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APT-6: Money and Collateral
Bitcoin as Decentralized Money: Prices, Mining, and Network Security
Imperial College Business School
We address the determination and evolution of bitcoin prices in a simple monetary economy that captures the salient features of a decentralized network. Network users forecast the transactional and resale value of bitcoin holdings and consider the risk of a network attack. Miners contribute resources that enhance network security and compete for mining rewards received in units of the same unbacked token. In equilibrium, the overall production of network security and the bitcoin price are jointly determined. We characterize how the network technologies and participants, users and miners, affect the number and dynamic stability properties of equilibria. We find that the relation between bitcoin prices and the supply growth rate is not monotonic: the same price is consistent with different rates. The model’s outcomes demonstrate how intrinsic price–security feedback effects can amplify or moderate the price volatility effect of demand shocks. We find rational patterns of price momentum, and that small and large stochastic bubbles can exist in general equilibrium and show how the probability of bursting decreases with the bitcoin price.
Equilibrium Bitcoin Pricing
1Toulouse School of Economics, Université Toulouse Capitole (TSM-Research); 2HEC Paris; 3McGill University; 4Vrije Universiteit Amsterdam
We offer an overlapping generations equilibrium model of cryptocurrency pricing and confront it to new data on bitcoin transactional benefits and costs. The model emphasizes that the fundamental value of the cryptocurrency is the stream of net transactional benefits it will provide, which depend on its future prices. The link between future and present prices implies that returns can exhibit large volatility unrelated to fundamentals. We construct an index measuring the ease with which bitcoins can be used to purchase goods and services, and we also measure costs incurred by bitcoin owners. Consistent with the model, estimated transactional net benefits explain a statistically significant fraction of bitcoin returns.
Repo rates and the collateral spread puzzle
1University of Zurich, Switzerland; 2Swiss Finance Institute
A puzzling feature of the market for liquidity is that repo rates frequently exceed unsecured rates. This paper offers an explanation by developing a theory where repos are motivated by the need to raise liquidity, there are unsecured borrowing constraints, and liquidity may also be raised by selling securities outright. This generates a constrained-arbitrage link between the repo rate, the (adjusted) expected rate of return of the underlying security, and the unsecured rate. Collateral spreads (unsecured less repo rate) can turn negative if borrowing constraints tighten, unsecured rates spike down, or from a depressed and illiquid security market. Collateral spreads increase in haircuts and liquidity-easing policies. The constrained-arbitrage theory sheds light on the evolution of collateral spreads over time.
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