Economics behind cryptocurrency

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Global Agenda The Agenda Weekly A weekly update of the most important issues driving the global agenda. Subscribe today. More on The Digital Economy. Nobel laureate Richard Thaler emphasizes the irrationality in the bitcoin market that has led to the bubble, demonstrating the irrationality with the example of firms that have added the word blockchain to their names which have then had large increases in their stock price.

The extremely high volatility in bitcoin's price also is due to irrationality according to Thaler. Hart cited Christopher Sims 's work showing no intrinsic value to bitcoin.

Heckman compared bitcoin to the tulip bubble. Deaton pointed to bitcoin's use by criminals. Professor Nouriel Roubini of New York University has called bitcoin the "mother of all bubbles", [69] [70] writing that the underlying blockchain technology has "massive obstacles standing in its way", including a lack of "common and universal protocols" of the kind that enabled the early Internet.

Early claims that bitcoin was a bubble focused on the lack of any intrinsic value of bitcoin. He stated "You really have to stretch your imagination to infer what the intrinsic value of Bitcoin is. I haven't been able to do it. In Greenspan compared bitcoin to the Continental dollar , which ultimately collapsed. He said "Humans buy all sorts of things that aren't worth anything. People gamble in casinos when the odds are against them. It has never stopped anybody. Former Fed Chair Ben Bernanke in and outgoing Fed Chair Janet Yellen in have both expressed concerns about the stability of bitcoin's price and its lack of use as a medium of transactions.

Louis , stated, "Is bitcoin a bubble? Yes, if bubble is defined as a liquidity premium. At least then you got a tulip [at the end], now you get nothing. American investor Warren Buffett warned investors about bitcoin in , "Stay away from it. It's a mirage, basically. He believes that bitcoin is a non-productive asset. Buffett's close associate Charlie Munger is even more direct in his disdain. Trading cryptocurrencies is "just dementia" according to Munger. Bitcoin is "worthless" and a "turd".

Did I make myself clear? There is nothing to support bitcoin except the hope that you will sell it to someone for more than you paid for it. George Soros , answering an audience question after a speech in Davos, Switzerland , in , said that cryptocurrencies are not a store of value but are an economic bubble.

Nevertheless, they may not crash due to the rising influence of dictators trying to "build a nest egg abroad". James Chanos , known as the "dean of the short sellers", believes that bitcoin and other cryptocurrencies are a mania and useful only for tax avoidance or otherwise hiding income from the government. Bitcoin "is simply a security speculation game masquerading as a technological breakthrough in monetary policy".

Two lead software developers of bitcoin, Gavin Andresen [85] and Mike Hearn, [86] have warned that bubbles may occur. On 13 September , Jamie Dimon referred to bitcoin to as a "fraud", [87] comparing it to pyramid schemes , and stated that JPMorgan Chase would fire employees trading while the company released a report critical of the cryptocurrency.

Some journalists, [92] economists, [93] [94] and the central bank of Estonia [95] have voiced concerns that bitcoin is a Ponzi scheme. In , Eric Posner , a law professor at the University of Chicago, stated that "a real Ponzi scheme takes fraud; bitcoin, by contrast, seems more like a collective delusion. In billionaire Howard Marks referred to bitcoin as a pyramid scheme.

Zero Hedge claimed that the same day Dimon made his statement, JP Morgan also purchased a large amount of bitcoins for its clients.

Financial journalists and analysts, economists, and investors have attempted to predict the possible future value of bitcoin. In April , economist John Quiggin stated, "bitcoins will attain their true value of zero sooner or later, but it is impossible to say when".

In December , finance professor Mark T. The "death" of bitcoin has been proclaimed numerous times. Forbes magazine declared bitcoin "dead" in June , [] followed by Gizmodo Australia in August Peter Greenhill, Director of E-Business Development for the Isle of Man, commenting on the obituaries paraphrased Mark Twain saying "reports of bitcoin's death have been greatly exaggerated".

Some economists have responded positively to bitcoin while others have expressed skepticism. Velde, Senior Economist at the Chicago Fed , described it as "an elegant solution to the problem of creating a digital currency".

Louis , stated that bitcoin is a threat to the establishment, which he argues is a good thing for the Federal Reserve System and other central banks , because it prompts these institutions to operate sound policies. Free software movement activist Richard Stallman has criticized the lack of anonymity and called for reformed development.

