Bursting the Bitcoin Bubble: Assessing the Fundamental Value and Social Costs of Bitcoin

Andrea Podhorsky
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Andrea Podhorsky: Asian Development Bank Institute

No 934, ADBI Working Papers from Asian Development Bank Institute

Abstract: This paper develops a microeconomic model of bitcoin production to analyze the economic effects of the Bitcoin protocol. I view the bitcoin as a tradable commodity that is produced by miners and whose supply is managed by the protocol. The findings show that bitcoin’s volatile price path and inefficiency are related, and that both are a consequence of the protocol’s system of supply management. I characterize the fundamental value of a bitcoin and demonstrate that the return on bitcoin appreciates proportionally to the rate of increase in the level of difficulty. In the model, where the price of a bitcoin is based on marginal production costs, successive positive demand shocks result in a rapidly increasing price path that may be mistaken for a bubble. The generalized supremum augmented Dickey-Fuller (GSADF) test is used to demonstrate that the model is able to account for the explosive behavior in the bitcoin price path, providing strong evidence that bitcoin is not a bubble. I also show that the difficulty adjustment mechanism results in social welfare losses from 17 March 2014 to 13 January 2019 of $323.8 million, which is about 9.3% of the miners’ total electricity costs during this time period.

Keywords: bitcoin; digital coins; Bitcoin protocol; cryptocurrency; bitcoin bubble (search for similar items in EconPapers)
JEL-codes: F30 G00 G11 (search for similar items in EconPapers)
Pages: 59 pages
Date: 2019-03-19
New Economics Papers: this item is included in nep-fmk, nep-pay and nep-sea
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Persistent link: https://EconPapers.repec.org/RePEc:ris:adbiwp:0934

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