Khóa luận tốt nghiệp: Returns and volatility connectedness between NFTs, DeFi assets and conventional cryptocurrencies

VNU UNIVERSITY OF ECONOMICS & BUSINESSFaculty of Finance - Banking GRADUATION THESIS RETURNS AND VOLATILITY CONNECTEDNESS BETWEEN NFTs, DEFI ASSETS AND CONVENTIONAL CRYPTOCURRENCIES Inst

VNU UNIVERSITY OF ECONOMICS & BUSINESS

Faculty of Finance - Banking

GRADUATION THESIS

RETURNS AND VOLATILITY CONNECTEDNESS BETWEEN

NFTs, DEFI ASSETS AND CONVENTIONAL

CRYPTOCURRENCIES

Instructor MSc Nguyễn Hồng Minh

Hanoi, 2023

During my research and implementation of this Thesis topic, I have receivedenthusiastic help and valuable encouragement With all respect and gratitude, I would like tosend our sincere thanks to:

The teachers and experts from the Faculty of Finance - Banking for taking the time toanswer and analyze questions, contributing to creating a foundation for the group to beconfident in the implementation

I would like to express our gratitude and deepest thanks to MSc Nguyen Hong Minh Lecturer of the Faculty of Finance - Banking The important person who always guided thelesson wholeheartedly I feel very fortunate to the support from her

-Due to the limited knowledge and time, the research paper cannot avoid its

shortcomings and errors We hope to receive comments from teachers and readers for thestudy to be more complete Once again, we would like to thank and wish everyone goodhealth, happiness, and success

Best regards,

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List of Abbreviations

AVAX Avalanche

BTC Bitcoin

CAGR Compound Annual Growth Rate

DeFi Decentralize Finance

ROI Return on Investment

SEC Securities and Exchange Commission

TCI Total Connectedness Index

TVP-VAR Time-varying parameter-vector Autoregression

TVP-VMA _ Time-varying parameter vector Moving Average

UNCTAD United Nation Conference on Trade and Development

UST TerraUSD

VAR Vector Autoregression

3AC Three Arrows Capital

List of Table

Table 2.1 The 2022 Global Crypto Adoption Index

Table 2.2 Comparison between cryptocurrencies, DeFi assets and NFTs

Table 3 Illustration of DY connectedness indices

Table 4.1 Summary statistics of return

Table 4.2 Summary statistics of volatility

Table 4.3 Averaged dynamic connectedness of return

Table 4.4 Averaged dynamic connectedness of volatility

List of Figure

Figure 4.1 Return of different crypto assets during the analyzed period

Figure 4.2 The volatility of different crypto assets during the analyzed periodFigure 4.3 Dynamic total connectedness of return

Figure 4.4 Dynamic total connectedness of volatility

Figure 4.5 Pairwise spillover connectedness

CHAPTER 1: INTRODUCTION

1.1 Rationale

Blockchain technology and money platforms and digital assets are growing and gaining

wide popularity The strong development comes from strong developments in the field of

information technology combined with events that bring strong impact around the world,especially financial markets

Introduced with the prospect of becoming the future of the financial market, theemergence of cryptocurrencies and digital assets have become an investment channel thathas received strong interest in the financial market, attracting millions of investors toparticipate and promising to grow strongly in the future With a multitude of advantages thatare considered much more optimal than traditional investment channels such as datasecurity or the fact that all data information is publicly listed and accessible to everyone

The decentralized market has recorded an explosion in trading volume, transactionvalue or the number of new investors participating Investor’s interest in cryptocurrencieswas demonstrated by the all-time highs reached by bitcoin (BTC) and ether (ETH), the

record-breaking growth of decentralized finance (DeFi) protocols, the surpassing of the $3

trillion market cap for cryptocurrencies, the exponential growth of the non-fungible token(NFT) market through the explosion of returns of floating NFTs (Decentraland, BayC) andinvestments by venture capital firms in many crypto businesses The Terra ecosystem, which

is led by the algorithmic stable coin UST and sibling cryptocurrency LUNA, attracted a lot of

interest and growth among new cryptocurrency initiatives

Despite such attention and investment into the market, crypto market is still underspeculation Many investors still doubt the market and worries about the certainty of themarket can be seen On market trends and fluctuations, digital assets are still being evaluatedand due to the characteristics of these markets - independent of any reputable legal entity in

the world, the assessment and control of this market is not clear and official Investors do not

yet have a suitable tool to be able to value, evaluate and compare between these promisingbut also extremely risky new forms of investment The article will explore and clarify theinformation and characteristics of cryptocurrencies, DeFi assets and NFTs The movementtrend of the cryptocurrency market is judged by the correlation and investment performancebetween different forms of investment in this market From there, it is possible to know thecorrelation and connection between the price of these 3 asset classes (cryptocurrencies, DeFi

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assets and NFTs) really according to the natural adjustment to market trends, or simply

inflated digital products, which do not have actual value like other conventional profitable

assets.

