The Economics of Cryptocurrencies—Bitcoin and Beyond

Jonathan Chiu and Thorsten Koeppl

Staff Working Papers from Bank of Canada

Abstract: A cryptocurrency system such as Bitcoin relies on a decentralized network of anonymous validators to maintain and update copies of the ledger in a process called mining. In such a permissionless system, someone can cheat by spending a coin twice, which leads to the so-called double-spending problem. A well-functioning cryptocurrency system must ensure that users do not have an incentive to double spend. We develop a general-equilibrium model of a cryptocurrency. We use the model to obtain a condition that rules out double spending and study the optimal design of cryptocurrencies. We also quantify the welfare costs of using a cryptocurrency as a payment instrument. We find that it is better to use the revenue from currency creation rather than transaction fees to finance the costly mining process. We estimate that Bitcoin generates a large welfare loss that is about 500 times bigger than the welfare loss in a monetary economy with 2 percent inflation. This welfare loss can be lowered in an optimal design to the equivalent of that in a monetary economy with moderate inflation of about 45 percent.

Keywords: Digital Currencies and Fintech; Monetary Policy; Payment clearing and settlement systems (search for similar items in EconPapers)
JEL-codes: E4 E5 L5 (search for similar items in EconPapers)
Pages: 60 pages
Date: 2019-09
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-pay
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (18)

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Related works:
Working Paper: The Economics of Cryptocurrencies -- Bitcoin and Beyond (2019)
Working Paper: The Economics Of Cryptocurrencies - Bitcoin And Beyond (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:19-40

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