Metcalfe's Law argues the value of a network is proportional to the square of its users. Bitcoin and other cryptocurrencies can be modeled as such: if Metcalfe's Law is true, then it is possible to forecast prices using the size of the network. I test this assertion by a cointegration test between price and an adjusted number of wallets' connections. It is stated that the series do not cointegrate, rejecting the Metcalfe's Law. A first-differences model is employed to further analyse the relation between returns and variations in the number of wallets. It is stated that Metcalfe's Law consistently predicts the trend in the value of Bitcoin; nevertheless, it is not possible to reject the reverse causation of Bitcoin returns leading to new wallets.
Abstract This article reviews what cryptocurrencies are, and it frames them within the context of historical monetary experiences and contemporary monetary economics. The article argues that, as pure fiduciary private money, cryptocurrencies are a bubble without a fundamental value and they will not provide, in general, optimal amounts of money or deliver price stability. Nevertheless, cryptocurrencies can play a role in improving the current means of payments and in disciplining central banks into providing better governmentârun fiduciary monies.
Advocates of cryptocurrencies such as Bitcoin believe that having currency competition will help achieve the economic objective of price stability. This Issue Brief summarizes research that explores whether competition among privately issued fiat currencies can actually produce price stability. The research finds that in most cases, a system of private monies does not deliver price stability. And even when it does, it always is subject to self-fulfilling inflationary episodes, and it supplies a suboptimal amount of money. Although there is no economic reason to curb the use of cryptocurrencies at the moment, it is important to review key regulatory issues that policymakers need to consider now, before the use of cryptocurrencies becomes even more widespread.
Abstract This paper documents inconsistent terminologies and misleading analogies in current discussions of digital money and payments. It offers a more consistent framework for understanding the potential of technological innovation in providing the functions of money and payments: as media of exchange, stores of value, and units of account and the implications of cryptographic technologies underpinning cryptocurrencies for the future of money and payments. These could support efficiency gains in money and payments, but decentralization is not inherent to their application. Radical reform leading to improved economic outcomes is conceivable, but not through disruptive displacement of existing institutional arrangements.
Kamwoo Lee, Sinan Ulkuatam, Peter A. Beling, William T. Scherer
In this paper, we present a novel method to predict Bitcoin price movement utilizing inverse reinforcement learning (IRL) and agent-based modeling (ABM). Our approach consists of predicting the price through reproducing synthetic yet realistic behaviors of rational agents in a simulated market, instead of estimating relationships between the price and price-related factors. IRL provides a systematic way to find the behavioral rules of each agent from Blockchain data by framing the trading behavior estimation as a problem of recovering motivations from observed behavior and generating rules consistent with these motivations. Once the rules are recovered, an agent-based model creates hypothetical interactions between the recovered behavioral rules, discovering equilibrium prices as emergent features through matching the supply and demand of Bitcoin. One distinct aspect of our approach with ABM is that while conventional approaches manually design individual rules, our agents' rules are channeled from IRL. Our experimental results show that the proposed method can predict short-term market price while outlining overall market trend.
The modern debate about monetary reform has taken on a new twist with the development of distributed ledger payments technology employing private digital currencies. In order to consider the appropriate state response, we go back to first principles of money and finance and the case for financial regulation: to ensure provision of a safe money asset and a stable supply of credit within an inherently unstable financial system. We consider calls to privatise money or to restrict money issue to the state against the background of the increasing marketisation of the financial sector and money itself. Following an analysis of private digital currencies, we then consider proposals for state issue of digital currency. It is concluded that the focus of attention should instead be on updating of regulation, not only to encompass digital currencies, but also to address other innovations in the financial sector which generate credit and liquidity, in order to meet the needs of the real economy. JEL Classification: E3, E5, G1
There has been a burgeoning Fintech literature in the past years, especially on cryptocurrencies. However, there is lack of research handling cryptocurrencies in a mainstream macroeconomic model. To bridge the gap, we develop a model for Bitcoin-like cryptocurrency as risky and costly bubbles in an infinite-horizon production economy. This model is consistent with the following facts: i) the surging Bitcoin market presents enormous volatility, ii) its price dynamics are significantly sensitive to both market sentiment and policy stances. Entrepreneurial firms choose to hold Bitcoins as liquid assets to buffer idiosyncratic investment distortions. The intrinsically worthless Bitcoins can emerge as rational bubbles when the market sentiment is optimistic enough. On the one hand, bubbly Bitcoins provide market liquidity to facilitate investment in the real sector, while on the other hand, they deteriorate the investment efficiency and crowd out aggregate production. Our quantitative exercise produces various cyclical features of Bitcoin bubbles and find that the collapse of Bitcoin bubbles can improve social welfare by decreasing distortion-driven real investment.
