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Blockchain structure and cryptocurrency prices

Author

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  • Zimmerman, Peter

    (Bank of England)

Abstract

I present a model of cryptocurrency price formation that endogenizes both the financial market for coins and the fee-based market for blockchain space. A cryptocurrency has two distinctive features: a price determined by the extent of its usage as money, and a blockchain structure that restricts settlement capacity. Limited settlement space creates competition between users of the currency, so speculative activity can crowd out monetary usage. This crowding-out undermines the ability of a cryptocurrency to act as a medium of payment, lowering its value. Higher speculative demand can reduce prices, contrary to standard economic models. Crowding-out also raises the riskiness of investing in cryptocurrency, explaining high observed price volatility.

Suggested Citation

  • Zimmerman, Peter, 2020. "Blockchain structure and cryptocurrency prices," Bank of England working papers 855, Bank of England.
    • Handle: RePEc:boe:boeewp:0855
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    References listed on IDEAS

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    Cited by:

    1. Aloosh, Arash & Ouzan, Samuel & Shahzad, Syed Jawad Hussain, 2022. "Bubbles across Meme Stocks and Cryptocurrencies," Finance Research Letters, Elsevier, vol. 49(C).
    2. Eric Ghysels & Giang Nguyen, 2019. "Price Discovery of a Speculative Asset: Evidence from a Bitcoin Exchange," JRFM, MDPI, vol. 12(4), pages 1-26, October.
    3. Lin, Min-Bin & Khowaja, Kainat & Chen, Cathy Yi-Hsuan & Härdle, Wolfgang Karl, 2020. "Blockchain mechanism and distributional characteristics of cryptos," IRTG 1792 Discussion Papers 2020-027, Humboldt University of Berlin, International Research Training Group 1792 "High Dimensional Nonstationary Time Series".
    4. Divakaruni, Anantha & Zimmerman, Peter, 2023. "The Lightning Network: Turning Bitcoin into money," Finance Research Letters, Elsevier, vol. 52(C).
    5. Son, Dong-Hoon, 2023. "On-demand ride-sourcing markets with cryptocurrency-based fare-reward scheme," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 171(C).
    6. Kim, S. Thomas, 2022. "Is it worth to hold bitcoin?," Finance Research Letters, Elsevier, vol. 44(C).
    7. Rodney J. Garratt & Maarten R. C. van Oordt, 2023. "Why Fixed Costs Matter for Proof-of-Work–Based Cryptocurrencies," Management Science, INFORMS, vol. 69(11), pages 6482-6507, November.
    8. Sakemoto, Ryuta, 2021. "Economic Evaluation of Cryptocurrency Investment," MPRA Paper 108283, University Library of Munich, Germany.
    9. Onur Özdemir, 2022. "Cue the volatility spillover in the cryptocurrency markets during the COVID-19 pandemic: evidence from DCC-GARCH and wavelet analysis," Financial Innovation, Springer;Southwestern University of Finance and Economics, vol. 8(1), pages 1-38, December.

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    More about this item

    Keywords

    Blockchain; cryptocurrency; global games; price volatility;
    All these keywords.

    JEL classification:

    • D04 - Microeconomics - - General - - - Microeconomic Policy: Formulation; Implementation; Evaluation
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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