The Economics of Cryptocurrencies Bitcoin and Beyond

Abstract

How well can a cryptocurrency serve as a means of payment? Cryptocurrencies need to overcome double spending by using costly mining and by delaying settlement. We formalize this insight through an incentive constraint that rules out double spending and pins down the welfare costs of a cryptocurrency. We find that it is optimal to use seignorage rather than transaction fees to finance costly mining. We estimate that Bitcoin generates a large welfare loss that is about 500 times as large as a monetary economy with 2% inflation. This welfare loss can be lowered in an optimal design to the equivalent of a monetary economy with moderate inflation of about 45%. Bank topics: Digital currencies and fintech; Monetary policy; Payment clearing and settlement systems JEL codes: E4, E5, L5How well can a cryptocurrency serve as a means of payment? Since the creation of Bitcoin in 2009, many critics have denounced cryptocurrencies as fraud or outright bubbles. Others have argued that such currencies are only there to support payments for illegal activities or simply waste resources. Advocates point out, however, that -based on cryptographic principles to ensure security -these new currencies can support payments without the need to designate a third party that controls the currency or payment instrument, possibly for its own profit. 1We take up this discussion and develop a general equilibrium model of a cryptocurrency that uses a blockchain as a record-keeping device for payments. Many existing models of cryptocurrencies are built by computer scientists who focus mainly on the feasibility and security of these systems.Crucial issues, such as the incentives of participants to cheat, and the endogenous nature of some key variables, such as the real value of a cryptocurrency in exchange, have been largely ignored.Such considerations, however, are pivotal for understanding the optimal design and, hence, the economic value of cryptocurrency as a means of payment.Our focus is thus primarily on understanding how the design of a cryptocurrency influences the interactions among participants and their incentives to cheat. These incentives arise from a so-called double-spending problem. Cryptocurrencies are based on digital records that can be duplicated easily and costlessly and, thus, that can potentially be used multiple times in transactions.Our first contribution is to formalize this double-spending problem and show how it is addressed by (i) a resource-intensive competition for updating the records of transactions -a process commonly referred to as mining; and (ii) by introducing confirmation lags for settling transactions. 2 Double spending with a cryptocurrency requires one to change the record of transactions after the transactions have been recorded and confirmed in the blockchain. Since a blockchain builds records based on previous records, to revoke past transactions, one must create an alternative history of transaction records in order to double spend successfully. More intensive competition to update the chain and longer c...

Cryptocurrencies: The Revolution in the World Finance

“…These currencies might be prone to double spending attacks (Narayanan, Bonneau, Felten, Miller, & Goldfeder, 2016) which depends on individual incentives to reverse a particular transaction (Chiu & Koeppl, 2017). This can be mitigated through designing alternate cryptocurrency called Scrooge-Coin (Chiu & Koeppl, 2017).…”

“…This can be mitigated through designing alternate cryptocurrency called Scrooge-Coin (Chiu & Koeppl, 2017). (Reynolds & Irwin, 2017) Found that to keep up with a rapidly expanding global environment, and with the gap between the 'global' and the 'local' becoming smaller, criminals are adopting new forms of currency, such as cryptocurrency, to increase the level of anonymity afforded to their illicit activities.…”

“…Doc Searls Weblog, 2017, refers cryptocurrencies are as a digital asset designed to work as a medium of exchange using cryptography to secure the transaction and to control the creation of additional units of the currency. The regulation of the currency is uthority of Singapore are studying its usage for interbank payment systems (Chiu & Koeppl, 2017). Though cryptocurrencies are an area of heightened pecuniary, numismatic, technological, and investment interest, a comprehensive understanding of the theories and foundations is still left wanting among many practitioners and stakeholders (Chohan, 2017).…”

Weighted Moving Average of Forecasting Method for Predicting Bitcoin Share Price using High Frequency Data: A Statistical Method in Financial Cryptocurrency Technology

“…The most popular is Bitcoin. It has been getting a lot of media attention, and its total market value has reached 20 billion USD in March 2017 (Chiu and Koeppl, 2017 (2017) shows the distribution of Bitcoin exchange rate with first difference is follow normal distribution with probability of 0.722. The result show the distribution of data after second stages of outlies deletion treatments is high normal distribution characteristics.…”

Quantitative Description of Internal Activity on the Ethereum Public Blockchain

“…Despite an increasing notoriety and a monthly growing fiat money equivalent volume, it remains difficult to find publications dedicated to the establishment of economical and behavioural models aiming at describing internal activity on Ethereum, similarly to the studies performed for the Bitcoin network [7]- [9]. Concomitantly, global, time-resolved or major actors-resolved statistical indicators on the past internal activity and on the blockchain network topology are not commonly found in the literature, while they exist for Bitcoin [10]- [12].…”