George Bissias, Brian Neil Levine, David Thibodeau
Abrupt changes in the miner hash rate applied to a proof-of-work (PoW) blockchain can adversely affect user experience and security. Because different PoW blockchains often share hashing algorithms, miners face a complex choice in deciding how to allocate their hash power among chains. We present an economic model that leverages Modern Portfolio Theory to predict a miner's allocation over time using price data and inferred risk tolerance. The model matches actual allocations with mean absolute error within 20% for four out of the top five miners active on both Bitcoin (BTC) and Bitcoin Cash (BCH) blockchains. A model of aggregate allocation across those four miners shows excellent agreement in magnitude with the actual aggregate as well a correlation coefficient of 0.649. The accuracy of the aggregate allocation model is also sufficient to explain major historical changes in inter-block time (IBT) for BCH. Because estimates of miner risk are not time-dependent and our model is otherwise price-driven, we are able to use it to anticipate the effect of a major price shock on hash allocation and IBT in the BCH blockchain. Using a Monte Carlo simulation, we show that, despite mitigation by the new difficulty adjustment algorithm, a price drop of 50% could increase the IBT by 50% for at least a day, with a peak delay of 100%.
Abstract Cryptocurrencies are expected to have a significant impact on banking, finance, and monetary systems. Due to the uncertainty as to the possible future trajectories of the evolving cryptocurrency ecosystem, governments have taken a relatively hands-off approach to regulating such currencies. This approach may be justified within the theoretical information-economics framework of this paper, which draws parallels between the information economics of money and quasi-money creation within the current central banking, commercial banking, and shadow banking systems with that of the cryptocurrency ecosystem. In particular, drawing lessons from the literature on the role of information in creating âsafe assetsâ, in this paper the authors find that by building on symmetric (common) knowledge as to the inner workings of the Bitcoin Blockchainâthough in a different wayâbitcoin possesses a degree of endogenous information insensitivity typical of safe assets. This endogenous information insensitivity could support bitcoinâs promise of maturing into a viable store of value and a niche medium of exchange. This finding should not be overlooked in the policy discussions for potential future regulatory interventions in the cryptocurrency ecosystem.
Do Bitcoin and other cryptocurrencies play a useful social role, or do they represent a social waste? Bitcoin is a decentralized recordkeeping system, with updating of the record of transactions in the blockchain.
We characterize various currencies according to their control structure, focusing on cryptocurrencies such as Bitcoin and government-issued fiat money. We then argue that there is a large unmet demand for a liquid asset that allows households and firms to save outside of the private financial sector. Central banks could offer such an asset by simply allowing households and firms to open accounts with them. Finally, we conclude that a central bank will not issue cryptocurrencies in the sense of a truly decentralized and permissionless asset that allows users to remain anonymous.
We analyze the Bitcoin protocol for electronic peer-to-peer payments and the operations that support the "blockchain" that underpins it. It is shown that that protocol maps formally into a dynamic game that is an extension of standard models of R&D racing. The model provides a technical foundation for any economic analysis of 'proof of work' protocols. Using the model, we demonstrate that free entry is solely responsible for determining resource usage by the system for a given reward to mining. The endogenous level of computational difficulty built into the Bitcoin protocol does not mitigate this usage and serves only to determine the time taken to process transactions. Regulating market structure will mitigate resource use highlighting the importance of identifying the benefits of competition for the operation of the blockchain.
At their essence, blockchains are digital sequences of numbers coded into computer software that permit the secure exchange, recording, and broadcasting of transactions between individual users operating anywhere in the world with Internet access. Like most technological changes, the development of blockchains drew on and combined several existing technologies. Blockchains incorporate digital encryption technologies that mask, to varying degrees, the specific content exchanged as well as the identities of individual users. Algorithms, pre-coded series of step-by-step instructions, are also mobilised in solving complex mathematical equations and arriving at a consensus on the validity of transactions within networks of users. Time-stamping technologies then periodically bundle verified transactions into datasets, or âblocksâ. Linked together sequentially, these âblocksâ form âchainsâ that make up larger âblockchainâ databases of transactions that broadcast a permanent record of transactions whilst maintaining the anonymity of users and specific content exchanged. Blockchains are intended to be maintained by all users in manners meant to be immutable, unless users arrive at a clear consensus to undertake changes.