Marcus calls bitcoin a "great place to put assets" but claims it will not be a currency until price volatility is reduced. In November , three US government officials testified at senate hearings that "Bitcoin has legitimate uses".

According to The Washington Post , "Most of the other witnesses echoed those sentiments. Most bitcoin transactions take place on a cryptocurrency exchange , rather than being used in transactions with merchants. Prices are not usually quoted in units of bitcoin and many trades involve one, or sometimes two, conversions into conventional currencies.

In and bitcoin's acceptance among major online retailers included only three of the top U. Bitcoin is "not actually usable" for retail transactions because of high costs and the inability to process chargebacks , according to Nicholas Weaver, a researcher quoted by Bloomberg. High price volatility and transaction fees make paying for small retail purchases with bitcoin impractical, according to economist Kim Grauer. Bitcoin started to be accepted also for real estate payments in late The first recorded sale of a house in exchange for bitcoin happened in September , when Texas based Kuper Sotheby's International Realty brokered the deal using bitpay.

Two months later, a first recorded sale of apartment in the world and first real estate property in Europe was sold for bitcoin in November in the Czech republic.

The Czech real estate agency HOME Hunters brokered a deal of a three-room apartment for a Russian buyer without using a payment service providers at all. Some U. Merchants accepting bitcoin, such as Dish Network, use the services of bitcoin payment service providers such as BitPay or Coinbase. When a customer pays in bitcoin, the payment service provider accepts the bitcoin on behalf of the merchant, directly converts it, and sends the obtained amount to merchant's bank account, charging a fee of less than 1 percent for the service.

Due to the design of bitcoin, all retail figures are only estimates. Bitcoin companies have had difficulty opening traditional bank accounts because lenders have been leery of bitcoin's links to illicit activity. The request was motivated by oil company's goal to pay its suppliers. Some Argentinians have bought bitcoins to protect their savings against high inflation or the possibility that governments could confiscate savings accounts.

Other methods of investment are bitcoin funds. The first regulated bitcoin fund was established in Jersey in July and approved by the Jersey Financial Services Commission. Forbes named bitcoin the best investment of To improve access to price information and increase transparency, on 30 April Bloomberg LP announced plans to list prices from bitcoin companies Kraken and Coinbase on its , subscription financial data terminals. The number of bitcoin millionaires is uncertain as people can have more than one wallet.

Bitcoin is useful for crowdfunding. He was shown by local TV company with a broadsheet "Hi mom, send bitcoins". The decentralization of money offered by virtual currencies like bitcoin has its theoretical roots in the Austrian school of economics such as subjective theory of value , [] [ unreliable source? Bitcoin appeals to tech-savvy libertarians , because it so far exists outside the institutional banking system and the control of governments. Bitcoin's appeal reaches from left wing critics, "who perceive the state and banking sector as representing the same elite interests, Jump to content Navigation.

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Price of bitcoin, [b] logarithmic scale [34] [35]. Annual volatility of bitcoin [36]. Further information: Cryptocurrency bubble.

In securities , the analogical form has been described as book entry , paperless , digital , electronic , uncertificated or dematerialized. Retrieved 3 May Retrieved 28 April The Economist. Retrieved 21 October Mercatus Center. George Mason University. Retrieved 22 October The New York Times. Retrieved 6 May A type of digital cash, bitcoins were invented in and can be sent directly to anyone, anywhere in the world.

Daily Tech. Archived from the original on 20 January Retrieved 30 September The New Yorker. Retrieved 22 December Standards vary, but there seems to be a consensus forming around Bitcoin, capitalized, for the system, the software, and the network it runs on, and bitcoin, lowercase, for the currency itself.

The Guardian. Retrieved 8 July USA Today. Retrieved 25 May Retrieved 13 January Money from nothing. Chronic deflation may keep Bitcoin from displacing its rivals". Retrieved 25 March Retrieved 3 January Bloomberg L. Retrieved 31 December Retrieved 8 August Financial Crimes Enforcement Network. Retrieved 1 June Sars is coming for you". Business Insider. Retrieved 22 May Library of Congress.

