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

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  • Podhorsky, Andrea

    (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.

Suggested Citation

  • Podhorsky, Andrea, 2019. "Bursting the Bitcoin Bubble: Assessing the Fundamental Value and Social Costs of Bitcoin," ADBI Working Papers 934, Asian Development Bank Institute.
    • Handle: RePEc:ris:adbiwp:0934
    as

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    References listed on IDEAS

    as
    1. Yukun Liu & Aleh Tsyvinski, 2018. "Risks and Returns of Cryptocurrency," NBER Working Papers 24877, National Bureau of Economic Research, Inc.
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    4. Brunnermeier, Markus K. & Oehmke, Martin, 2013. "Bubbles, Financial Crises, and Systemic Risk," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1221-1288, Elsevier.
    5. Peter C. B. Phillips & Shuping Shi & Jun Yu, 2015. "Testing For Multiple Bubbles: Limit Theory Of Real‐Time Detectors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 56, pages 1079-1134, November.
    6. Evans, George W, 1991. "Pitfalls in Testing for Explosive Bubbles in Asset Prices," American Economic Review, American Economic Association, vol. 81(4), pages 922-930, September.
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    More about this item

    Keywords

    bitcoin; digital coins; Bitcoin protocol; cryptocurrency; bitcoin bubble;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • G00 - Financial Economics - - General - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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