges because by voluntarily subjecting themselves to the United States’s higher disclosure standards and greater threat of enforcement (both by public and private enforcers), they partially compensate for weak protection of minority investors under their own jurisdictions’ laws and thereby achieve a higher market valuation.
A firm’s decision to cross-list on a U.S. exchange subjects it to a set of new disclosure and legal requirements. Firms thus are choosing to “rent” the securities laws of other countries under the bonding theory. Among the principle considerations that drive a company’s decision to seek a cross-listing of its shares are financial gains, increased liquidity, shares marketability, and marketing and growth motivations.
While there are many reasons to cross-list, important ones deal with the regulation provided by cross-listing in the United States. Indeed, the benefits must outweigh the significant costs of doing so as compliance is an expensive endeavor for companies. These benefits include that exposure to an international capital market can induce changes in corporate governance and improves investor perception of the quality of its governance. A U.S. listing can also reduce the extent to which controlling shareholders can engage in expropriation and thereby increases the firm’s ability to take advantage of growth opportunities.
Empirical research confirms the benefits of cross-listing. One team of authors examined what happens to the global value of trading, turnover and prices of non-U.S. stocks over the twelve- month period surrounding their listing on the New York Stock Exchange. Its sample consists of 128 NYSE-listed non-U.S. stocks. On average, it finds the combined (home plus U.S.) value of trading in the sample stocks changed from $240 million per stock per day prior to the NYSE listing to $340 million after, a 42 percent increase, and that the home-market value of trading increased 24 percent from $210 to $260 million, while annual turnover increased from 65 to 90 percent. The results suggest that, on average, listing on the NYSE is not a zero-sum game, but a win-win situation with both the home market and the U.S. market benefitting. In addition, an NYSE listing also benefits the companies being listed: stock prices in the six months after listing are 8 percent higher than prices in the six months immediately prior.
Studies have thus shown that firms cross-listed in the U.S. are worth more than those who are not. One such article explains that non-U.S. firms cross-listing shares on U.S. exchanges as American Depositary Receipts earn cumulative abnormal returns of 19 percent during the year before listing, and an additional 1.20 percent during the listing week, but incur a loss of 14 percent during the year following listing. These unusual share price changes are robust to changing market risk exposures and are related to an expansion of the shareholder based and to the amount of capital raised at the time of listing. Furthermore, growth opportunities are more highly valued for firms that choose to cross-list in the U.S., particularly those from countries with poorer investor rights.
Another paper examines whether cross-listing in the U.S. reduces foreign firms’ cost of capital. It finds strong evidence that firms with cross-listings on U.S. exchanges experience a decrease in their cost of capital, which is economically significant and sustained. Consistent with the bonding hypothesis, it documents that these effects are larger for firms from countries with weaker institutional structures. Further, it explains cross-listings in the over-the-counter market are associated with minor reductions in firms’ cost of capital, and private placements seem to have adverse effects. In addition, it documents positive valuation effects for all types of U.S. cross- listings stemming from changes in (financial analysts’) growth expectations and suggests the latter result could reflect that firms seek to cross-list when their growth opportunities happen to expand.
In sum, there was significant cross-listing of international company shares on the American exchanges in the 1990’s to take advantage of the security that the attendant regulatory regime provides. Those international companies that cross-listed their shares experienced measurable benefits from doing so. Commentators have offered several explanations for this phenomenon, including the prominent Coffee bonding theory that there are legitimacy gains to renting American securities laws through cross-listing. This theory about regulation has direct implications in the bitcoin context.
In its short lifespan of a decade, bitcoin has amassed many issues that have plagued it. Bitcoin is not regulated like stocks and futures, and this lighter regulation allows price manipulation. Bad actors can manipulate the price of cryptocurrencies and then cash out before the rest of the investors catch on. There are also concerns about initial cash offerings of bitcoin, with the main reason for going public being for insiders to cash out. Additional concerns arise regarding a bitcoin bubble. This all contributes to its volatility.
The regulation of bitcoin is important due to these important reasons that are unique to bitcoin. Thus, in the same way as international stocks, regulation legitimizes bitcoin to a certain extent, particularly important given its dark start as an anonymous cryptocurrency for criminals. Historically, the legitimizing effect of regulation has brought some value. On the other hand, criticism has generally targeted the enforcement of any regulation. For example, there is the possibility of bias in enforcement of the laws. Furthermore, there are separate critiques regarding over-regulation of the business environment. These concerns regarding regulation no doubt hold true in the bitcoin context, but must be considered alongside the benefits of regulation, including those articulated by the Coffee bonding theory.
While bitcoin is a new product, its issues are old. One product that experienced similar issues are international stocks. International companies, like bitcoin, had difficulty attracting trust. Therefore, they borrowed foreign securities law. Bitcoin has similarly suffered legitimacy concerns, and may thus also need to benefit from the legitimacy gained from American regulation. As cross-listing by foreign issuers onto U.S. exchanges accelerated during the 1990s, bitcoin users may find themselves increasingly open to regulation.