June Retrieved 14 August Retrieved 11 April The central bank will keep watching risks from Bitcoin, which is fundamentally not a currency but an investment target, Sheng Songcheng, head of the monetary authority's statistics department, told reporters in Beijing on Jan.

Bloomberg View. Bloomberg LP. A principal knock on bitcoins has been the claim that they are inherently insecure. The principal defense has been that they are as secure as "real" currency. The Wall Street Journal. Retrieved 27 January Archived from the original on 13 April February Retrieved 28 August Cambridge University. Archived from the original PDF on 10 April Retrieved 14 April Business Wire. Retrieved 5 November Retrieved 4 February Retrieved 31 October Consumer Financial Protection Bureau.

August Retrieved 10 July Archived from the original on 3 November Retrieved 2 November Retrieved 24 October Retrieved 13 October Boston University. Retrieved 11 November Social Science Research Network. SSRN There is no price stabilization mechanism. Retrieved 7 January Retrieved 15 November Casey 30 April Retrieved 23 March It's 'the Harlem Shake of currency' ". Retrieved 2 May The Washington Post. Retrieved 10 January Archived from the original on 7 February Journal of Monetary Economics.

S2CID Archived from the original on 16 January Retrieved 16 January Archived from the original on 18 January Retrieved 18 January Bank of Canada Staff Working Paper. Retrieved 20 April Retrieved 22 April Electronic Commerce Research and Applications. Here's what Warren Buffett is saying". Archived from the original on 13 January Globe and Mail.

Bloomberg News. Archived from the original on 9 June South China Morning Post.

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Since the inception of Bitcoin in , the economic impact of cryptocurrency has been both overt and subtle.

Now in its eleventh year of existence, the digital or virtual money that takes the form of tokens or coins has established itself as a viable currency and form of investment, and the economic impact of cryptocurrency is evident in a number of areas in national and global communities.

As of January , more than 2, cryptocurrencies exist and nearly Still a youthful currency, the economic impact of cryptocurrency is expected to continue to be a relevant discussion amongst economists and investors alike.

Here are some of the ways the economic impact of cryptocurrency has manifested. Blockchain, the underlying technology behind cryptocurrency, has slowly moved into the mainstream. Many experts predict that the use of this technology in other markets can potentially unlock billions of dollars for those markets.

So far, Blockchain technology has proved to have impacted the following business practices in several industries:. Messaging apps have used the technology in favor of deals with private investors. Car leasing and sales can use Blockchian to streamline car leasing.

Cloud computing can use Blockchain to execute smart contracts and resist hacking. Government and public records can use Blockchain to reduce paperwork and fraud while increasing accountability. Companies like Kodak intend to launch their own cryptocurrency to make sure photographers are paid properly.

The rise of cryptocurrency has brought with it an entire industry that is dedicated to supervising cryptocurrency exchanges that take place throughout the world. While some early adopters have become rich quickly, others have developed companies that rely on trading as their source of income.

The number of jobs in the Blockchain industry increased from just over 1, in to over 4, in Software engineers have been the most directly sought after professionals for the cryptocurrency industry.

And while this job market has fluctuated in the past few years, interest in these professions have not faltered. As cryptocurrency continues to be legalized outside of the western world, we can expect to see more global investments and job creation within the field. Since the s, confidence in U.

And in countries where the domestic currency is constantly fluctuating, causing living conditions to plummet, cryptocurrency can be used to circumvent these situations. Cryptocurrency is a wholly utilitarian practice in which peers oversee each transaction without the oversight of the government.

They are financially disadvantaged and often must resort to dangerous lending practices. Interestingly, a large number of this population possess a cell phone, and because cryptocurrencies can be transacted through mobile applications, cryptocurrency can easily become a viable option for them. Aside from Bitcoin in its current state, transaction costs for most cryptocurrency users are minimal to none.

Because cryptocurrencies and Blockchain are decentralized and do not require investment into physical property, there are no extra costs that users are expected to account for. This means, unlike a branch of a bank, there is no need to pay utility bills, rental property, or employee wages.

Little to no transaction costs also encourages trust in the system of cryptocurrency and in turn sees more use in financial tools, transactions, and a closer global economy. Blockchain technology and cryptocurrency transactions are automated, digitized, and tracked on a ledger that can never be manipulated by people, companies, or governments. Not only does this bring power and freedom to the people, but it also diminishes the risk of fraud and corruption.

