Digital Currency and Financial Markets in Nigeria: Impact and Policy Implications

The rise of privately issued digital currencies, which primarily serve as alternative investment assets poses a challenge to the traditional financial instruments traded in the financial market. This study examines the dynamic relationship between the major privately issued digital currency (Bitcoin) and two financial market securities in Nigeria. The paper employed Vector Autoregressive (VAR) model and presents three relevant findings. First, the impulse response function indicates the absence of a significant response of the Nigerian financial market to shocks emanating from the Bitcoin market, implying lower connectedness between the two markets. Secondly, the outcome of the variance decomposition reveals a lower contribution of Bitcoin to changes in stock prices and treasury bills, however, stock prices and treasury bills contributed higher impact to each other compared to the contribution of Bitcoin. Thirdly, a weak bi-directional causality between the Bitcoin and treasury bills was observed and a uni-directional causality running from treasury bills and stocks, implying the existence of portfolio rebalancing from the fixed income to the equities market. Despite the weak connection between digital currency and the financial market, the paper recommends that the Central Bank of Nigeria and the Securities and Exchange Commission should maintain monitoring the development of crypto exchanges and continue reviewing the existing policy restricting cryptocurrency transactions through banks to avoid its unsavoury effects.

The traditional financial market on the other hand, which is a system that enables the facilitation of transactions and investment of securities such as stocks, bonds, and foreign currencies has been empirically proven to be interconnected with the emerging privately issued digital currencies, popularly known as cryptocurrencies, such as Bitcoin and Ethereum (Kumah et al, 2021;Agyei et al, 2022;Ha, 2023;Frikha et al, 2023).Therefore, owing to the rising adoption of privately issued digital currency, especially Bitcoin, by individual and institutional investors, it is becoming increasingly difficult to detach these cryptocurrencies from the financial market as this instrument becomes an integral part of the financial system with increasing investments.The trends in the volume of transactions and market capitalisation are presented in Appendix 1 & 2.
Available studies on digital currency and its relationship with the financial market can be broadly grouped into two categories in terms of findings.The first strand of studies maintains that investment in the financial market, specifically, in equities and bonds would remain unaffected by digital currencies (Dabrowski & Janikowski, 2018;Gilbert & Loi, 2018;Gkillas & Longin, 2019).The second strand of studies pointed out that digital currency has an inimical effect on the financial market with a tendency for spillover effects (see, Matkovskyy & Jalan, 2019;Handika et al, 2019;Zhang et al, 2021;Kumah et al, 2021;Agyei et al, 2022;Iyer, 2022;Frikha et al, 2023;Ha, 2023).Similarly, some studies have also discovered that cryptocurrencies function as a separate risk source from traditional assets (Liu & Serletis, 2019;and Li & Huang, 2020).
The current regulations in Nigeria do not consider transactions in this form of digital currency (all forms of privately issued digital currency) as a legal undertaking, following the restriction of cryptocurrency trading through commercial banks by the Central Bank of Nigeria (CBN) in February 2021, as they are perceived to pose financial stability threat.However, before this restriction, Nigeria was the leading destination of cryptocurrency (Bitcoin) trading in Africa (Nault, 2021;Ozili, 2022;and Mohammed, 2023).Appendix 3 demonstrates the rising transaction of Bitcoin on online exchanges in Nigeria, prior to the CBN restriction.
The restriction of cryptocurrency trading by the regulatory authority in Nigeria led Nigerian crypto investors to adopt peer-to-peer trading (Onyekwere et al, 2023).A survey revealed that 65.0 per cent of Nigerian crypto investors make fiat deposits to crypto exchanges for crypto trading via peer-to-peer trading with other investors1 .This action implies portfolio diversification from investing in the Nigerian financial market instruments such as the Nigerian equities, bonds, or treasury bills to cryptocurrency.
A global and domestic outlook indicates that the pace of global adoption remains high even with falls in the prices of crypto assets, as the global cryptocurrency market is predicted to grow with a compound annual growth rate of 56.4 per cent from 2019 to 2025, while on the domestic front, the crypto penetration rate in Nigeria is predicted to increase by an average of 2.4 per cent annually between 2024 to 2027 2 .Trading value in Bitcoin in Nigeria was tallied at around $400 million, in the first two quarters of 2022 according to P2P exchange Paxful.
The trend in cryptocurrency adoption is of concern to policymakers and investors as it portends financial stability concerns along two main pathways.First, the potential for asset switching as a significant adoption of privately issued digital currencies could partially absorb a chunk of investment that could ordinarily be invested in the Nigerian financial market.Another concern is the tendency for currency substitution as cryptocurrencies could potentially replace legal tender as a medium of payment and store of value.Since controlling the supply and demand for money for payments and investments is critical for monetary policy, the significant substitution of legal tender currency for cryptocurrency and the switching of traditional financial assets to cryptocurrencies would limit the efficacy of monetary policy formulation and implementation.Moreover, investments, especially within financial markets, are a veritable means for resource mobilisation and allocation for economic activities.Therefore, it has become pertinent to examine the relationship between financial markets and privately issued digital currencies and the impact of this relationship on investors and macroeconomic policy.
Given the above trend in the adoption of cryptocurrencies and the financial stability considerations, this paper attempts to investigate if the Nigerian financial market is susceptible to movements in trading activities of privately issued digital currency (Bitcoin) and to examine the magnitude and direction of any interconnectedness between these variables.The literature on cryptocurrencies and financial market dynamics in Nigeria is sparse with most focusing on regulatory considerations (Alvarez, 2018;Alekseenko & Gidigbi., 2021;Opebiyi, 2022) while Jimoh & Oluwasegun (2020) considered the effect of cryptocurrency returns volatility on stock prices.This paper contributes to the discourse by analysing specifically the dynamic relationship between cryptocurrency and the financial market in Nigeria to inform policy and investment decision-making.Moreover, we undertake a review of jurisdictional experiences of cryptocurrency regulation to provide context on the regulatory treatment of cryptocurrencies in relation to monetary and financial systems.
Following the introduction section, the next sections are organised in the following sequence: the second section contains the literature review, while the third section is the jurisdictional experiences; the fourth section, explains the methodology, the fifth section deals with the findings and discussion, whereas the sixth sections provide conclusion and recommendation.

