Bubbles in a world asset: The case of cryptocurrencies

Abstract

Cryptocurrencies have made the headlines in mainstream news in the recent years. There are people who become rich in a matter of a few weeks as well as those who lose a fortune with Cryptocurrency. High Cryptocurrency price volatility has been witnessed as influential people and governments take turns fueling both the ups and downs. Prices rise when influential investors or persons express support for Cryptocurrencies while prices fall sharply when there are news regarding Cryptocurrency frauds and scams. Governments everywhere are still trying to find the right balance between control and leniency of Cryptocurrency adoption despite its long years of existence. In this paper, we attempt to develop a simple theoretical model to study the rational bubbles in the Cryptocurrency. In the model, two highlighted features of the Cryptocurrency are (1) an asset with fixed positive supply and (2) an asset traded internationally with infinitesimal transaction cost. We strikingly find that oscillatory bubbly equilibrium dynamic is common over a wide range of parametrization; for example, large income inequality across countries. In other words, the Cryptocurrency is highly volatile by its very own nature. Cryptocurrencies may increase welfare for agents in economies with certain parameters such as those with low relative risk aversion or high output elasticity of capital. It is a vector that can easily transfer shocks from one country to another through means of its price change alone or through means of propagated risk perception. We found an interesting insight that differentiates Cryptocurrencies from normal country restricted bubbles. When a shock happens to a Cryptocurrency anywhere, no matter how small or insignificant the economy of the source of the shock may be, a larger impact can ripple through other economies which are much bigger than the source country. This characteristic makes Cryptocurrencies either a hero or villain depending on the different parameters of the world and each economy.