This is particularly beneficial for underdeveloped countries and government-oppressed peoples. The utilitarian structure of cryptocurrencies allows these people to invest and transact with a global economy, which can boost their own economy and quality of life. With its decentralized format, cryptocurrency is a global economy in which all users exchange currency regardless of their citizenship.

This is particularly profound for entrepreneurs who are no longer subject to a national audience but one that is international with whom funds can be exchanged without the hassle of exchange rates and international law. In fact, there are cryptocurrency companies that assist business owners in Africa make financial transactions with European, American, and Asian companies with the intention of creating financial coverage and financial liberation through exchanges worldwide.

In an increasingly digitized world, the social need to communicate across borders is now manifesting itself in financial needs, and traditional financial institutions are not able to provide this as well as cryptocurrencies can.

In time, entrepreneurs can assist in the opportunities to invest in, save, and send money across borders, in turn reframing global business practices.

Knows buying one bitcoin can

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Cryptocurrency is a wholly utilitarian practice in which peers oversee each transaction without the oversight of the government. They are financially disadvantaged and often must resort to dangerous lending practices. Interestingly, a large number of this population possess a cell phone, and because cryptocurrencies can be transacted through mobile applications, cryptocurrency can easily become a viable option for them.

Aside from Bitcoin in its current state, transaction costs for most cryptocurrency users are minimal to none. Because cryptocurrencies and Blockchain are decentralized and do not require investment into physical property, there are no extra costs that users are expected to account for.

This means, unlike a branch of a bank, there is no need to pay utility bills, rental property, or employee wages. Little to no transaction costs also encourages trust in the system of cryptocurrency and in turn sees more use in financial tools, transactions, and a closer global economy. Blockchain technology and cryptocurrency transactions are automated, digitized, and tracked on a ledger that can never be manipulated by people, companies, or governments.

Not only does this bring power and freedom to the people, but it also diminishes the risk of fraud and corruption.

This is particularly beneficial for underdeveloped countries and government-oppressed peoples. The utilitarian structure of cryptocurrencies allows these people to invest and transact with a global economy, which can boost their own economy and quality of life. With its decentralized format, cryptocurrency is a global economy in which all users exchange currency regardless of their citizenship.

This is particularly profound for entrepreneurs who are no longer subject to a national audience but one that is international with whom funds can be exchanged without the hassle of exchange rates and international law. In fact, there are cryptocurrency companies that assist business owners in Africa make financial transactions with European, American, and Asian companies with the intention of creating financial coverage and financial liberation through exchanges worldwide.

In an increasingly digitized world, the social need to communicate across borders is now manifesting itself in financial needs, and traditional financial institutions are not able to provide this as well as cryptocurrencies can. In time, entrepreneurs can assist in the opportunities to invest in, save, and send money across borders, in turn reframing global business practices.

Big businesses are taking over many different markets, and supporting small businesses is now more critical than ever before. Small businesses are not only important, but they allow customers to support a good, genuine company and a great cause. Cryptocurrency can provide several benefits to small businesses. The low transaction fees that come with cryptocurrency are one of the biggest reasons many establishments have opted to accept the digital currency. While traditional forms of currency, especially credit and debit cards, can cost businesses high processing fees, cryptocurrency takes away nearly everything.

In addition to low transaction costs, crypto transactions can happen almost instantly. While debit and credit transactions may take a few days to process fully, a crypto transaction is fast and efficient. Furthermore, there is no need for a third party in crypto transactions meaning the transactions can happen quickly. Another great benefit of accepting crypto is that it can open small businesses to broader audiences. Due to crypto being a universal, international currency, it can be used by anyone, enabling small companies to serve global customers.

Additionally, with crypto being popular among younger individuals, accepting cryptocurrency can allow a small business to appeal to a younger audience. Accepting crypto enables a business to reach a broader range of customers and demonstrate its ability to innovate and progress as a company. Crypto is still a new commodity, making it the perfect time for businesses to adopt it. Many traditional investors have chosen to invest in cryptocurrency. The digital currency has many benefits for individuals looking to invest in something other than a conventional stock.