We address the valuation of bitcoins and other blockchain tokens in a new type of production economy: a decentralized financial network (DN). An identifying property of these assets is that contributors to the DN trust (miners) receive units of the same asset used by consumers of DN services. Therefore, the overall production (hashrate) and the bitcoin price are jointly determined. We characterize the demand for bitcoins and the supply of hashrate and show that the equilibrium price is obtained by solving a fixed-point problem and study its determinants. Price-hashrate âspiralsâ amplify demand and supply shocks.
ABSTRACT We offer a general equilibrium analysis of cryptocurrency pricing. The fundamental value of the cryptocurrency is its stream of net transactional benefits, which depend on its future prices. This implies that, in addition to fundamentals, equilibrium prices reflect sunspots. This in turn implies multiple equilibria and extrinsic volatility, that is, cryptocurrency prices fluctuate even when fundamentals are constant. To match our model to the data, we construct indices measuring the net transactional benefits of Bitcoin. In our calibration, part of the variations in Bitcoin returns reflects changes in net transactional benefits, but a larger share reflects extrinsic volatility.
In a novel model of an endowment economy, we analyze coexistence and competition between traditional fiat money (Dollar) and another intrinsically worthless medium of exchange, not controlled by a central bank, such as Bitcoin. Agents can trade consumption goods in either currency or hold on to currency for speculative purposes. A central bank ensures a Dollar inflation target, while Bitcoin mining is decentralized via proof-of-work. We analyze Bitcoin price evolution and interaction between the Bitcoin price and monetary policy which targets the Dollar. We obtain a fundamental pricing equation, which in its simplest form implies that Bitcoin prices form a martingale. We derive conditions, under which Bitcoin speculation cannot happen, and the fundamental pricing equation must hold. We show that the block rewards are not a tax on Bitcoin holders: they are financed by Dollar taxes imposed by the Dollar central bank. We discuss monetary policy implications and characterize the range of equilibria.
The amount of computational power devoted to anonymous, decentralized blockchains such as Bitcoinâs must simultaneously satisfy two conditions in equilibrium: (1) a zero-profit condition among miners, who engage in a rent-seeking competition for the prize associated with adding the next block to the chain; and (2) an incentive compatibility condition on the systemâs vulnerability to a âmajority attackâ, namely that the computational costs of such an attack must exceed the benefits. Together, these two equations imply that (3) the recurring, âflowâ, payments to miners for running the blockchain must be large relative to the one-off, âstockâ, benefits of attacking it. This is very expensive! The constraint is softer (i.e., stock versus stock) if both (i) the mining technology used to run the blockchain is both scarce and non-repurposable, and (ii) any majority attack is a âsabotageâ in that it causes a collapse in the economic value of the blockchain; however, reliance on non-repurposable technology for security and vulnerability to sabotage each raise their own concerns, and point to specific collapse scenarios. In particular, the model suggests that Bitcoin would be majority attacked if it became sufficiently economically important â e.g., if it became a âstore of valueâ akin to goldâ which suggests that there are intrinsic economic limits to how economically important it can become in the first place.
This thesis will begin with a critique to the orthodox paradigm in monetary economics. Secondly, I will offer a theoretical, economic, structural and biopolitical analyses of the origin, nature and effects of money on society. After a critique to conventional paradigm of money, I will then propose a semiotic genealogy of money followed by an analysis of the Common, the Multitude together with a tentative fourfold proposal for monetary reform, i.e. a monetary dispositif for the socio-economic emancipation of the Multitude from the rule of capital to build a new paradigm of money. In particular, I will discuss the literatures on basic income and the emerging notion for bottom-up welfare named Commonfare; the Neo-Chartalist approach to money; complementary, viz. subaltern currencies; and crypto-currencies and distributed ledgers technology. In turn, I will present the two qualitative methodologies that I endorsed to design and research four sites of inquiry in Iceland, Spain, Finland and Italy: Participatory Action Research and Critical Muti-Sited Ethnography. A discussion of fieldwork findings will follow. Moreover, I will offer a comparative analysis on fieldwork findings by identifying not only commonalities and differences among the four sites, but also by eliciting the limits of methodological choices. I will conclude this thesis by arguing to refine the theoretical framework introduced in the literature review; and notwithstanding personal and objective limitations to the application of the monetary dispositif in the real world, I will advocate for further inquiry on Money for the Common Wealth of the Multitude to increase the quality and effectiveness of the debate on suggestions for monetary reform.