Abstract This chapter aims to offer readers an entry point to the deep discussion of this volume and the rationale for the âFinance 4.0â system described in later chapters. What is money, why is it designed this way, and what could it become in the crypto age? The chapter contains three parts. The first part describes in rough strokes the basic functions of money and how todayâs fiat money system implements them. The second part offers a modest critique of the fiat money system, arguing that many problems take root in the intimate power relationship between âmoney and state.â The final part presents two cases that address some of the shortcomings. The first is Bitcoin that infamously pursues a state-independent, decentralized conception of money. The second is Finance 4.0, a system that proposes a participatory multi-dimensional money system with built-in incentives for sustainable behavior. If more readers feel empowered to enter the public debate for a better money system in the twenty-first century, this short introduction achieved its aim.
We look at the association between the price of a cryptocurrency and the secondary market prices of the hardware used to mine it. We find the prices of the most efficient Graphical Processing Units (GPUs) for Ethereum mining are significantly positively correlated with the daily price returns to that cryptocurrency.
The emergence of Bitcoin poses an important question for monetary theorists: can Bitcoin compete with, or even replace existing fiat monies? To answer this question, one must be able to determine what gives intrinsically useless monies their value, what determines the coexistence of alternative monies, and under what conditions economic agents would prefer to hold one money relative to another. We attempt to answer these questions in light of the emergence of Bitcoin. In particular, we outline a theoretical model in which an intrinsically useless money is essential.
We rationalize cryptocurrency adoption in a small open economy model. We show that digital dollarization, where stablecoins pegged to the USD are used for transactions, can improve social welfare. In contrast, the adoption of volatile cryptocurrencies, such as El Salvadorâs 2021 decision to make Bitcoin legal tender, results in welfare losses. This outcome aligns with the observed low take-up of Bitcoin as legal tender. The welfare benefits of digital dollarization increase with the magnitude of macroeconomic shocks, providing motivation for the growing use of stablecoins in emerging markets as a safeguard against high inflation and macroeconomic instability .
This paper uses a search-theoretic model to study conditions under which cryptocurrency is valued and under which it coexists with fiat money. In my model, a cryptocurrency economy is one in which private agentsâ decisions determine the stock of money and in which the marginal cost of producing money is increasing in the existing nominal stock. I show that the inflation rate of cryptocurrency must be zero in a stationary monetary equilibrium. This result is in sharp contrast to models with fiat money in which the stock of money is exogenously given. In fiat money economies, the inflation rate is determined by the rate of growth of the money stock. My result is also in sharp contrast with other types of private money economies, in which the inflation rate must necessarily be different from zero. In such private money economies, the cost of producing additional money does not depend on the existing nominal stock. Moreover, I show that cryptocurrency and fiat money can circulate at the same time and that the rates of return on these two assets may not be the same. Competition with cryptocurrency restricts the governmentâs ability to over-issue fiat money and thereby might improve on pure fiat money equilibria without government commitment.
Today, financial system and all its services are completely centralized. Banks, exchanges, insurance companies and other financial institutions have someone in charge that controls these services. This centralized financial system, or CeFi, has its own risks. What if we decentralized the financial system in the same way that Bitcoin decentralized money?
One of the benefits of decentralized finance (DeFi) ĂąâŹâ an alternative financial system built on blockchain ĂąâŹâ is composability, which means the system's building blocks (tokens) can freely interact with one another to form new services. One example is stablecoin, a token with fixed exchange rate, which is backed by token collaterals. While stablecoins can be used to facilitate payments and exchanges, in DeFi they can be used to earn returns (ĂąâŹĆyield farmingù⏠), potentially multiplicatively. We use transaction-level blockchain data to analyze a stablecoin's flows between protocols and provide suggestive evidence of DeFi yield-chasing behavior. We shed light on what DeFi total value locked might really measure and highlight the complexity in DeFi analysis and market surveillance.
Carol Alexander, Jun Deng, Jianfen Feng, Huning Wan
Bitcoin prices are driven by upward as well as downward jumps and so the bitcoin implied volatility surface behaves differently from those of established options markets. We analyze tick-level Deribit option price data, demonstrating increasing support for the limits-to-arbitrage hypothesis. Hence market makers are managing order imbalance and inventory more effectively as Deribit bitcoin options trading volumes increases. On the demand side, volatility traders drive both at-the-money and out-of-the-money option prices, the latter also being driven by directional traders. Directional effects were most pronounced during the price bubble of 2021. Further refinements of our tests assess time-to-maturity and time-of-day effects.