Conceptual Clarification
Generally, digital currencies are virtual representations of value accepted for exchange by transacting parties.The literature differentiates between privately issued digital currencies and government-issued digital currencies.For example, the European Banking Authority (EBA) conceptualised privately issued digital currency as a "digital representation of value that is neither issued by a central bank or public authority nor necessarily attached to a fiat (conventional) currency but is accepted by natural or legal persons as a means of exchange and can be transferred, stored, or traded electronically" (EBA, 2014, p. 7).
In this study, we adapt the conceptualisation of the privately issued digital currency by the European Central Bank (ECB), which defines privately issued digital currencies as a "type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community" (ECB, 2012, p. 14).Following the above conceptualisation, in this paper, we use the term digital currency to refer to privately issued digital currency commonly known as cryptocurrencies such as Bitcoin, Ethereum, and Binance coin.
Another important concept in this study is the concept of financial market.While the concept of financial market is not new to literature, our conceptualisation of financial market centres around an investment destination for trading stocks and treasury bills.These instruments were selected as they play vital role in resource allocation and liquidity mobilisation.

Theoretical Linkages
The theoretical linkages of how cryptocurrency affects the Nigerian financial market can be explained by the flight-to-safety theory, which states that risk-averse investors tend to allocate a large portion of their portfolios in safer instruments such as stocks and bonds as opposed to highly volatile and risky asset such as cryptocurrency.We consider this theory relevant to explain the possibility of higher appetite for traditional financial market instruments to cryptocurrencies or vice-versa.

Flight to Safety Theory
On the backdrop of the attractiveness of privately issued digital currency as a new investment vehicle for portfolio investments owing to their role in international portfolio diversification.Especially in episodes of increasing crypto valuations and market prices.Bitcoin in specifics yields high risk-adjusted returns on average and has evolving connections with equities particularly in highly developed markets, making them desirable alternative for both domestic and foreign investors (Agyei, 2023).Risk-averse investors would always prefer riskless portfolios; however, other investors are driven by high returns and are less sensitive to inherent risk in assets.This tendency would result in diversification and risk.In connection with the above background, the flight to safety theory with its variant such as flight to quality, flight to liquidity, and the Pricing of Risk by Vayanos (2004) is apt in discussing a dynamic relationship of a multi-asset market.The key assumption in the theory is that investors and fund managers are subject to withdrawals when fund performance falls below a threshold.This generates a preference for near liquid assets that is time varying and increases with volatility.Risk-averse investment managers fear redemptions during high volatility periods and therefore an increase in volatility may lead to a flight-to-liquidity.At the same time, their risk aversion also increases, leading to a flight-to-safety, meaning that they require higher risk premiums, which in turn drives down the prices of risky assets to a flight-to-quality.The driving force in the theory is that uncertainty may lead agents to shed risky assets in favour of un-contingent and safe claims when aggregate liquidity is low thereby provoking a flight-to-quality or safety.

