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Cryptocurrencies, Network Effects, And Switching Costs

Author

Listed:
  • William J. Luther

Abstract

type="main" xml:id="coep12151-abs-0001"> Cryptocurrencies are digital alternatives to traditional government-issued paper monies. Given the current state of technology and skepticism regarding the future purchasing power of existing monies, why have cryptocurrencies failed to gain widespread acceptance? I offer an explanation based on network effects and switching costs. In order to articulate the problem that agents considering cryptocurrencies face, I employ a simple model developed by Dowd and Greenaway (1993) (Dowd, K., and D. Greenaway. “Currency Competition, Network Externalities, and Switching Costs: Towards an Alternative View of Optimum Currency Areas.” The Economic Journal, 103(420), 1993, 1180–89). The model demonstrates that agents may fail to adopt an alternative currency when network effects and switching costs are present, even if all agents agree that the prevailing currency is inferior. The limited success of bitcoin—almost certainly the most popular cryptocurrency to date—serves to illustrate. After briefly surveying episodes of successful monetary transition, I conclude that cryptocurrencies like bitcoin are unlikely to generate widespread acceptance in the absence of either significant monetary instability or government support. (JEL E40, E41, E42, E49)

Suggested Citation

  • William J. Luther, 2016. "Cryptocurrencies, Network Effects, And Switching Costs," Contemporary Economic Policy, Western Economic Association International, vol. 34(3), pages 553-571, July.
  • Handle: RePEc:bla:coecpo:v:34:y:2016:i:3:p:553-571
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    File URL: http://hdl.handle.net/10.1111/coep.2016.34.issue-3
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    Citations

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    Cited by:

    1. Andreas Hanl, 2018. "Some Insights into the Development of Cryptocurrencies," MAGKS Papers on Economics 201804, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    2. Pieters, Gina, 2016. "Does bitcoin reveal new information about exchange rates and financial integration?," Globalization and Monetary Policy Institute Working Paper 292, Federal Reserve Bank of Dallas.
    3. William Luther, 2014. "Evenly rotating economy: A new modeling technique for an old equilibrium construct," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 27(4), pages 403-417, December.
    4. repec:kap:revaec:v:30:y:2017:i:3:d:10.1007_s11138-016-0348-x is not listed on IDEAS
    5. Luisanna Cocco & Michele Marchesi, 2016. "Modeling and Simulation of the Economics of Mining in the Bitcoin Market," Papers 1605.01354, arXiv.org.
    6. Pieters, Gina & Vivanco, Sofia, 2017. "Financial regulations and price inconsistencies across Bitcoin markets," Information Economics and Policy, Elsevier, vol. 39(C), pages 1-14.
    7. repec:eee:jeborg:v:141:y:2017:i:c:p:188-195 is not listed on IDEAS
    8. Gina Christelle Pieters, 2017. "Bitcoin Reveals Exchange Rate Manipulation and Detects Capital Controls," 2017 Papers ppi307, Job Market Papers.
    9. repec:eee:quaeco:v:66:y:2017:i:c:p:50-56 is not listed on IDEAS
    10. Walter blocher & Andreas Hanl & Jochen Michaelis, 2017. "Revolutionieren Kryptowährungen die Zahlungssysteme?," MAGKS Papers on Economics 201748, Philipps-Universität Marburg, Faculty of Business Administration and Economics, Department of Economics (Volkswirtschaftliche Abteilung).
    11. repec:jpe:journl:1460 is not listed on IDEAS

    More about this item

    JEL classification:

    • E40 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - General
    • E41 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Demand for Money
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E49 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Other

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