1.2 Research goal

The research is conducted in order to, first of all, to define and ïllustrate the basics of

types of cryptocurrency, DeFi asset and NFT in general Information about cryptocurrencies

is provided with definition, characteristics, illustrations and real examples are given tospecify such information The aim of the research is to figure out the movement of cryptoassets in the market and to find out the traits of the movement The research uses the rate ofreturn and volatility index of different crypto assets in order to find out the correlationbetween such index and the changes in the market of crypto assets From this, the mainobjective of the research is to find the connectedness between different types of crypto

e Spatial scope: 2 conventional cryptocurrencies, 2 DeFi assets, 2 NFT

e Time span: The time selected for data collection is from May 11, 2021 to April 23, 2023

Yilmaz (2009, 2012, 2014) was used to run the test results Because, first, the TVP-VAR model

is an empirical analysis model for volatility spillover Second, the model makes it possible toidentify net risk generators and recipients and the spread of returns between the assetvariables selected as samples, thereby knowing which assets are dominant or which are

dominant or which are dominant by others Third, TVP-VAR can self-estimate transmissionfluctuations from a static point of view and change over time Fourth, this model captures

static return and volatility linkages and the impact of flash events on the volatility spillovereffect that can be detected Fifth, TVP-VAR can capture dynamic associations with a small andlow-frequency data set because the econometric framework is based on the separation ofvariance of the predicted error Finally, TVP-VAR allows for a two-way volatility diffusioncheck as it can analyze the orientation from each variable to all other factors and analyze theoverall volatility spread, analyzing the effect of return diffusion and net pair volatility usingthe model to consider the impact of assets on the market

1.6 Contribution of research

The research will help to broaden reader's knowledge about 3 types ofcryptocurrencies and how they are nominated and traded throughout digital financialmarkets The information about cryptocurrencies provided comes from many reliablesources, which can be very helpful for the readers to have a deep insight about the definition

of cryptocurrency, DeFi asset and NFT; their characters, their market situation and how theyare traded and exchanged in the digital financial market Readers will find information aboutacquiring the connectedness between some noticing cryptocurrencies and traditional assetsfrom normal investment means, which will help them to find the answer of the questionabout how the cryptocurrencies react with the financial market's changes The research alsosuggests some reliable sources of information and data about cryptocurrencies and financialassets, which can be useful for many different purposes This paper is one of the few empirical

studies on the connectedness of the 3 types of cryptocurrency, DeFi asset and NTF And also

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suggests some reliable sources ofinformation and data about cryptocurrencies and financial

assets so that readers can see the above markets more clearly

1.7 Structure of the study

Chapter 1: Introduction

Chapter 2: Literature review

Chapter 3: Data method

Chapter 4: Empirical results and discussion

Chapter 5: Conclusion

CHAPTER 2: LITERATURE REVIEW

2.1 Cryptocurrencies

2.1.1 Definition

According to Kaspersky (2022), Cryptocurrency, sometimes called crypto-currency orcrypto, is any form of currency that exists digitally or virtually and uses cryptography tosecure transactions Cryptocurrencies don't have a central issuing or regulating authority,instead using a decentralized system to record transactions and issue new units A digitalpayment system known as cryptocurrency doesn't rely on banks to validate transactions.Peer-to-peer technology makes it possible for anybody, anywhere, to send and receivepayments Payments made using cryptocurrencies do not exist as actual physical coins thatcan be transported and exchanged; rather, they only exist as digital entries to an onlinedatabase that detail individual transactions A public ledger keeps track of all bitcointransactions that involve money transfers Digital wallets are where cryptocurrency is kept

The first cryptocurrency was created in 2009 and is still the most well-known today:

Bitcoin Satoshi Nakamoto, a pseudonym for an author or group of authors whose identities

are shrouded in mystery, introduced Bitcoin in 2008 According to Vranken (2017), Bitcoin

is a digital, virtual currency without a physical counterpart like coins or banknotes Thebitcoin ecosystem is a network of users who interact with one another over the Internetutilizing the bitcoin protocol Users can store and transfer bitcoins to buy and sell items, tradebitcoins for other currencies, and more using the open source software program known asthe bitcoin protocol While processing transactions in a process known as bitcoin mining,bitcoins are issued in the network

A large portion of cryptocurrency interest is in trading for financial gain, withspeculators occasionally sending prices stratospheric The increased use of cryptocurrenciesfor cross-border remittances is expected to accelerate market expansion due to a reduction

in consumer and exchange fees

2.1.2 Characteristic

A cryptocurrency is a decentralized, digital, and encrypted form of money Acryptocurrency's value is not managed and maintained by a single entity like the US dollar orthe euro Instead, via the internet, these jobs are widely divided among users of acryptocurrency Although most people invest in cryptocurrencies the same way they would

in other assets like stocks or precious metals, investors can use cryptocurrencies to purchase

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common goods and services Although cryptocurrency is a new and intriguing asset class,

buying it can be risky because investors must undertake some significant research to fullycomprehend how each system functions (Kate Ashford - 2023)