Impact of digital currencies on Financial Market: Insight from Jurisdictions
Countries learn from the experiences of other countries.In this section, we have drawn lessons from the experiences of some selected countries on the impact of privately issued digital currency on financial market.The insight was summarised and presented in Table 1.For a comprehensive review of the jurisdictional experience for more sample countries see, Jeris et al (2022).

Methodology
In addition to country experiences and insight obtained from the literature review on the form of interaction and relationship between the privately issued digital currency and traditional financial market, this section utilised data on some variables of interest to examine the relationship for Nigeria.

Data Sources and Description
The paper employed monthly data spanning from 2018M1 to 2023M6 for the analysis.The dataset includes the all-share index (ASI) measured as the composite index of all the traded stocks on the Nigerian Exchange Limited (NGX) market, 91-day treasury bills rate (NTB) measured in rate, and Bitcoin prices (BTC) measured in millions of naira.The idea is to examine the causal relationship between the private digital currency (Bitcoin) and some financial market instruments.The choice of Bitcoin as a proxy for private digital currency was determined by three factors.First Bitcoin is the most traded privately digital currency in terms of volume and market capitalisation.
Secondly, the price of Bitcoin is internationally determined like oil price, making it suitable for analysis irrespective of the country's location.Thirdly, Bitcoin data was readily available for the sample period used in the paper.The other variables were chosen as Holovatiuk (2020) submitted that the five (5) most common key asset classes in the financial market are stocks, fixed income, commodities, foreign exchange, and real estate.Thus, we use 2 of these key variables (stocks and fixed income instrument) because of data availability on these variables and their suitability to the context of the study.The dataset was obtained from the Central Bank of Nigeria statistical database and the Nigerian Exchange Limited (NGX) Statistics database.Bitcoin data was obtained from Coinmarketcap website.

Technique of Analysis
The paper employs a Vector Autoregressive (VAR) in first difference, which is used in examining the dynamic relationship among the study variables.The choice of VAR in first difference was informed by the non-stationarity of the variables (that is, all being I (1) series) from the unit root test and were not cointegrated based on the Johansen Cointegration test.The paper considered preliminary tests including summary statistics, unit root, and pairwise correlation matrix to adequately explain the salient features of the data.

Model Specification
The VAR in first difference has proven to be useful for describing the dynamic behaviour of economic and financial time series.In the VAR framework, all the variables are treated as endogenous variables being explained by its lagged values and the past values of the other endogenous variables (Granger, 1969;Sims, 1982).The VAR in difference is given by: In equation 1-3, Δ is the difference operator,   is the innovations and is assumed to be white noise with zero mean.K is the number of lags, and 2 optimal lag length has been decided by the Akaike information criterion (AIC) and final prediction error (FPE) reported in Table 2.As reported in Table 5, we find that all the variables are integrated of the same order one, i.e.I (1), implying the suitability of the technique.The above model is used for the purpose of testing for testing the dynamic relationship between the privately issued digital currency and the two selected financial market indices.

A-priori Economic Expectation
Guided by the flight-to-safety theory and the institutional knowledge on the contemporaneous relationship among the variables, all things being equal Bitcoin is expected to have a weak causal relationship with the financial market variables in Nigeria as the penetration and use of Bitcoin is still evolving.However, we expect the Unidirectional/bi-directional causality among the other variables, ASI and NTBs.

Pre-estimation test
The preliminary checks entail the basic descriptive statistics to understand the underlying data-generating process and nature.In addition to the preliminary checks, the second procedure involves the estimation of pairwise correlation and unit root test.

Descriptive Analysis
Deduced from the standard deviation in Table 3, it was shown that Bitcoin appears to be the most volatile among the variables, followed by stock index (ASI).This justifies the inherent price fluctuations that characterise these variables, leading to difficulty in forecasting their future behaviour with precision.The volatile nature of Bitcoin also lends voice to the previous submissions of Kumar (2021), Kyriazis (2021), and Anamika et al. (2023).Further deduced from the results of summary statistics in Table 2 is that NTB was the only variable that is not normally distributed series as its probability value is less than 0.05.The mean values show the averages of the dataset over the study period.Notes: * & ** denotes rejection of null hypothesis at 1% level of significance.

