Bubbly Bitcoin

Feng Dong (), Zhiwei Xu () and Yu Zhang ()
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Feng Dong: Tsinghua University
Yu Zhang: Peking University

Economic Theory, 2022, vol. 74, issue 3, No 10, 973-1015

Abstract: Abstract 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: (1) the surging Bitcoin market presents enormous volatility, (2) 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.

Keywords: Cryptocurrency; Asset bubbles; Financial frictions; Market sentiment (search for similar items in EconPapers)
JEL-codes: D84 E30 E60 G10 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s00199-021-01389-y

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