Bitcoin and its associated technologies have had a significant impact on the global financial arena, leading to the development of unique markets and trading platforms. In this section, we offer an examination of the mechanics underpinning Bitcoin’s market, its standing in the international financial markets, and its particular implications for Colombia. We also delve into the regulatory nuances surrounding Colombia’s foreign exchange (FX) market. Additionally, we explore the interplay between macroeconomic variables and cryptocurrencies, highlighting how broader economic conditions and policies influence the cryptocurrency landscape.
Macroeconomic variables and cryptocurrencies
Recent studies have increasingly focused on the interplay between macroeconomic variables and cryptocurrencies, shedding light on the complex dynamics that govern these digital assets. Saleem et al. (2024) investigated the relationship between cryptocurrencies and various facets of the financial system, including stock markets and inflation rates. The study reveals a strong positive correlation between cryptocurrency market capitalization and key financial indicators, such as the Dow Jones Industrial Average and the Consumer Price Index. This correlation suggests that macroeconomic conditions significantly impact cryptocurrency markets, aligning with our investigation into how FX convenience yields and broader economic factors influence the Bitcoin yield gap in Colombia.
Moreover, Alam et al. (2024) examined the relationship between cryptocurrencies and monetary policy using a Structural Break GARCH-MIDAS approach. The research highlights that the long-term volatility of cryptocurrencies is sensitive to structural breaks in monetary policy, emphasizing the importance of considering macroeconomic policies when assessing cryptocurrency markets. While our study does not directly explore monetary policy, it documents how exchange rate dynamics, which can be influenced by various macroeconomic factors, including but not limited to monetary policy, affect how Bitcoin is priced in Colombia. This connection helps contextualize our findings within the broader scope of macroeconomic influences on cryptocurrency markets.
Additionally, Nakagawa and Sakemoto (2022) explored the macroeconomic factors affecting cryptocurrency returns through long-horizon predictive regressions. The findings suggest that macroeconomic variables such as interest rates and inflation significantly impact cryptocurrency returns. Our study builds on these insights by specifically investigating how FX convenience yields and Bitcoin network activity correlate with the Bitcoin yield gap in Colombia, focusing on the regional dynamics and contributing to the understanding of how these factors influence cryptocurrency pricing.
These studies collectively contribute to a more comprehensive understanding of the relationship between macroeconomic variables and cryptocurrencies, providing a robust framework for analyzing the impact of economic policies on the digital currency market. Our research builds on these insights by specifically investigating how FX convenience yields and Bitcoin network activity correlate with the Bitcoin yield gap in Colombia, adding a regional perspective to the existing body of literature.
Bitcoin market mechanics
In traditional payment systems, a centralized operator, such as a bank or payment processor, validates transactions. They ensure the spender has adequate funds, and they can verify a transaction within seconds. Cryptocurrencies, however, diverge from this centralized model. They rely on cryptographic techniques and decentralized networks, making them free from any single point of control, such as governmental oversight. Introduced by Nakamoto (2009), Bitcoin was the pioneering cryptocurrency, setting the stage for a wave of similar digital assets.
Cryptocurrencies operate on a unique premise: when two parties want to transact, they broadcast this intent to a network of nodes that validate it. Upon acceptance, the transaction is enshrined in the blockchain, a distributed ledger recording all such exchanges. This blockchain is stewarded by a decentralized network of nodes working in tandem to validate and chronicle transactions. Validation hinges on consensus mechanisms, with proof of work (PoW) being a prime example. Here, nodes solve intricate mathematical problems, with successful solvers rewarded with new coins. There are alternative mechanisms, too, such as proof of stake (PoS), where validators are chosen based on the cryptocurrency amount they hold and are willing to stake as collateral.
Bitcoin, for instance, uses a PoW consensus mechanism that takes roughly an hour to fully validate a transaction, with a new block added to its blockchain every ten minutes. Transaction validation duration, however, is not uniform across cryptocurrencies; it varies depending on the consensus mechanism they employ.
Cryptocurrencies can be exchanged for fiat money either through peer-to-peer arrangements or via exchanges. In peer-to-peer setups, parties might know each other’s full legal identity or merely recognize a forum username. Such transactions involve negotiating terms, such as cryptocurrency volume, pricing, and payment method. There are also platforms—for example, Kraken and LocalBitcoins—connecting cryptocurrency buyers and sellers.
In contrast, exchange-based transactions are facilitated by a centralized entity, employing an order book design where traders place buy or sell orders. These orders are ranked, and a trade occurs when a buy matches a sell order. Unlike peer-to-peer trades, exchange-based transactions are more anonymous, as the buyer and seller remain unknown to each other. Exchange operators temporarily hold funds during trades. Yet, while providing some level of security and oversight, exchanges can pose risks if they are mismanaged or inadequately regulated.
