Cryptocurrency Value Formation: An Empirical Analysis Leading to a Cost of Production Model for Valuing Bitcoin

This paper aims to identify the likely source(s) of value that cryptocurrencies exhibit in the marketplace using cross sectional empirical data examining 66 of the most used such 'coins'. A regression model was estimated that points to three main drivers of cryptocurrency value: the difficulty in 'mining 'for coins; the rate of unit production; and the cryptographic algorithm employed. These amount to relative differences in the cost of production of one coin over another at the margin, holding all else equal. Bitcoin-denominated relative prices were used, avoiding much of the price volatility associated with the dollar exchange rate. The resulting regression model can be used to better understand the drivers of relative value observed in the emergent area of cryptocurrencies. Using the above analysis, a cost of production model is proposed for valuing bitcoin, where the primary input is electricity. This theoretical model produces useful results for both an individual producer, by setting breakeven points to start and stop production, and for the bitcoin exchange rate on a macro level. Bitcoin production seems to resemble a competitive commodity market; in theory miners will produce until their marginal costs equal their marginal product.