A distributed public ledger known as blockchain, which is updated and maintained bycurrency holders, is the foundation of cryptocurrencies Through a process known as mining,

which employs computer power to solve challenging mathematical problems, units of

cryptocurrency are created Additionally, users have the option of purchasing the currenciesfrom brokers, then storing and using them in digital wallets When you holdcryptocurrencies, you don't actually own anything What you possess is a key that enablesyou to transfer a record or a unit of measurement between people without the use of a

reliable third party

A cryptocurrency is a digital currency, which is an alternative form of payment createdusing encryption algorithms The use of encryption technologies means _ thatcryptocurrencies function both as a currency and as a virtual accounting system To usecryptocurrencies, you need a cryptocurrency wallet These wallets can be software that is acloud-based service or is stored on your computer or on your mobile device The wallets arethe tool through which you store your encryption keys that confirm your identity and link toyour cryptocurrency (Oswego - State University of New York - 2023)

2.1.3 Overview of the cryptocurrency market

Digital economy has become the goal and vision of countries to meet the needs of theprocess of transforming the country into the economy in the digital age

Worldwide non-cash transactions (in billions) have grown rapidly over 10 years from

$311.1 billion in 2013 to $1347.7 billion as of March 16, 2023 (Statista, 2023) It is forecast

that by 2026, this figure will increase to $ 2121.6 billion.

As of 2023, global crypto ownership rates is estimated at an average of 4.2%, with over

420 million crypto users worldwide In which, the countries with the highest number ofowners are: USA (46 million people), India (27 million people), Pakistan (26 million people),

Nigeria (22 million) and Vietnam (20 million people), The number of global crypto holderscould reach about 600 to 800 million by 2023, depending on market conditions according toCrypto.com At the same time, the total crypto user index also rose in line with the internetuser timeline index (according to the World Bank)

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Table 2.1: The 2022 Global Crypto Adoption Index (Source: Chainalysis)

Country Overall Overall Centralized Retail P2P DeFi

index index service centralized exchange value

ranking score value service trade received

received value volume ranking ranking received ranking

Pakistan 6 0.609 10 10 50 22.

Brazil 7 0.562 4 7 113 8 Thailand 8 0.560 12 a2) 61 5

Russia 9 0.541 8 8 109 13.

China 10 0:535 z2 z2 144 6

The global cryptocurrency market capitalization is valued at more than $800 billion in

2022 At this year, the global value of cryptocurrencies is valued at $4.67 billion, and this

figure is expected to grow in line with a CAGR of 12.5% from 2023 to 2030 Thecryptocurrency market is predicted to grow at a compound annual growth rate of 56.4% from

2019 to 2025

Table 2.1 illustrates that Asia have higher adoption rates than other countries in the

region 3 countries in Southeast Asia, namely Vietnam, Philippines and Thailand, are all in the

ranking with high scores, respectively 1.000, 0753 and 0.560 Meanwhile, war-torn Ukraineranked third with 0.694 The world's super economic powerhouses the United States, Russiaand China as well as the upper middle-income country (Brazil) are also found in the ranking

Another report found that 15 of the 20 countries with the largest percentage of the

world's population owning cryptocurrencies belong to the group of developing nations

(according to UNCTAD) The reason is that the well-received cryptocurrency at the momenthas the ability to support fast and low-cost money transfers, and many people see owningcryptocurrency as a way to "shelter" from inflation

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North America accounted for the largest share with more than 35.0% of total revenue

in 2022 and became the dominant region of the global industry This dominance is furthercontributed in part by the fact that the region is one of the world's largest cryptocurrencymarkets, with cryptocurrency transactions accounting for 37% of all transactions betweenJuly 2020 and June 2021 (Chainalysis' Crypto Geography Report, 2021) People in this region

contribute around $276 billion in cryptocurrency to DeFi platforms The United States is

rated as the country with the highest revenue achieved in 2023 with 781,900.00 thousand

US dollars In the United States, more than 85% of merchants consider allowingcryptocurrency payments a high priority Merchants who accept cryptocurrency paymentsreceive an average ROI of 327% and up to 40% increase in new customers Customers using

cryptocurrency spend on average about $250 more per transaction than what the average

customer spends

In Asia Pacific, there are currently many cases of DeFi platforms and otherorganizations operating with blockchain technology in this region Shows the potential forcryptocurrency development in the Asia Pacific region as Asian countries increasingly have

a high number of crypto holders and adoption indexes (according to table 2.1)

Bitcoin and Ethereum are among the most widely known and discussed representativecryptocurrencies in the world, Bitcoin and Ethereum From 2015 to 2023, the price of Bitcoinhas increased by more than 173,000%, reaching an annual growth rate of 60% in 2021

Ethereum became positive as the value of this token increased by 9900% from its initial

value of just $10 in early 2017 to its current value of over $1000 on January 5, 2018 As other

cryptocurrencies have increased in value, Bitcoin's market share has fallen below 50%

Bitcoin's value has more than halved since April 2021, from nearly $45,000 to around

$20,000 The relationship between Bitcoin and Ethereum has garnered a lot of interest with

frequent discussions about Ethereum's potential to overtake Bitcoin However, Ethereum is

currently trailing Bitcoin in terms of market value and global demand (Beneki et al, 2019)

