[Focus on] Research activities of the CERAG lab

By Elise Alfieri, Radu Burlacu, Geoffroy Enjolras, Sonia Jimenez-Garces, Florentina Soiman

As a team of specialists in finance and management sciences, research on cybersecurity in the CERAG lab is focusing on the blockchain and cryptocurrency financial aspects. More precisely, we work on the following issues:
  • The nature of crypto-assets;
  • The interest of investing in cryptocurrencies;
  • The blockchain’s impact on financial markets and firms;
  • The new forms to raise capital using the blockchain technology;
  • The market microstructure of cryptocurrency Exchanges;
  • The insurance of cyber risks.

The nature of crypto-assets

While at the beginning, the “crypto-asset” and “cryptocurrency” terms could have been used interchangeably, Blockchain technology has now received some extra applications, as shown in the figure below (Fig. 1). The financial world has received new classes of crypto-assets, the term ‘cryptocurrencies’ is thus not universally defined anymore.
Crypto-assets classes. Source: (Ernst & Young Global Limited, 2018)
Fig. 1 Crypto-assets classes Source: (Ernst & Young Global Limited, 2018)
One of the most important research issues about cryptocurrencies was initially to define what are the crypto-assets in financial terms. To which well known financial assets do they resemble the most? Created at the origin with the purpose to disrupt the electronic payments and bring a digital alternative to the national currencies, cryptocurrencies might represent a new form of currency. However, some of the economic properties of these assets call this definition into question. Another way of research focused on the crypto-gold point of view. Crypto-currencies could be thought about as commodities because of similarities with the latter such as monetary creation and the role of safe haven decorrelated from the government. Finally, another research challenge has been to compare the Bitcoin cryptocurrency to a financial asset, and more precisely to a common stock. Under this asumption, the Blockchain and its community could be the intangible asset of this specific ecosystem with a particular high-risk/high-return profile. The quite recent apparition of tokens could confirm the similarity of crypto-assets with common stocks since tokens have mainly the objective to raise funds for financing new projects through the Initial Coin Offering projects. Some countries regulation decisions confirm this panel definition of the crypto-assets.

Investing in cryptocurrencies

One of the main reasons why cryptocurrencies became so largely known by investors resides in their volatility. These assets are shadowed by their unstable values that make the markets vulnerable and challenge the investors that already embraced them. Finance is a double dimension world: return goes hand into hand with risk. Researchers have thus focused their attention on risk and also return of crypto-assets. Analyzing this question, and more precisely the performance (return adjusted for risk) of the main cryptocurrency (Bitcoin), we find very remarkable results (whatever the regions analyzed) that raise the question of the speculative bubble and the contagion aspect on the cryptocurrency market. One of the current research issues consists in detecting and predicting speculative bubbles inside the cryptocurrency market as well as the contagion effect between the cryptocurrency leaders and the others.

Blockchain impacts on financial markets and firms

Another main research area focuses on the underlying technology of cryptocurrencies, the blockchain. As we can intuitively learn from its name, blockchain technology refers to linear chains of blocks which contain transactional information. Since its inception, blockchain technology has developed and become an innovative tool in many areas. Nowadays, there are three categories of blockchains, each offering different types of solutions (see Fig. 2 below).
 Fig.2. The timeline of blockchain’s versions  Source: (Soiman, 2020)
Fig.2. The timeline of blockchain’s versions Source: (Soiman, 2020)
Blockchain is a very important innovation for the financial world, in particular because the first two developments of this technology have brought important contributions in this direction. The subsequent versions of Blockchain brought different types of tokens, which complete the list of digital assets. In this context, we propose to also analyze another research question about the interaction between blockchain design and cryptocurrencies’ risk. Which technological characteristics of the blockchain have an impact on the financial risk of cryptocurrencies as assessed by investors, and on the volatility of cryptocurrencies’ prices? This question seems essential for understanding how some blockchain’s design (technological characteristic or combination of several technological characteristics) may help decrease the investment’s risk in these markets. Similar to the internet adoption challenges (about twenty years ago) and investors’ mania to fund and develop businesses related to that is promising technology, blockchain seems to now “suffer” from the same phenomenon. The famous “tech bubble” created an event without precedent and the investors’ frenzy for crypto-assets looks very similar to the previous “.com” large interest. Besides risk, we also aim to study the Blockchain’s impact on financial on firms’ performance. We address questions such as “Does blockchain contribute to creating value for firms? and how?”. This study will, in particular, make a parallel between the internet and the blockchain technologies. Following the events which happened two decades ago, it seems particularly relevant to ask whether firms, that changed just their names up to those that changed their core businesses to introduce the blockchain technology, have experienced a higher performance or not.