Correlation Analysis
Correlation analysis involves the determination of the level of association between two or more variables.In this case, we deployed a pairwise correlation matrix to examine the level of relationship between the study variables.The aim for this analysis is to discover the degree (magnitude) and direction of relationship between the financial market and digital currency to aid policy direction.
The result in Table 4, shows that fair and positive correlation exists between the stock index (ASI) and the Bitcoin prices.This suggests that Bitcoin price does not erode stocks performance measured by the ASI, as an increase in the former does not lower the latter.However, the result pointed fair and negative correlation between the fixed income instrument (NTB) and the Bitcoin.This finding is indicative of cross-investment rebalancing.This outcome was in tandem with the case of China as highlighted in Table 1, indicating negative spill overs in the Chinese market.Interestingly, a negative relationship was spotted between the stock index and the NTB, implying the existence of assets switching or portfolio rebalancing as increase in stocks performance tends to lure more investors to the stock market, leading to a shift of investment from the fixed income to the equities market, and vice-versa.This form of relationship was also consistent with the flight-to-safety theory.5 reveals that all the variables were not stationary at level, however, the after differencing the variables, they become stationary.Therefore, the summary of the stationarity of the variables is that all the variables are stationary at first difference.In line with this, the VAR in difference becomes the most appropriate as it was suitable for non-stationary series that are not cointegrated (Granger, 1969).
Following the non-stationarity of the study variables at their level form, we conduct a Johansen cointegration test to test whether a linear combination of the variables would produce a stationary outcome (Johansen, 1988).As shown in Table 6, the null hypothesis of no cointegrating relationship cannot be rejected and we therefore, we conclude that there is no evidence of long cointegrating relationship between Bitcoin and financial market variables in Nigeria.Thus, we could not estimate the Vector Error Correction Model (VECM), but rather estimate a VAR model in difference to examine the dynamic relationship between the variables.

Dynamic relationship between Bitcoin and selected financial market variables
The impulse response result indicates that Bitcoin responded positively and significance to its own shocks in the short run, particularly for two months within the ten-month forecast horizon.This implies that in the short term, self-generated shocks explain the dynamics in Bitcoin price behaviour.Similarly, the selected financial market variables (stocks and NTB) exhibit a similar reaction to their own shocks.However, there was absence of significant response of the Nigerian financial market to shocks emanating from the Bitcoin market.Specifically, the result suggests that both stocks and NTB responded positively to shocks originating from Bitcoin, though, at a statistically insignificant level.This implies lower connectedness between the dynamics in the Bitcoin market and the Nigerian financial market.Therefore, the activities of the Bitcoin market would not have a significant consequence on the performance of the Nigerian local bourse.This outcome contradicts the findings of Jiang et al (2021) who demonstrate dependence between cryptocurrencies and stocks, and further highlight that the significance dependence is rarely negative, which indicates that cryptocurrencies fail to be a strong hedge or safe haven against stock markets.On the contrary, the finding was consistent with the stance of Dabrowski and Janikowski (2018), Gilbert and Loi (2018), and Gkillas and Longin (2019) who maintain the null effect of Bitcoin on financial markets.
The insignificant impact of activities in the Bitcoin market on selected financial markets variables in Nigeria was further buttressed by lower contributions of Bitcoin to the historical decompositions of stocks and NTBs.The  7 shows that internal dynamics contribute higher to each of the variable dynamics than dynamics from other variables.However, some nuanced results were discovered in that stocks contribute about 6.4 per cent to the changes in Bitcoin, further contribute 5.9 per cent to changes in NTB.Similarly, NTB appears to contribute about 10.4 per cent to the variations in stocks and only 1.9 per cent to Bitcoin.The lower contribution of Bitcoin to changes in financial market indicates a weak connectedness between Bitcoin and selected financial market indices in Nigeria.This finding was consistent with some previous discoveries in the literature (see, Wu et al, 2014;Gilbert & Loi, 2018;Dabrowski & Janikowski, 2018;and Gkillas & Longin, 2019, among others).Testing for the causality among the variables via the block exogeneity test, the result in Table 8 shows that when the digital currency (Bitcoin) is considered as the dependent variable, it was only the NTB that was weakly significant at 10 per cent, which is considered as a borderline.This reaffirms the correlation result where weak negative correlation of 51.0 per cent was obtained.However, there was absence of causality between the stock index and Bitcoin.This implies that for now, Bitcoin does not have significant effect on the Nigerian stocks traded in the financial market.But the weak causality of 10 per cent between BTC and NTB is a pointer of a stronger relationship and as time progresses and adoption increases, this relationship might become highly significant at 5 per cent, or even 1 per cent level of significance.
Surprisingly, when stock index was considered as the dependent variable, there was no evidence of causality moving from the stock index to any of the study variables.This was surprising, given the close relationship between stock index and the NTB.However, when NTB is considered as the dependent variable, the variable was found to granger cause ASI at 1 per cent level of significance.This alluded to the asset switching phenomena and the flightto-safety incidence and was consistent with the expectation.Similarly, NTB also granger cause BTC at weak level of significance (10 per cent).This shows a bi-directional causality, though at a policy borderline level of significance.