Legal framework

Due to the high rate of cryptocurrency ownership, the majority of countries around theworld do not consider the use of cryptocurrency illegal, its legality as a currency orcommodity is varied, with different legal implications Therefore, each country has differentregulations on cryptocurrency management In countries such as the USA, Canada, Russia,Japan, Australia, Activities related to virtual currencies are considered legal Meanwhile,

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China, Arabia, Zambia, Indonesia, Bangladesh, Bolivia, Ecuador, Kyrgyzstan, introducelegislation banning all virtual currency-related activities (China is a country with the largestnumber of cryptocurrency miners in the world, but Chinese authorities have just decided toban financial institutions in their country from conducting any business related to virtualcurrencies and warned against trading virtual currencies)

2.2 DeFi assets

2.2.1 Definition

According to Steven Ehrlich (2023), DeFi (Decentralized Finance) assets are digitalassets that are created and operated on decentralized blockchain networks, which operatewithout intermediaries such as banks or financial institutions DeFi assets includecryptocurrencies, stablecoins, and other digital tokens that are used for various financialpurposes, such as lending, borrowing, trading, investing, and more One of the main features

of DeFi assets is their ability to operate without intermediaries This means that they can betraded and transferred between individuals without requiring the involvement of a third

party Additionally, many DeFi assets have smart contracts built into them, which automate

certain financial processes and ensure that transactions are executed according topredefined rules

2.2.2 Characteristic

By enabling individuals, businesses, and merchants to perform financial transactions

through new technologies, decentralized finance eliminates middlemen DeFi makes use of

connection, software, hardware, security protocols, and peer-to-peer financial networks

People can lend, trade, and borrow using software that logs and validates financialtransactions in distributed financial databases from anywhere there is an internetconnection A distributed database collects and aggregates data from all users and utilizes aconsensus process to verify it, making it available from different locations (Investopedia -2023)

Decentralized finance eliminates middlemen by making it possible for people,organizations, and merchants to conduct financial transactions using modern technology.Peer-to-peer financial networks, software, hardware, security protocols, and connections areall used in DeFi (Kubera - 2023) Using software that records and verifies financial

transactions in distributed financial databases, anyone can lend, trade, and borrow from

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anywhere there is an internet connection With the help of a consensus process, a distributeddatabase gathers and combines data from all users and makes it accessible from many places.2.2.3 Overview of the DeFi market

Although the decentralized finance market is active, this finance market was the mostattractive category in 2021 but it received little interest and money from large funds and

investors in 2022, with the average investment size of each investment round in the portfolio

is about 10 million USD, much lower than the whole market in general (about 25 millionUSD) and of CeFi in particular (50 million USD) The total fundraising value in the DeFi

portfolio is $2.4 billion, with 229 investments, accounting for 9% and 20% of the total

fundraising market, respectively The currently decentralized exchange's cryptocurrency

market capitalization is more than $37 million (data from Coinmarketcap).

United States, Vietnam, China, United Kingdom is one of the highest-ranking countries

in grassroots DeFi adoption with adoption indexes of 1.00, 0.82, 0.62 and 0.60 respectively(Chainalysis) These are middle- to high-income countries or have developed cryptocurrencymarkets, especially strong professional and institutional markets

DeFi assets are gaining popularity due to their potential for providing lower fees andmore flexible financial products and services than traditional institutions However, as themarket for DeFi assets is still relatively new, they also come with risks such as volatility,security concerns, and regulatory uncertainty

"uniqueness" and thanks to being mounted on a blockchain, the NFT ensures its

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"individuality", thereby guaranteeing the ownership of the owner When owning an NFT, the

owner is assured that he is in possession of the unique NFT, which cannot be copied orcopied, the NFT always clearly displays his unique owner's name Each NFT exists for thepurpose of being “proof” of a person’s “ownership” of an asset class Currently, there are anumber of NFT standards that are multi-owned (NFT Multiple Ownership), multi-identifier(Multi-token standard), non-exchangeable NFT (Soulbound token)

2.3.2 Characteristic

Investopedia illustrates that the process of minting, which involves storing the NFT'sdata on a blockchain, is how NFTs are produced On a broad level, the minting procedurecomprises the creation of a new block, validation of NFT data by a validator, and closing of

the block Smart contracts are frequently incorporated as part of the minting process to

govern ownership and transferability of the NFT.As tokens are created, a specialidentification number that is connected to a single blockchain address is given to each one.Each token has an owner, and the owner's information (i.e., the address where the token isphysically located) is made available to the public Similar to general admission tickets for amovie, even if 5,000 NFTs of the same exact item are produced, each token has a specialidentification number

NFTs can be bought and sold in the same way as physical assets since their value isdetermined by the market, or by supply and demand NFTs are digital depictions of assets;they can also represent actual objects, such works of art or real estate Some users believe

that by tokenizing tangible real-world goods in this way, it will be easier to buy, sell, and trade

them It may also make fraud less likely (Kaspersky - 2023)

