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Models of Cryptocurrencies: Pricing and Design

Paper Session

Friday, Jan. 3, 2020 8:00 AM - 10:00 AM (PST)

Marriott Marquis, Grand Ballroom 12
Hosted By: American Economic Association
  • Chair: Guillaume Rocheteau, University of California-Irvine

Bitcoin as Decentralized Money: Prices, Mining, and Network Security

Emiliano Pagnotta
,
Imperial College London

Abstract

We address the determination and evolution of bitcoin prices in a simple monetary economy that captures the salient features of a decentralized network. Network users forecast the transactional and resale value of bitcoin holdings and consider the risk of a network attack. Miners contribute resources that enhance network security and compete for mining rewards received in units of the same unbacked token. In equilibrium, the overall production of network security and the bitcoin price are jointly determined. We characterize how the network technologies and participants, users and miners, affect the number and dynamic stability properties of equilibria. We find that the relation between bitcoin prices and the supply growth rate is not monotonic: the same price is consistent with different rates. The model’s outcomes demonstrate how intrinsic price–security feedback effects can amplify or moderate the price volatility effect of demand shocks. We find rational patterns of price momentum, and that small and large stochastic bubbles can exist in general equilibrium and show how the probability of bursting decreases with the bitcoin price.

The Economics of Cryptocurrencies: Bitcoin and Beyond

Jonathan Chiu
,
Bank of Canada
Thorsten Koeppl
,
Queen's University

Abstract

How well can a cryptocurrency serve as a means of payment? We study the optimal design of cryptocurrencies and assess quantitatively how well such currencies can support bilateral trade. The challenge for cryptocurrencies is to overcome double-spending by relying on competition to update the blockchain (costly mining) and by delaying settlement. We estimate that the current Bitcoin scheme generates a large welfare loss of 1.4% of consumption. This welfare loss can be lowered substantially to 0.08% by adopting an optimal design that reduces mining and relies exclusively on money growth rather than transaction fees to finance mining rewards. We also point out that cryptocurrencies can potentially challenge retail payment systems provided scaling limitations can be addressed.

Privacy as a Public Good: A Case for Electronic Cash

Rod Garratt
,
University of California-Santa Barbara
Maarten R.C. van Oordt
,
Bank of Canada

Abstract

Privacy is a feature inherent to the use of cash for payments. With steadily increasing market shares of commercial digital payments platforms, privacy in payments may no longer be attainable in the future. In this paper, we explore the potential welfare impact of reductions in privacy in payments in a dynamic framework. In our framework, firms may use data collected through payments to price discriminate among future customers. A public good aspect of privacy in payments arises because individual customers do not bear the full costs of failing to protect their privacy. As a consequence, they may sub-optimally choose not to preserve their privacy in payments. When left to market forces alone, the use of privacy-preserving means of payments, such as cash, may decline faster than is optimal.

Money Mining and Price Dynamics

Guillaume Rocheteau
,
University of California-Irvine
Michael Choi
,
University of California-Irvine

Abstract

We develop a random-matching model to study the price dynamics of monies produced privately according to a time-consuming mining technology. There exists a unique equilibrium where the value of money reaches a steady state. There is also a continuum of perfect-foresight equilibria indexed by the starting value of the currency where the price of money inflates and bursts gradually over time. In the aftermath of its introduction, private money is held for a speculative motive and it acquires a transactional role when it becomes sufficiently abundant. We study divisible, indivisible, fiat and commodity monies, and adopt implementation and equilibrium approaches.
Discussant(s)
David Andolfatto
,
Federal Reserve Bank of St. Louis
Harald Uhlig
,
University of Chicago
Cathy Zhang
,
Purdue University
Randall Wright
,
University of Wisconsin
JEL Classifications
  • G0 - General
  • E4 - Money and Interest Rates