Crypto has been making a huge impact all over the world. Some individuals say that it has the potential to take over the world the way the internet did in the nineties. Cryptocurrency cannot be controlled by a government entity, which draws many investors to buy tokens of their own. Currency that the government issues, also known as fiat money, has the potential to depreciate over time, but cryptocurrency does not. Due to most cryptocurrencies having a limited supply, no governmental agency can lower its value through inflation.

In addition, the government can't tax or take crypto tokens without permission. That, in essence, is the process behind proof-of-work. What is a zero knowledge proof zkp? ZKP basically means that a person A can prove to person B that they have knowledge of a certain piece of information without telling them what that knowledge specifically is.

In this example, the person A is the prover and the person B is a verifier. In cryptography, this becomes especially useful because this helps in proving an extra layer of privacy for the prover.

In this example, the prover P is saying to the verifier V that they know the password of the secret door at the back of the cave and they want to prove it to the verifier without actually telling them the password. So this is what it looks like:. The Prover goes down any of the paths A and B, suppose they initially decide to go through path A and reach the secret door at the back. When they do so, the verifier V comes in at the entrance, with no knowledge of which path the prover actually took and declares that they want to see the prover appear from path B.

In the diagram, as you can see, the prover does indeed appear in path B. But what if this was dumb luck? So, to test the validity, the experiment is done multiple times. Many blockchain based technologies are using Zk-Snarks, in fact, even Ethereum in its Metropolis phase is planning to bring in Zk-Snarks and add it to its arsenal. They can be used to generate a proof of statement to verify each and every transaction by just taking a simple snapshot of each transaction which is enough to prove to the receiving side that a transaction was done without revealing the transaction itself.

So these are some of the important cryptographical functions which are being used by the blockchain. Now let us look at the second pillar, Economics. Like we mentioned in the beginning, the place where blockchain differs from other decentralized peer-to-peer system is that it gives its users financial and economic incentives to get some work done. Like with any solid economic system, there should be incentives and rewards for people to get work done, similarly, there should be a punishment system for miners who do not act ethically or do not do a good job.

We will see how the blockchain incorporates all these basic economic fundamentals. Cryptocurrencies have value because of the same reason that money, in general, has value, trust.

So when a given commodity is given value, the value changes in accordance with one of the oldest rules in economics, called Supply and Demand. This is the supply-demand graph and one of the most common things that you will see as in economics. As you can see, the demand for the commodity is in an inverse proportion with its supply. The spot where the two graphs meet is the equilibrium i. The supply of bitcoins is fixed at 21 million. Since the total number is fixed there are several things that need to be considered when it comes to the supply of bitcoin.

Because of this, certain regulations need to be made to make sure that bitcoins become progressively harder to mine. If these steps are not taken, the miners will mine indiscriminately, pumping out the remaining bitcoins and putting it in the market, decreasing its overall worth. With these two factors and the fact that mining has become a lot more specialized process which includes humongous investment, the entire process makes sure that the supply of bitcoins in the market is kept at check.

And this is true for all cryptocurrencies, using proof of work, as well. So how does an unregulated, decentralized peer to peer system remain honest? Miners have a lot of power and they can easily commit crimes and get away with it. So how do you keep a decentralized system of humans honest? The answer lies in one of the most fundamental economic ideas: Game Theory. Game theory is basically the study of strategic decision-making.

Making decisions which make the most sense to you, keeping in mind the decision of the competitors is basically what game theory is all about. The numbers are units of payoffs that a person will get upon taking or not taking an action. So the optimal strategy for B is to take action. A has a payoff of 0 for not taking action and a payoff of 4 for taking action.

So the best way for A is to take action. Now, what is the application of the Nash Equilibrium in the blockchain? Consider the above blockchain. The blue blocks 1,2 and 3 are part of the main chain. Now suppose a malicious miner mines a block 2A and is attempting a hardfork for his own financial gains. What is stopping the other miners from joining him and mining on the new block?

Well, the miners have a very hard and fast rule, any block that is mined on an invalid block is not considered a valid block. So, the other miners will simply ignore the invalid block and keep mining on the old chain anyway. Remember, all currency works on trust and perceived value, so the currency that the malicious miner may mine from the new block will not be considered of any value at all.

And remember, mining is a very expensive process, so why will anyone waste so much resource on a block that may or may not even be considered valid?