2.3.3 Overview of the NFT market

The rise of decentralized finance and crypto investing has sparked interest in NFTs as

a potential investment opportunity This market has experienced explosive growth in recentyears and is expected to continue to grow in the coming years, as artwork, music, and otherdigital assets sold as NFTs become unique

NFT is 1 of the segments that generates the most revenue in the Crypto market,especially NFT Marketplace development projects In the first 8 months of 2022, the NFTMarketplace group's revenue accounted for 49% of the total market

As of May 2023, the market capitalization is close to $610 thousand (data from

Coinmarketcap) As of September 2022, India is the world leader with NFT holders

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accounting for 7% of the country's population On average, around 2% of women worldwide

say they own, compared to 4% of men (Finder, 2022) According to Statista, revenue in the

NFT marketplace is expected to reach $1,601.00 million in 2023, with average revenue per user in the NFT marketplace amounting to $114.80 this year Revenue is expected to show a

compound annual growth rate of 18.5% from 2023 to 2027 on an expected amount of

$3,162.00 million The number of NFT users is expected to reach 19.31 million by 2027 with

an expected penetration rate of 0.2%

Currently, NFT has not been able to step out of the cryptocurrency market, however,NFT has shown its potential through sales of NFT Marketplace Besides, market-related risksand challenges, such as concerns about environmental impacts and the possibility of

speculative bubbles forming, will dominate the growth of the market That makes it likely to

go through ups and downs in the coming years

The percentage of adopting NFTs is highest in the Philippines with the highestpercentage (with 32% holders), followed by Thailand (27%), Malaysia (24%), UAE (23%)and Vietnam (17%) Japan has the smallest percentage of Internet users with NFTs (2%),

followed by the UK and the US (3% each), Germany (4%), Australia (5%) and Canada (6%)

NFTs are unique digital assets, which creates scarcity and exclusivity, increasing theirperceived value High-profile NFT sales, such as Beeple's "Everydays: The First 5000 Days,"

which sold for $69 million, generate significant media attention and interest in the market.

2.4 Comparison between cryptocurrencies, DeFi assets and NFTs

Table 2.2: Comparison between cryptocurrencies, DeFi assets and NFTs

Cryptocurrencies DeFi asset NFT

Primary use is as a Represents financial Represent anything

Usage medium of exchange products built on | from artwork, music,

blockchain technology videos, and even tweets

Decentralized Decentralized and Often traded on Decentralized and

or operates without a | decentralized exchanges operates without a central Centralized | central authority authority

Operate as a kind of Operate as a kind of Represent an unique Uniqueness | monetary currency, | financial product, which | item or commodity, which

make them replicable make them one of a

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Method of

storing data

which make them kind and cannot’ be

replicable replaced or copied

Cryptocurrencies DeFi assets store data NFTs store unique

store transaction data | on a decentralized | digital asset ownership

on a distributed ledger | blockchain Data can |data on a blockchain called blockchain.

Transactions are verified by network

participants calledminers, who add them

to blocks on the

blockchain Each block

contains a set of transactions and is

cryptographically linked to the previous

block in the chain.

Transaction data _ is publicly accessible and

transparent but user identity is anonymous.

include information about

financial instruments,

investments, and yields.

Smart contracts on the

blockchain automate the execution of financial

products and transactions.

Decentralized exchanges provide liquidity for

trading these assets.

Storing data on-chain

enables transparency, immutability, and

chain but rather linked to

a URL or IPFS NFTs are

stored on.

blockchain,

often

Ethereum's which has smart contract

functionality that enables developers to _ create

custom NFTs Storing NFTs on-chain provides

proof of ownership and authenticity for digital

process requires

significant

DeFi asset is created

using smart contract code

on a decentralized blockchain | Developers

can create custom DeFi

products by coding smart

contracts that automate

programming skills using

existing templates or coding their own smart contracts NFTs are often created through platforms dedicated to the creation and distribution of digital

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computational power and energy resources.

Some cryptocurrencies

alternative also use

methods such as

staking or delegation to

products such as loans,

insurance, and investments Oncecreated, DeFi assets can be

traded on decentralized exchanges or used within

art or collectibles NFTs can represent anything

from artwork, music, videos, tweets, and more.

Once created, NFTs can be

sold on bought and

Trading

Method

create new _ tokens | their respective DeFi| various marketplaces or

Once created, | ecosystem auctioned off to the cryptocurrencies are highest bidder

often distributed

through initial coin

offerings (ICOs) or airdrops.

Cryptocurrencies DeFi assets are traded NFTs are traded on

are traded on | on decentralized | various marketplaces or

centralized and | exchanges - _ operate | auctioned off to the

decentralized without a central | highest bidder Prices can

exchanges They can be exchanged for fiat

currency or _ other

cryptocurrencies.

Cryptocurrencies exchange facilitate

transactions bymatching buyers and

sellers Trading

volumes and prices can

vary widely across different exchanges.

Some cryptocurrencies have high liquidity and trade volumes, while

others are less liquid

authority, allowing users

to trade directly with each

other using smart contracts and automated

market makers Liquidity

is provided through pools

of tokens that are locked

in smart contracts Users

can earn rewards’ by

providing liquidity to

these pools Price

discovery can be more challenging on DEXs due

to the lack of order books

vary widely depending on factors such as _ rarity,

creator, and demand.