Exchanges can be broadly segmented into custodial and noncustodial. Custodial exchanges, operating off-chain, do not record transactions on the blockchain. Rather, akin to conventional banks, they manage users’ assets and maintain balance records. This allows for near-instantaneous transactions but introduces counterparty risk. The collapse of Mt. Gox, a once-renowned Japanese custodial exchange, underscores such risks, as detailed by McLannahan (2015).
Conversely, noncustodial exchanges empower users to retain asset control. These on-chain transactions, chronicled on the blockchain, operate without central oversight. Some noncustodial exchanges even permit fiat—cryptocurrency trades via credit cards, though reverse transactions are often restricted. Noncustodial exchanges provide heightened security by decentralizing asset control but demand greater user vigilance.
Fang et al. (2022) offer a comprehensive survey on cryptocurrency trading, shedding light on the diverse platforms, strategies, and algorithms currently in play, including Bitcoin.
Buda.com: a Latin American cryptocurrency exchange
Buda.com is a centralized, custodial cryptocurrency exchange based in Chile. Founded in 2015, it serves multiple Latin American countries, including Argentina, Chile, Colombia, and Peru. The platform supports various cryptocurrencies, such as Bitcoin, Ether, Litecoin, Bitcoin Cash, and recently USDC. Users can trade within each fiat–crypto pair and also engage in crypto–crypto pair trading.
In 2022, the distribution of Bitcoin trading volume on Buda.com was notably concentrated in Chile, which accounted for 80.4% of the total volume. Colombia followed with 11.4%, Peru with 8.1%, and Argentina with a minimal 0.1%.
To contextualize the significance of Buda.com in our study, we observed its trading volumes in comparison to other exchanges. Between 2018 and mid-2022, the weekly average trading volume for BTC/PEN on Buda.com was 2.9 Bitcoins, whereas for BTC/COP, it stood at 4.9 Bitcoins from 2020 to mid-2022. In stark contrast, LocalBitcoins, a peer-to-peer platform, recorded substantially higher weekly volumes: 39.8 Bitcoins for BTC/PEN and 139.7 Bitcoins for BTC/COP in the same time frame.
The Colombian market: FX and cryptocurrency landscape
The “Crypto on the Rise 2022” report by Thomson Reuters indicates that cryptocurrency activities in Colombia are largely viewed as illegal. In 2014, the Superintendencia Financiera de Colombia (SFC), the governmental body responsible for financial market oversight, clarified that the government did not oversee cryptocurrency marketsFootnote 1. However, by 2017, the SFC had taken a more restrictive stance, barring any financial institution in the country from participating in cryptocurrency activitiesFootnote 2. As a consequence of this directive, Buda.com temporarily halted its operations in Colombia from August 2018 to June 2019, unable to offer users fiat currency transactions. In 2021, the SFC greenlit select fintech pilot projects related to cryptocurrencyFootnote 3.
From the perspective of the Colombian central bank (Banco de la Republica de Colombia), cryptocurrencies are not acknowledged as legal tender, as reiterated in a 2016 directiveFootnote 4. On the taxation front, the government’s tax and customs agency, DIAN, emphasized that cryptocurrency transactions are taxableFootnote 5. Moreover, the government’s financial information agency, UIAF, mandates that all cryptocurrency exchange platforms report their activitiesFootnote 6. Currently, the Colombian Congress is deliberating on a legislative proposal focused on supervising and regulating cryptocurrency exchanges, with the overarching goal of fortifying security and safeguarding user interests.
Regarding foreign exchange in Colombia, regulations stipulate that transactions connected to imports and exports, investments, and derivative dealings be channeled through the exchange rate market. Set-FX dominates this space, facilitating the negotiation and registration of OTC spot and derivative operations in foreign currency. It is also the origin of the TRM (representative market rate), the weighted average of daily exchange rate prices. The rates tabulated by the Set-FX system are recognized as the official exchange rate.
Colombia’s macro-prudential measures, as determined by the Colombian central bank, impose limitations on foreign exchange balances held by Financial Market Intermediaries (abbreviated as IMC in Spanish). These restrictions specify both minimum and maximum thresholds for assets and liabilities held in foreign currencyFootnote 7. These thresholds are articulated in terms of “proprietary positions” (PP) and “spot proprietary positions” (PPC) involving foreign currency. Castellanos et al. (2011) explored the implications of these constraints on foreign exchange balances, contending that such limitations curb the IMCs’ unrestricted participation in spot and foreign exchange markets, subsequently skewing the price dynamics, because when an IMC enters into a forward contract with a client and simultaneously hedges it by trading foreign currency, it does not affect the PP but does affect the PPC. This dynamic mirrors the consequences observed in the US foreign exchange market, as documented by Du et al. (2018).