New forms to raise capital

The blockchain technology enables new forms of raising capital. The idea is to issue tokens against cryptocurrency to obtain funds for launching a new project. In this context, we will study the relevance for firms to use the blockchain technology in order to obtain financing from investors. In this part, the Security Token Offerings (STO), Initial Coin Offerings, (ICO) and Initial exchange Offering (IEO) financing will be analyzed as an alternative to traditional financing and crowdfunding. The first work consists in building a general database by merging, organizing and completing the data from different existing databases. A first research will study such ICO-related projects in order to predict their success based on available financial information but also on the team’s characteristics. It will be interesting to see how firms choose between those financing channels, how asymmetric information and regulatory mechanisms affect these choices, and in which conditions Blockchain financing alternatives could be the optimal choice.

Market Microstructure and Cryptocurrency Exchanges

The development of the cryptocurrencies’ trading raises questions about the impact of the market model and the investors’ behavior on the crypto-assets prices. One subject which attracts a lot of attention from both investors and academics concerns the impact of a possible regulation of the cryptocurrencies’ trading on asset’s prices. How do investors welcome a possible regulation? Is it a good news for them or not? We address this question by analyzing how do cryptocurrencies prices react to announcements which increase the probability of a possible regulation. In particular we show that such events induce a drop of cryptocurrencies’ prices.We further find that this negative reaction to a regulation of this market has not the same magnitude for all the analyzed cryptocurrencies.

The insurance of cyber risks

Cyber risk and cyber insurance have become global concerns due to the increasing use of information technologies all over the world. Besides many benefits, there are many potential cyber risks arising from technological innovations that have brought noticeable losses for users from individuals to corporations and even nations on a massive scale and over many aspects. Indeed, $11.5 billion is the estimated amount of losses caused by ransomwares all over the world in 2019, which is a significant increase in comparison to $5 billion of losses in 2017. In the finance sector, cyber attacks have become more complicated and sophisticated; and cyber risk could be considered as a trigger for a future financial crisis. In fact, the average time for a business being attacked by ransomware is 14 seconds in 2019 and this is an important warning for risk managers. However, there is lack of standardized knowledge and uniform approach about cyber risks. The first issue is related to the definition of a cyber risk which can be considered as “a risk related to information and technology, which leads to errors in information security systems and results in various losses of all domains”. Generally speaking, threats mainly come from deliberate, accidental, negligence and environmental (disasters) origins. They affect vulnerable hardwares, softwares, networks, and organizations. Cyber risks are characterized by several features, one of them being contagion as failures and attacks spread from one system to another. Classifying cyber risks represents another challenge and no clear consensus exists. Following Peters, Shevchenko, and Cohen (2018, Understanding Cyber-Risk and Cyber-Insurance), we consider 4 main types of risks:
  1. System malfunctions/issues which systematically lead to decline or damage to third-party’s systems;
  2. Data confidentiality breaches in which the client database can be stolen or leaked; 
  3. Data integrity/availability due to the corruption of system or data overlap;
  4. Malicious activities such as cyber bullying over social platforms or phishing attempts.
To prevent and face cyber risks, cyber risk management has been improved since the last few decades all over the world. Besides, cyber risk insurance plays an important role in managing risk and it represents an important challenge. At the moment, cyber insurance policies mainly address the following issues:
  1. Legal liabilities in case of private information disclosure and data breaches;
  2. Replacement costs of damaged network facilities;
  3. Financial compensation in case of loss of profit/money (if the bank account or the credit card are hacked), extortion as well as restauration of reputation.
All these risks are considered as insurable since a fair insurance premium can be computed and risks remain mostly uncorrelated. Yet, the insurance market suffers from some limitations such as a lack of available data since only few databases exist. The modelling of cyber risks remains limited as these risks encompass many realities. Moreover, information asymmetries may result in a lack of preventive efforts from insured people/companies when insured and adverse selection effects (the most risky get insured). Facing the extension of cyber risks, the reinsurance of these risks may also be compromised, which addresses the role of governments as a guarantee of the system. Cyber insurance can then be considered as an interesting tool for hedging the consequences of cyber attacks and failures provided it is considered as a complement to other preventive and protective measures.

Published on February 28, 2020