Ownership andtransaction history stored

on blockchain provide proof of authenticity and

ownership Marketplaces may take a commission on

sales Some NFTs are also used in gaming and virtual worlds, where they can be

traded or used to unlock

content

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Legal status varies

by country and can range from fully legal to

banned outright Some countries have taken a

more supportive stance

towards

cryptocurrencies, while others have been more

cautious or restrictive.

Regulatory frameworks Legal status

are still developing in

many areas to address

issues such as taxation,

money laundering, and

investor protection.

Cryptocurrency

exchanges and other

service providers may need to comply with

local regulations to

operate legally.

Legal status also

varies by country and can depend on the specific

DeFi product or service In general, DeFi products and services are subject to

the same _ regulatory

frameworks as traditional financial

products However, the decentralized nature of

DeFi can make it difficult

to regulate and enforce

compliance Some DeFi protocols may be subject

to licensing requirements, while others may be

classified as securities and subject to additional

comply with local

regulations for the sale of

collectibles or artwork Regulatory frameworks

for NFTs are still developing, and legal issues such as ownership,

authenticity, and value are

still being addressed.

2.5 Literature review

Cryptocurrency is a recent phenomenon that is getting attention, so the extensiveacademic research surrounding it has also become significant Especially those studies thatfocus on developing theoretical models of this asset class

It is possible to consider the group of articles linking the movement of cryptocurrencyprices to traditional asset classes such as fiat money (typically Schilling and Uhlig, 2019;

Jermann, 2018) In the study of Schilling and Uhlig (2019), important factors capable of

valuing cryptocurrencies were proposed in a study on the alignment of price movementsbetween cryptocurrencies and traditional assets This article discusses the implications ofmonetary policy, Bitcoin production, taxation, welfare and price by providing a model of afunded economy with two competing currencies, the Dollar, Bitcoin Shows that price

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fluctuations do not invalidate the average exchange function For Jermann's (2018) study, the

model presents a simple closed-form expression for the highly volatile Sharp ratio andmarket risk price

Or papers that build models that emphasize the network effect of cryptocurrencyadoption (e.g., Pagnotta and Buraschi, 2018; Cong, Li and Wang, 2019) and emphasize price

dynamics caused by positive externalities of network effects The paper by Pagnotta and

Buraschi (2018) investigates the theory, several studies investigate the influence of thenetwork on the price of Bitcoin to solve the valuation of Bitcoin and other blockchain tokens

in a decentralized finance network Cong, Li, and Wang (2019) analyze how decentralizationrelates to consensus quality, implications for antitrust policies targeting blockchain

applications, and how blockchain's quintessential features reshape the competitive

landscape, thereby deriving that blockchain maintains market equilibrium with a broaderrange of economic outcomes

In addition, the assessment of cryptocurrency profitability can be predicted by factorsspecific to the cryptocurrency market, but not by the factors of cryptocurrency production inthe study of Yukun Liu and Aleh Tsyvinski (2020) Some other literature on thecryptocurrency market has also been studied, such as the perception that individualcryptocurrencies face the risk of tailing the cryptocurrency market (Borri, 2019) Makarovand Schoar (2020) found that the cryptocurrency market presents periods of potentialarbitrage opportunities on exchanges

Besides cryptocurrencies, documents related to DeFi assets and NFTs are also widelydiscussed For NFTs, studies have used the Hot NFT Asset Proxy to perform price bubbledetection analysis and portfolio management (Vidal-Tomás, 2022; Wang, Lucey, &; Vigne,2022a) This study contributes to the crypto literature by analyzing the short/long-termperformance and dynamics of this new NFT crypto market as a diversification tool for crypto

portfolios This is a similar trend observed during the ICO bubble throughout the entire

cryptocurrency market in 2017 (Momtaz, 2021)

Research papers on the price mechanism of NFTs (Aharon & Demir, 2021; Dowling,2021a; Vidal-Tomás, 2022) or using the average prices of NFT domains (Aharon & Demir,2021; Umar, Gubareva et al., 2022) were also tested However, NFTs vary in quality and tradeinfrequently, making it difficult to develop an NFT price composite index, so controversial

conclusions have been expressed in articles (such as Dowling, 2021b and Vidal-Tomas,

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2022) Moreover, investor attention can be the driving force influencing asset valuationstatistics (Da, Engelberg, and Gao, 2011).

