The Economics of Cryptocurrencies – Bitcoin and Beyond∗

A general equilibrium monetary model is developed to study the optimal design of a cryptocurrency system based on a blockchain. The model is then calibrated to Bitcoin transaction data to perform a quantitative assessment of the scheme. We formalize the critical elements of a cryptocurrency: the blockchain to keep a history of transactions, the distributed updating of information and consensus through competition for such updating. We show that, unlike cash, a cryptocurrency system does not support an immediate, final settlement. In addition, the current Bitcoin scheme generates a welfare loss of 1.4% of consumption. Such loss can be lowered substantially to 0.08% by adopting the optimal policy which reduces mining and relies on money growth rather than transaction fees to finance mining rewards. The efficiency can potentially be improved further by adopting an alternative consensus protocols such as the proof-of-stake. A key economic feature of a cryptocurrency system is that mining is a public good, while double spending to defraud the cryptocurrency depends on individual incentives to reverse a particular transaction. As a result, a cryptocurrency works best when the volume of transactions is large relative to the individual transaction size (e.g., as in a retail payment system).