Some simple Bitcoin economics

That is a new paper by Linda Schilling and Harald Uhlig, here is the abstract:

How do Bitcoin prices evolve? What are the consequences for monetary policy? We answer these questions in a novel, yet simple endowment economy. There are two types of money, both useful for transactions: Bitcoins and Dollars. A central bank keeps the real value of Dollars constant, while Bitcoin production is decentralized via proof-of-work. We obtain a “fundamental condition,” which is a version of the exchange-rate indeterminacy result in Kareken-Wallace (1981), and a “speculative” condition. Under some conditions, we show that Bitcoin prices form convergent supermartingales or submartingales and derive implications for monetary policy.

In this framework, I would attribute the volatility of the recent Bitcoin price to a) sometimes being in the speculative equilibrium or uncertainty about such, b) regulatory uncertainty, and c) uncertainty about the hedging or store of value properties of Bitcoin and other cryptoassets.  If you are interested in other considerations, here is a good Jimmy Song essay on why Bitcoin might be special.  And see this paper by Garratt and Wallace, though unlike with Schilling and Uhlig I am less sure how they are modeling the black/gray market uses for Bitcoin as a transactions medium.


Jimmy Song wrote some things that are simply untrue, such as:

"It’s important to remember here that alternatives to Bitcoin have been proposed since 2011 and none of them have even come close to displacing Bitcoin in terms of price, usage or security."

Regarding price, Ethereum has gotten as high as 85% of the BTC market cap last year, and as high as 65% this year. Ethereum also does everything Bitcoin does better than Bitcoin and far more, and has a lot more transactions per day than Bitcoin does. There is every reason to believe that as Ethereum continues to vacuum up network effects and adds more functionality, it will eventually surpass the Bitcoin market cap, permanently.

If we've learned anything about cryptos last year, it's that price is no indicator of value. This year isn't looking much better. Another thing we learned is that transaction volume can be manipulated so I wouldn't place high value on that information.

Jimmy does mention Ethereum specifically, you might address the tangible problems he raises.

> "Ethereum also does everything Bitcoin does better than Bitcoin and far more, and has a lot more transactions per day than Bitcoin does. There is every reason to believe that as Ethereum continues to vacuum up network effects and adds more functionality, it will eventually surpass the Bitcoin market cap, permanently.

You do not understand what Bitcoin is about nor what Ethereum is about if you believe this.

How can you compare a chain that forks if governance by one centralized actor decides it is so, versus a chain where, relative to the decisions made in forking on the other chain, are tiny yet take years to move through? The latter, for one of the chains, is a feature, not a bug. For the other chain, it would be the other way around.

"More functionality" is a bug, not a feature, for a global, uncensorable (internet) money. The base layer is meant to be a dumb and slow pipe.

If you were correct, the long-term crypto / BTC ratio would not be down, down, down.

Obviously, functionality and actual use matters, a lot, or Ethereum would not be knocking on the door of a market cap swap with Bitcoin.

Should have written BTC/Crypto ratio.

So, the paper covers bitcoin forking and its implications, right?

I have been investing in bitcoin since December 2017, both short and long. I have been studying past evolution of bitcoin prices and I believe there is substantial seasonality in bitcoin's price. For instance March was a really bad month for bitcoin, but that would not be a surprise if you would have looked at data from March 2013 to 2017, since pretty much every March is a bit of a disaster. Also there seem to be some periods of the month where it is very likely that bitcoin will fall (example: 6-9,22). In particular the 22nd of the month is since July 2017, without a exception always a negative day for bitcoin. Is this evidence of price manipulation? Or is this simply a "self-fulfilling prophecy? Or could it be just a coincidence?

"Or could it be just a coincidence?"

This. Statistically, you should expect to have asymmetries. Indeed, symmetric data is generally an indication of manipulation.

I don't believe this kind of price movements are just a coincidence and I wouldn't be surprised at all if in a few months/years people would find evidence of price manipulation, however I think "self fulfilling prophecy" could also be an explanation.

I don't own any crypto. The kids do. They respond to falls with "whataver." If (and I'm not saying this has to be the case) they generalize to the population, the bubble was millennials dropping non-crucial amounts of cash on a meme.

And so it becomes a lesson without being a genuine hit to the economy.

What are the implications of this for the pricing of tulips circa 1636-37?

As of this comment, Bitcoin is $6,740 US dollars. Is it a long bet on the significant decline of the USD? Holy moly, The Happening is happening--alert the Austrians. ! But I don't see a lot of people out there buying a used car with two Bitcoins. Maybe they are.

I didn't purchase the Schilling paper. I did look up martingale convergence theorem, but mathematical analysis of past prices doesn't tell us much of anything.

Song says it's scarcity enforced by decentralization which is a good explanation--not too popular with the Federal Reserve's economists I'm sure--but still doesn't address the fundamentals. Why is one bitcoin worth 5 times an ounce of gold?

The Garratt paper seems the most honest: "The value of bitcoin depends upon self-fulfilling beliefs that are hard to pin down."

I say Bubble and randomness.

Here is a fun read about Michael Novogratz:

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