Volatility connectedness between financial asset classes has also been studied in anumber ofarticles in recent years As quantifying liquidity connectedness across stock, bond,money and foreign exchange markets (Chordia et al 2005; Ping-Xin Liew et al., 2021) usingthe TVP-VAR model outlined the drivers and determinants of liquidity connectivity in thesefinancial asset markets, while showing sensitivity to extreme market events but low averagecross-asset liquidity spreads

The study on the volatility between NFT news for DeFi, Bitcoin, and traditional assetswas also conducted by Lucey et al (2022) and Yizhi Wang (2022) showing that crypto returns

react strongly to crypto network factors Portfolio relevance and portfolio optimization can

be improved with NFTs attention indexes as strong or weak volatility spilloverconnectedness between NFTs and other underlying financial markets can affect passive andactive portfolio managers

Research by Imran Yousafa, Larisa Yarovaya (2022) reports weak static return resultsand volatile spreads between NFTs, Bitcoin, DeFi assets, and select financial markets Thepaper is based on the modern portfolio theory of Fabozzi, Gupta, & Markowitz (2002), whichshows that if markets are weakly connected then their portfolios offer higher diversificationbenefits This study adds more data to help readers understand how portfolio managementallocates capital between traditional and digital assets available, and make more informedportfolio management decisions

2.6 Research gap

Through the process of referring to research papers, it can be seen that there have beensome studies on the connection between financial assets, but there are some limitations that

still exist in the references:

Firstly, the spillover-oriented analyses in previous studies is the rolling-windowapproach of DY Or use Granger causality based on the VAR model (Yukun Liu and AlehTsyvinski, 2022; Haas and Reynolds, 2020) caused limit quantitative spread when onlypairwise spillovers can be inferred and a numerical measure of overall connectivity acrossmarkets cannot be computed

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Secondly, there is still less literature measuring returns between assets in

over-the-counter finance markets compared to centralized financial markets

Moreover, there are few articles evaluating return and volatility connectednessbetween NFTs, DeFi assets, and conventional cryptocurrency (BTC, ETH) in thecryptocurrency market alone Therefore, this article has been designed to supplement thelimited knowledge in previous research articles

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CHAPTER 3: RESEARCH METHOD

3.1 Data collection

The data of this study is available from Coinmarketcap.com where aggregatesinformation from over 200 major exchanges and provides daily opening, closing, high, andlow prices, as well as volume data and market capitalization for most of the cryptocurrencies

The daily data of the selected 2 NFTs (Decentraland-MANA, Internet Computer - ICP), 2 DeFi

assets (Chainlink-LINK, Avalanche-AVAX), and 2 conventional cryptocurrencies BTC, Ethereum-ETH) from May 11, 2021 to April 23, 2023 because the data of all selectedconventional cryptocurrency, NFT and DeFi assets are available from this date Criteria for

(Bitcoin-selecting Bitcoin, Ethereum, NFTs and DeFi assets are based on the maximum availablelonger period data and higher market capitalization from Coinmarketcap Ethereum and

Bitcoin were selected as the conventional cryptocurrencies because of their highcapitalization and famous currencies to present

The study only chose those NFTs, DeFi assets and Bitcoin, Ethereum whose data isavailable from May 11, 2021 because the NFT - ICP has the data from this day and has a

market cap of over $1,000,000 The Covid-19 period was specified from this day to July 01,

2022, whereas the cryptocurrency market's bubble period commences following the data ofthe spread of the COVID-19 pandemic and dynamics of Bitcoin prices in the first half of 2021(Maouchi, Charfeddine, & El Montasser, 2021; Shilov & Zubarev, 2021; Shu, Song, & Zhu,

2021)

3.2 Method

This study begins the empirical analysis with a TVP-VAR model, which is the methodproposed by Diebold and Yilmaz (2009, 2012, 2014, hereinafter DY) that has been widelyused in recent years to capture static and dynamic connectedness networks across multiple

Đtand xt are matrices of N x N dimension

vec(6t) and tt are parameter matrices of N* x 1 dimension

Q, is an N? x N* dimensional matrix

N = 6 (with related strings as BTC, ETH, AVAX, LINK, ICP, MANA)This study converted the TVP-VAR model to a TVP-VMA following the proposal byAntonakakis et al (2020) after being estimated The resulting coefficients will be extracted

for GFEVD developed by Koop et al (1996) and Pesaran and Shin (1998) and calculating theIRF.

According to GFEVD, total connectedness index (TCI) is given to do the system shockanalysis or also known to reveal the dynamic interconnection between a system’s variables.TCI is denoted in Eq (3):

Bj=1¡xjNðƒ „ (h)

C4 (h) = wx 100 (3)

t EL, 67, (h)

Where:

OF (h) denotes h-step ahead pairwise spillover from variable j to i.

According to GFEVD and Eq (3), the contribution of variable i TO (FROM) all othervariables in a variable system Simply, TCI can be valued as processing a decomposition on

the TCI ‘From’ or ‘To’ a particular source TCI can be given follow:

The To-TCI can be expressed as Eq (4):

Net spillover connectedness values show the difference between static total directional

spillover connectedness to others and static total directional spillover connectedness

nà h t f

Moreover, C;;,, is the difference between É¡_,; ; and C¡_; ;

Net pairwise directional connectedness can be given as Eq (7):

x9

np ¬

Crit (h) = SC) , x 100 (7)

The Cit between variable i and j is the difference between the directional spillovers

transmitted from variables i to j, as well as those transmitted from j to i The static netpairwise directional volatility spillover connectedness between the volatility of two variables

i and j illustrated by the off-diagonal elements matrices 6 x 6 in Table 3

From the mathematical frameworks have been clearly explained in part 3.2 The DYconnectedness framework is best understood through the following table:

