Exogenous Regulatory and Technological Shocks, and Bitcoin's Path to Legitimacy

Friday, June 24, 2016: 4:15 PM-5:45 PM
210 South Hall (South Hall)
Andreea Daniela Gorbatai, UC Berkeley, Berkeley, CA
Legitimacy is a fundamental social currency (Meyer and Rowan, 1977). Institutional
scholars view legitimacy as conformity with the prevailing social norms and expectations of an
institutional environment (Singh et al, 1986; Baum and Oliver, 1991; Ruef and Scott, 1998). This
study looks at the role of negative exogenous technological and regulatory shocks in establishing
the legitimacy and increasing the adoption of bitcoin. I propose that initial negative regulatory
shocks have a negative impact because they increase the uncertainty surrounding this new
financial market, whereas later negative regulatory shocks serve as signals of oversight. On the
contrary, initial negative technological shocks such as hacking scandals decrease trust and
contribute to decreasing the perceived legitimacy of this new financial market, whereas later
shocks are limited in negative impact to affecting the reputation of particular market actors and
do not impact bitcoin legitimacy.

Prior research proposed that media plays a central role in facilitating the public’s meaning
construction processes (Kennedy 2008), the visibility and diffusion of a message in the public
realm (Andrews and Caren 2010), and the cognitive legitimation of new markets (Aldrich and
Fiol 1994). The meaning-construction and message-diffusion facilitated by the media can in turn
affect the diffusion of new markets by attracting new market participants into the space.

Research Setting
Bitcoin is a digital asset and a payment system invented by an individual using the alias
Satoshi Nakamoto. Satoshi published a document detailing the design and functioning of this
decentralized, peer-to-peer system in 2008, and released open-source software implementing this
invention in 2009. Bitcoin allows users to transact directly without a financial intermediary, and
allows for transactions to be verified by network nodes and recorded in a public transaction
ledger (“blockchain”) that is stored at all times on all computers in the network, such that there is
no central repository or single administrator.

New bitcoins are created as a reward for payment processing work that results in recording
the payments in the blockchain. The payment processing work (“mining”) is rewarded with both
newly minted bitcoins and (optional) transaction fees. One can also obtain bitcoins via sale of a
product or service, or by exchanging other currencies into bitcoin. Transaction fees are optional;
because they are rewarded to the “miners” they serve to expedite transaction recording in the

The bitcoin exchange rate (or “price”) is established via a competitive market mechanism.
Transactions are conducted through an auction mechanism, whereby buyers enter bids and
sellers enter offers at the same time, and the exchange happens when the two overlap. The last
price for such as exchange becomes the exchange rate, which means that bitcoin prices are
determined by supply and demand. Since new bitcoins are minted in limited quantities only
when new transactions are recorded, such that supply is limited, bitcoin price fluctuations are
largely a measure of demand.

One controversy surrounding bitcoin as money is that, unlike other monetary financial assets that
pay no interest or dividends, it is not practical as store of value. Economists have argued that
bitcoin does not have a fundamental value, in the sense that it not backed by a firm’s assets or by
a central government (Woo, Gordon, and Iaralov 2013). I propose that this attribute makes
bitcoin an interesting empirical case for analyzing legitimacy fluctuations in a financial market,
because its equilibrium price is solely affected by people’s trust, beliefs, and expectations about
its value.

Data, Measurements, and Methods
For the purposes of my analysis I am focusing on all bitcoin transactions occurring
between December 14, 2009 and November 9, 2013, coupled with a complete dataset of all
media coverage between May 1, 2011 and December 18, 2013, and a list of exogenous shocks
derived from online lists of milestones in bitcoin history (omitted due to space constraints).
In preliminary work, I use aggregate measures of bitcoin market transactions to estimate the
mediating role of media coverage on bitcoin financial metrics in response to exogenous shocks.
These are indirect measures of bitcoin legitimacy, because they rely on the assumption that
choices of market participants are guided by perception of legitimacy. The argument is that
“financial transactions [based on] the opinions of a large number of independent [actors] who put
money at stake in financial trades may reveal more information [about the legitimacy of a
financial instrument, and trust in that instrument] than expert opinions, newspaper articles, or
declarations by politicians or government officials” (Kim and Roland 2015).

In further analysis, I plan on improving my empirical approach in two ways: a. by employing an
event study methodology to reveal the response of financial markets to specific events; b. using a LDA algorithm
to uncover the themes that emerged in media coverage over time, such as hacking scandals; the
use of bitcoin for payments; illegal activities; and regulation regarding bitcoin trading and
investment (categories available upon request, due to space constraints). Additionally, I am in the
process of using a sentiment analysis dictionary to quantify the positive and negative emotion in
the media coverage related to bitcoin. These two categorizations will ultimately allow me to
refine the mediation model, by quantifying the extent to which media coverage is related directly
to the exogenous shock, as opposed to a more generic coverage regarding bitcoin usage, and the
valence and intensity of the coverage.

Preliminary results based on four shocks (old/new x regulatory/technological) suggest that recent
regulatory shocks lead to an increase in the overall number of transactions once the market
rebounds while early regulatory shocks may be detrimental (see Figure 1). This may be because
once the currency is on its way to gain legitimacy, regulatory shocks signal oversight and
“course corrections” in the bitcoin market, which in turn increase participant trust in this

This study contributes to our understanding of how financial markets operate by
examining the path to legitimacy of a decentralized digital currency— and a financial market that
arose as a technological innovation independent of established market actors and
institutions. Because bitcoin lacks underlying fundamentals its value is particularly vulnerable to
legitimacy shocks. I hope that this study furthers the research agenda for organizational studies
of finance. Traditionally, research has looked at markets as social constructions that reflect the
unique interactions of states and organizations; looking at a decentralized currency we can
examine an instance of collective social construction of a new currency, and the role that media
can play in signaling the legitimacy of this new financial market along cognitive, normative, and
regulative dimensions.