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The Economics of Cryptocurrencies—Bitcoin and Beyond

Author

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  • Jonathan Chiu
  • Thorsten Koeppl

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.

Suggested Citation

  • Jonathan Chiu & Thorsten Koeppl, 2019. "The Economics of Cryptocurrencies—Bitcoin and Beyond," Staff Working Papers 19-40, Bank of Canada.
  • Handle: RePEc:bca:bocawp:19-40
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Digital Currencies and Fintech; Monetary Policy; Payment clearing and settlement systems;
    All these keywords.

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit
    • L5 - Industrial Organization - - Regulation and Industrial Policy

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