Table 3: Illustration of DY connectedness indicesBTC,„ ETH, AVAX;„ LINK,, ICPs, MANAg, FROM

BTC, , BTCy4, BTC¡;„ BTCia„ we se BT Cie, Số ,BTCƑ „„j# 1

ETH), ETH, ETH;; „ ETH;; „ ae ETH oe S6 ,ETHÌ, ,,j# 2

AVAX;„ AVAX+„ AVAX30 AVAX33 “ AVAX 36 Số ,4VAX],„.j#3

LINK, „

ICP,

MANA,, — MANAg, » MANAgp > MANAss, se se MAN Age Số MANA, „„j# 6

TO S6,BTCR„i# SEETHER, ES ,AVAXS., “ ¬— — TCL `.

1 ix 2 jx 3 it 6 iF

Note: The 6 x 6 matrix contains the 6 forecast error variance decomposition from a connectedness

perspective, which denotes as 47, The column ‘FROM’ is ‘From others’, shows the sums of off-diagonal rows

The bottom row ‘TO’ meanings ‘To others’, displays the sums of off-diagonal column The inter-variables’

information transmission level can be found in the bottom-right, indicated by TCI calculated as sum of all Aijh.

This table allows one to understand the different measures of connectivity and their relationship in terms of time and defines the variance decomposition matrix for this study The matrix which listed on the main upper-left N x N block is 4?; 4?

illustrated for the ij-th h-step ahead GFEVD, which generalized forecast error variance

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due to shocks arising from variable j and contains the variance and spectral decomposition results TCI is also known as the system-wide connectedness index.

3.3 Variable measurements

3.3.1 Return variable

Return or return on investment is a variable showing net profit on total investmentcosts Helps measure the rate of return on investment and the rate of return oninvestment This indicator helps to assess investment efficiency, the higher the return index,the higher the profitability Investments with a positive net return are preferred by investorsover investments that have suffered losses or no growth Investors can look at this indexalong with other financial indicators to objectively assess the market or project beforemaking investment decisions, and at the same time measure the impact of financial leverage

In addition, this index also assesses the ability to pay interest of enterprises based onbusiness activities This indicator is used in the article because the advantages of the indexare quite simple, easy to understand, suitable for investors who are new to the market, donot have much experience From there, it is easy to evaluate the performance and measurethe profitability of the markets, thereby choosing the cryptocurrency market to investappropriately

Based on the return R in the previous study of Andrea Baronchelli and associates (2022).This paper calculated profit R as follows in Eq 8:

P(Œ)— P(t-1)

P(t-1) (8)

Re; =

W here:

Rsz is the simple return for period t

P(t) is the price at time t

P(t - 1) is the price at time t - 1

If R > 0 shows that the NFT was sold for more than the price at which it was purchased

IfR <0 shows financial losses to the seller And if R = 0 (null) meaning that the seller balancesthe investment

Market return is constructed as a value-weighted return of all base currencies based ondaily closing prices Prices based on the closing prices of representative asset classes were

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also used in studies by Yukun Liu and Aleh Tsyvinski (2020), Karim et al (2022), Ko et al.

(2022), Yousaf and Yarovaya (2022), Yizhi Wang (2022)

3.3.2 Volatility variable

Based on the research question, this study tries to investigate the volatility

transmission between crypto markets A volatility index is a technical measure used to

identify price patterns and focus on possible price movements Volatility indices vs industry

volatility rates may vary A volatility index is a help for investors to track the movement ofstock or cryptocurrency prices in the market From there, measure past price movements totrack future price movements Investors and traders will have their own mechanism tomonitor and spot patterns from the volatility indicator, which is usually displayed as an

overlay in the display window or as a line on a technical chart

To analyze the volatility index between NFTs and financial assets, compared to thecryptocurrencies chosen as samples, the volatility index can be considered below the long-term (or medium-term) trend of the time series (daily index price percentage change)

va (daily index value at time t) Or use a guaranteed assisted formula as a volatility scale in

h, ], c are present for high, low and closing prices on day t

This formula is based on the formula for calculating the volatility index written byRogers, Rachel and Yoon (1994)

Overall, this volatility could be a signal of turmoil or developments that could affectprices in the cryptocurrency market It also explains the behavior of this superimposed dailyvolatility component of cryptocurrencies Therefore, high volatility can lead to a new trend

for cryptocurrency prices in general and individual currency prices in particular in a positive

or negative direction Traders can follow volatility and volatility rates, combined withanalytical models, to make more accurate investment decisions

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Market volatility is calculated based on high, low profits from high, low, and closing

prices of each currency on a daily basis High, low, and close price numbers are also included

as data for price-based volatility index calculations in articles by Rogers, Rachel and Yoon(1994), Chan and Lien (2003), an exploration stock price movements by Christos Floros

(2009) and an exploration of the predictive power of range-based volatility estimators by

Gabor Petnehazi and Jozsef Gall (2019)

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