Now you may be thinking, what if a lot of miners decide to join the new miner and mine on the new block? The problem with that is that the blockchain network is a huge and widely distributed network wherein communication and coordination is next to impossible.

Keeping that in mind, a coordinated attack like that on the blockchain is infeasible. Most miners will simply choose the route where they get a maximum payoff, and this way the Nash Equilibrium of the main chain is maintained. Like with any efficient economic systems, good actions should be rewarded and negative actions should be punished. How does punishment work in a game theory model? Imagine a payoff matrix where the payoff for the participants is high but the implication on the society, in general, is very high.

Suppose there are two people A and B and they are both about to commit a crime. Now according to the matrix, the payoff for both of them is high when they commit a crime so their Nash Equilibrium lies in both committing a crime. Now while this does make sense logically, the implications on the society, in general, is very bad. Humans, more of than not , are motivated by personal greed and not everyone is altruistic.

If this were to hold true, the world will be a terrible place to live in. So, how did humans counteract this? By introducing the concept of punishment. Suppose we have a system where for every Now, punishment is expensive, a utility of So what is the incentive for society to join the punishment game?

The way this question was answered was by making punishment mandatory for everyone i. An example of this is a tax-driven police force. The police can punish the perpetrators but a utility in the form of tax is taken from the public. In a blockchain, any miners who are not following the rules and mining illegal blocks are punished by having their privileges taken away and risk social ostracization.

The punishment becomes even more severe when proof-of-stake is involved more on this later. By using simple game theory and punishment system, the miners are kept honest. When a miner s successfully mines a block, they become the temporary dictator of that block. It is completely their jurisdiction as to which transactions go in the block and the speed of the said transactions.

For the transactions to be included, they can charge a transaction fee. This incentivizes the miners because they get additional financial rewards OVER the reward they gain from mining a new block anyway 25 BTC in bitcoin and 5 Eth in Ethereum.

In order to make the system fair and to make sure that not the same miners get to mine new blocks and collect the rewards every single time, the mining difficulty level is adjusted periodically. This makes sure that the miners who get to mine a new block is completely random. Over the long run, mining is a zero sum gain, in other words, the profits that a miner gets from mining a new block eventually gets adjusted because of the costs of mining.

In order to understand how this attack works we must define some terms beforehand. The participants may form groups but at no time is the group big enough to become a majority. Coordinated choice model: This is a model where all the participants coordinate because of a common incentive. Now it is assumed that the blockchain is an uncoordinated model, but what if there is an incentive for the miners to do an action which goes against the integrity of the blockchain?

What if there is a bribe involved to make the miners take a particular action? This is where the bribing attacker model comes in. Imagine an uncoordinated model. Now, what if an attacker enters the system and incentivizes the miners to coordinate with each other after giving them a bribe? This new model is called a bribing attacker model. In order to successfully bribe the system, the attacker must have two resources:.

For reference check out this table:. Imagine a simple game such as an election. Now imagine, that a briber enters the system and lays down this condition to an individual. What do you think the players will do then? Of course, they are going to vote to get a guaranteed payoff. Now, this is where things get interesting. However, in this situation, since everyone is voting, the Nash equilibrium shifts to:. It is a huge win-win scenario for the briber and this has heavy implication on the blockchain especially in a proof-of-work system.

The solution to this form of incentive driven attack lies in proof of stake. In this system, the miners have to put up a portion of their personal fortune and invest it in future blocks. As an economic system, this is much better because the punishment in it is way more severe.

You have a part of your fortune invested inside a block which is to be added in the main chain. Now a briber comes and tells you that you can get an extra payoff if you make your block join the main chain. For a miner, once that they have invested a stake, it is a no brainer for them to continue in the main chain and not to get involved in any malicious activities. So as you can see, cryptography and economics have combined in a very beautiful and intricate manner to create the blockchain technology.

The growth that it has experienced over the last few years is staggering and it is only going to get better and more widely used. However, before you do this, I suggest you really educate yourself about both the risks and possible rewards of trading.

Its coin prices are fair, and not too far off market value. It offers several altcoins as well, and I believe that they are planning to implement even more sooner. Instead, read about it first, and determine whether you actually want to buy it, or whether you would rather wait, or whether it is even the right coin for you.

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