Residual Diagnostics
The most relevant post-estimation test for Multivariate Models is the Serial Correlation test (using the LM test).The result of the LM and heteroskedasticity test indicates the absence of serial correlation and heteroskedasticity.

Conclusion and Policy Options
Motivated by the continued development of blockchain technology and the rise of privately issued digital currencies, which primarily serve as alternative investment assets and pose a challenge to traditional financial instruments traded in the financial market.This study examines the impact of the major privately issued digital currency (Bitcoin) and two financial markets securities in Nigeria.Following a systematic literature review, the paper also provides a snapshot of countries experiences of some selected countries.Finally, the paper examines the dynamic relationship using VAR framework.
Conclusively, the paper discovered that in the jurisdictional experiences, cryptocurrency transactions are restricted in China, while in Singapore and Brazil, they are licenced and regulated.Furthermore, the jurisdictional experience pointed out that there is negative spill over of cryptocurrencies on the Chinese financial market.However, in Brazil it was found to be a veritable haven instrument, while the effect in Singapore was mixed.The impulse response function indicates the absence of significant response of the Nigerian financial market to shocks emanating from the Bitcoin market, implying lower connectedness between the two market.Similarly, the outcome of the variance decomposition reveals lower contribution of Bitcoin to changes in stocks and treasury bills), however, stocks and treasury bills contributed higher impact to each other compared to the contribution of Bitcoin.This further buttresses a weak connectedness between Bitcoin and selected financial market indices in Nigeria.The causality test shows a weak bi-directional causality between the privately issued digital currency (BTC) and fixed income instrument (NTB).However, there was no evidence of causality between the stock index (ASI) and BTC.Finally, the paper revealed a one-way directional causality running from NTB to ASI, implying the existence assets switching or portfolio rebalancing from the fixed income to the equities market.
Following the above summary of findings, the paper recommends the need for CBN and SEC to intensify monitoring of crypto exchanges and continue reviewing the policy restricting cryptocurrency transactions through banks to avoid negative spill overs as in the case of China.In tandem with the causality result, it was evident that there is growing significant relationship between NTB and BTC, though at a very weak level of significance, therefore, the CBN should intensify monitoring of crypto exchanges and continue reviewing the cryptocurrency restriction, despite the weak causality to avoid its unsavoury effects.Additionally, we recommend that further studies, especially with country-specific data from major exchanges be conducted by other researchers to expand the body of knowledge on the crypto and financial markets dynamics in Nigeria.

Figure 1 .
Figure 1.Response of financial market to shocks from Bitcoin.result in Figure 2 and Table7shows that internal dynamics contribute higher to each of the variable dynamics than dynamics from other variables.However, some nuanced results were discovered in that stocks contribute about 6.4 per cent to the changes in Bitcoin, further contribute 5.9 per cent to changes in NTB.Similarly, NTB appears to contribute about 10.4 per cent to the variations in stocks and only 1.9 per cent to Bitcoin.The lower contribution of Bitcoin to changes in financial market indicates a weak connectedness between Bitcoin and selected financial market indices in Nigeria.This finding was consistent with some previous discoveries in the literature (see,Wu et al, 2014;Gilbert & Loi, 2018;Dabrowski & Janikowski, 2018; and Gkillas & Longin, 2019, among others).

Figure 2 .
Figure 2. Contribution of Bitcoin to changes in financial market variables.

Table 1 .
Jurisdictional Experience on privately issued digital currency and Lessons.

Table 2 .
Determination of appropriate lag length (k).
Notes: The appropriate lags selected is 2 based on AIC.Source: Author's computations.

Table 5 .
Unit Root test result.

Table 8 .
Causality between digital currency and some financial market instrument.