Decentralizing Money: Bitcoin Prices and Blockchain Security

Abstract

We address the determination of bitcoin prices and decentralized security. Users forecast the transactional and resale values of holdings, pricing the risk of systemic attacks. Miners contribute resources to protect against attackers and compete for block rewards. Bitcoin’s design leads to multiple equilibria: the same blockchain technology is consistent with sharply different price and security levels. Bitcoin’s monetary policy can lead to welfare losses and deviations from quantity theory. Price-security feedback amplifies fundamental shocks’ volatility impact and leads to boom and busts unconnected to fundamentals. We characterize how viability versus fiat currency depends on bitcoin’s relative acceptability and inflation protection.

A Survey of Fintech Research and Policy Discussion

“…Their analysis further shows that POW blockchains dominate in adoption, delegated POS blockchains dominate in scale, and blockchains using nonstandard protocols dominate in security. Pagnotta (2020) documents that the security of any open blockchain should be seen as an economic outcome rather than an embedded property of its blockchain technology. Compared with the POS protocol, the agent updating the blockchain in the POW protocol receives a coin reward.…”

“…Tripling the current network size raises the equilibrium price of bitcoin from $14,200 to $77,627 (a 546 percent increase). Pagnotta (2020) further models the interactions between users and miners, which give rise to multiple self-fulfilling equilibria with distinct price-security levels. In his model, the price-security feedback effects can amplify the volatility impact of fundamental shocks and lead to boom-bust cycles not driven by fundamentals.…”

Money Creation in Decentralized Finance: A Dynamic Model of Stablecoin and Crypto Shadow Banking

“…Law of one price can fail in segmented markets (Makarov and Schoar, 2020). Proof-of-work protocol has innate limits on adoption Hinzen, John, and Saleh (2019), system security risks (Budish, 2018;Pagnotta, 2021), and requires wasteful energy consumption that crowds out other users (Benetton, Compiani, and Morse, 2021). Researchers are active in studying alternative protocols, such as proof-of-stake (e.g., Saleh, 2020;Fanti, Kogan, and Viswanath, 2019).…”

Is It Possible to Forecast the Price of Bitcoin?

“…In management, the focus is more on the "cryptocurrency mania" that risks leading to speculative bubbles, as in Cheng et al [32], Wei and Dukes [33]. Financial practitioners are also concerned about the security of the blockchain (Pagnotta [34]). Quantum computers are posing a serious challenge to the security of the Bitcoin blockchain indeed.…”