Massimo Bartoletti, James Hsin-yu Chiang, Alberto Lluch Lafuente
Automated market makers (AMMs) are one of the most prominent decentralized finance (DeFi) applications. AMMs allow users to trade different types of crypto-tokens, without the need to find a counter-party. There are several implementations and models for AMMs, featuring a variety of sophisticated economic mechanisms. We present a theory of AMMs. The core of our theory is an abstract operational model of the interactions between users and AMMs, which can be concretised by instantiating the economic mechanisms. We exploit our theory to formally prove a set of fundamental properties of AMMs, characterizing both structural and economic aspects. We do this by abstracting from the actual economic mechanisms used in implementations, and identifying sufficient conditions which ensure the relevant properties. Notably, we devise a general solution to the arbitrage problem, the main game-theoretic foundation behind the economic mechanisms of AMMs.
One of the exciting recent developments in decentralized finance (DeFi) has been the development of decentralized cryptocurrency exchanges that can autonomously handle conversion between different cryptocurrencies. Decentralized exchange protocols such as Uniswap, Curve and other types of Automated Market Makers (AMMs) maintain a liquidity pool (LP) of two or more assets constrained to maintain at all times a mathematical relation to each other, defined by a given function or curve. Examples of such functions are the constant-sum and constant-product AMMs. Existing systems however suffer from several challenges. They require external arbitrageurs to restore the price of tokens in the pool to match the market price. Such activities can potentially drain resources from the liquidity pool. In particular, dramatic market price changes can result in low liquidity with respect to one or more of the assets and reduce the total value of the LP. We propose in this work a new approach to constructing the AMM by proposing the idea of dynamic curves. It utilizes input from a market price oracle to modify the mathematical relationship between the assets so that the pool price continuously and automatically adjusts to be identical to the market price. This approach eliminates arbitrage opportunities and, as we show through simulations, maintains liquidity in the LP for all assets and the total value of the LP over a wide range of market prices.
Multiagent incentive contracts are advanced techniques for solving decentralized decision-making problems with asymmetric information. The principal designs contracts aiming to incentivize non-cooperating agents to act in his or her interest. Due to the asymmetric information, the principal must balance the efficiency loss and the security for keeping the agents. We prove both the existence conditions for optimality and the uniqueness conditions for computational tractability. The coupled principal-agent problems are converted to solving a HamiltonâJacobiâBellman equation with equilibrium constraints. Extending the incentive contract to a multiagent setting with history-dependent terminal conditions opens the door to new applications in corporate finance, institutional design, and operations research.
Cryptocurrencies provide an important dimension of innovation to the evolution of the exchange medium we call money. There are now close to 2,000 such currencies, and their potential and volume is growing. The impact of such currencies for money laundering, law enforcement, and banking supervision have been extensively discussed on the transaction level. But this is the âmicroâ level of analysis. What has been rare is a âmacroâ level discussion of the impact on the monetary system of a country. Central banks, which are institutions tasked with providing monetary stability, will see their problems rise while the power of their traditional tools to control money supply and interest rates â such as reserve requirements and the discount rates â is declining. But the new digital technologies â such as distributed ledgers â and new approaches provide regulatory bodies also with new and potentially powerful tools. The task for central banks and policy makers is to create new approaches to use, regulate, and incent them in shaping the macro-economic path of their economy. The paper will propose several of these approaches. This is of particular importance in an economic recovery post coronavirus. In the process, central banks will also, predictably, issue their own digital currencies, and a tiny number of those will become global super-currencies. This will create a new type of issues.
Abstract We study the fundamental differences that separate: Litecoin; Bitcoin Gold; Bitcoin Cash; Ethereum; and Zcash from Bitcoin, and draw some analysis to how these features are appreciated by the market, to ultimately make an inference as to how future successful cryptocurrencies may be invented and behave. We use Google Trend data, as well as price, volume and market capitalization data sourced from coinmarketcap.com to support this analysis. We find that Litecoinâs shorter block times offer benefits in commerce, but drawbacks in the mining process through orphaned blocks. Zcash holds a niche use for anonymous transactions, benefitting areas of the world lacking in economic freedom. Bitcoin Cash suffers from centralization in the mining process, while the greater decentralization of Bitcoin Gold has generally left it to stagnate. Etherâs greater functionality offers the greatest threat to Bitcoinâs dominance in the market. A coin that incorporates several of these features can be technically better than Bitcoin, but the first-to-market advantage of Bitcoin should keep its dominant position in the market.
A new type of Automated Market Makers (AMMs) powered by Blockchain technology keep liquidity on-chain and offer transparent price mechanisms. This innovation is a significant step in the direction of building a more transparent and efficient financial market. This paper explores analytically market mechanisms and shows the conditions when those mechanisms are equivalent. Furthermore, we show that AMM mechanisms inherently create loses for market makers from inefficient prices (dictated by the AMM solutions), however, these mechanisms work well for assets with low volatility. We further analytically explore the losses and quantify them. The paper ends by discussing the design of efficient decentralized exchange compared to traditional Central Limited Order Books (CLOBs) and highlights the former's potential regarding decentralized finance.