Investigating the relationship between cryptocurrencies and exchange rates: evidence from selected African countries.

Abstract

The rise of cryptocurrencies has had a significant impact on the financial system, the world of finance and financial markets. After being written off as a passing fad, cryptocurrencies have come to be accepted as real investment assets with some hedging capabilities. Some even regard them as a form of payment, which has led to many businesses, financial institutions, and policy makers, including reserve banks examining the technology more closely and considering possible returns. This study aimed to, firstly, examine the connection between the fiat currencies for African countries and cryptocurrencies. It focused on the fiat currencies for the top eight economies in Africa with nominal Gross Domestic Product above $100 billion -Algeria, Egypt, South Africa, Morocco, Nigeria, Angola, Ethiopia, and Kenya - and the top three cryptocurrencies, Bitcoin, Ethereum and Binance coin which together represent more than 66% of the cryptocurrency market by market capitalisation. Secondly, the study assessed the relationship between cryptocurrencies, Bitcoin and Ethereum and the five main fiat currencies (the South African Rand, British Pound, Swiss Franc, Euro, and Australian Dollar) traded in South Africa fiat currency market. These crypto and fiat currencies were analysed using the daily market price returns from 1 March 2018 to 12 May 2023. Time as well as time frequency information in the time series of cryptocurrencies and fiat currencies were captured using ensemble empirical mode decomposition (EEMD), while quantile regression (QR) was applied on the decomposed time series data to examine the connection between cryptocurrencies and fiat currencies under various currency regimes. The results revealed that QR adequately captured the asymmetric behaviour of cryptocurrencies and fiat currencies that changes with time. They illustrate that the connection between fiat currencies and cryptocurrencies at different magnitudes ranges from very strong to weak dependencies, although both positive and negative across different quantiles. In the African context, the study found that Bitcoin has some hedging characteristics against the Egyptian Pound, Ethiopian Birr, and South African Rand. Binance coin can also be used as a hedge against the depreciating Ethiopian Birr, while Ethereum can be utilised as a hedge against loss in the Egyptian Pound, and South African Rand. Furthermore, Bitcoin and Ethereum can be employed for diversification purposes in a portfolio with the Kenyan Shilling and Bitcoin and Ethereum are suitable alternatives to the Egyptian Pound, the Moroccan Dirham, Nigerian Naira, and South African Rand for transacting. Binance coin can be utilised as alternative to the Ethiopian Birr, Kenyan Shilling and South African Rand, Algerian Dinar, and Moroccan Dirham. In the case of South Africa, Bitcoin can be used as a hedge against the depreciating value of the Australian Dollar, Euro, and South African Rand. Similarly, Ethereum can be used as a hedge against the Australian Dollar as well as the British Pound. The research contributes to the existing literature on the subject by providing further empirical evidence on the connection between cryptocurrency and African fiat currencies, and the association between cryptocurrency and the fiat currencies traded in South Africa. Based on the results, it is recommended that policy makers, forex dealers and investors should adopt Binance coin, Bitcoin and Ethereum as a substitute for fiat currency in Africa and particularly South Africa to mitigate currency depreciation on the continent.