Currency substitution in the shadow economy: International panel evidence using local Bitcoin trade volume

While mainstream adoption of cryptocurrency as a replacement for traditional fiat money has yet to be realized, anecdotal evidence suggests that such substitution is more pervasive in the shadow economy. I test this hypothesis by exploiting cross-country shadow market variation and exogenous shocks to darknet marketplaces used exclusively for illegal transactions in 28 emerging market economies. I find that Bitcoin trade volume generated by underground activity reacts much more strongly to inflation expectations than Bitcoin trade volume among the general population, providing direct evidence that shadow market participants substitute away from cash and towards cryptocurrency to conduct anonymous transactions. This effect is particularly strong among countries experiencing high annual inflation. (C) 2021 Elsevier B.V. All rights reserved.