Speculation And The Price Of Virtual Currency

By | January 13, 2022

But that prompted a huge drop in per-coin value from more than $17 to $0.01 because there weren’t enough buyers at the higher price. Read more about DRGN to BTC here. Hackers and members of the underground like Bitcoins because transactions involving them are almost untraceable, yet can be carried out between computers. That has proved both a blessing and a curse, though, after one user discovered in June that his computer had been hacked and 25,000 Bitcoins – then worth almost $500,000 – had been removed from the “wallet.dat” file BTC to USD

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The volatility of the exchange rate of bitcoin has decreased over time, but it remains high. As the transactional demand for virtual currency increases, our model predicts that the exchange rate will become less sensitive to the impact of shocks to speculators’ beliefs and their decisions to participate in the virtual currency market. If correct, the excessive exchange rate volatility of virtual currencies such as bitcoin will not remain prohibitively high in the long run. In this case, widespread transactional usage and lower price volatility would go hand-in-hand. This reduces the number of virtual currency units necessary to facilitate any given dollar amount of real transactions. This frees up virtual currency units that can now be held by speculators, which implies a partial adjustment in the quantity domain instead of an adjustment in prices.

Speculation And The Price Of Virtual Currency

This is because speculators experience a more elastic supply of virtual currency when the transactional usage of virtual currency is higher. Intuitively, the adjustment to a new equilibrium after an increase in speculative demand will occur partially in the price, and partially in the quantity, domain. Here the size of the speculative position is roughly proxied by the number of bitcoins that will remain dormant for an extended period . Economic theory, such as buffer stock models, suggests that consumers and merchants do not instantly adjust their positions to their liquidity needs in response to fluctuations. This suggests that a strongly smoothed version of the orange line, such as the black line, may provide an even better indication of the equilibrium exchange rate in the absence of speculation. The model predicts a steep increase in the exchange rate due to speculation when a potentially successful virtual currency is introduced.

We formally adopt Fisher’s idea that speculators may effectively regulate the money supply into the quantity equation . Our model combines an investor’s portfolio model with a payment network model to determine the drivers of speculation. This column explains a theoretical framework to link exchange rates to currency creation, speculative behaviour, and real growth in goods and services transactions. It suggests that the exchange rate will be less sensitive to speculators’ beliefs when a virtual currency becomes more established as a means of payment.

Exchange Rate Volatility

The currency can therefore be used in a decentralised system while preventing ‘double spending’ (Huberman et al. 2017, Brunnermeier and Abadi 2018). Transactions in virtual currency occur outside the scope of financial institutions, and make possible direct payments between merchants and consumers across large distances. However, commentators had suggested that the biggest weakness about Bitcoin was that although many were being produced, their apparent value was based on small numbers of transactions within a small group – which is not an effective model for a viable currency. Although there are a number of websites that accept Bitcoins in exchange for real-world goods and services, it is very difficult to measure how many transactions have occurred. Economists have shown considerable interest in what causes the turbulent exchange rates of virtual currencies (Gandal et al. 2017, Garratt and Wallace 2018, Biais et al. 2018). On the consumer side of the market, private benefits may be large for those who frequently execute cross-border payments such as remittances.

Consumers who value privacy and anonymity more, and those who are technologically more adept, are likely to gain from using virtual currencies. With the value of Bitcoins dropping so low, and the computing power required to produce them growing steadily, it is becoming uneconomic to generate more except through the use of hacked computers in “botnets”. Although there has been anecdotal evidence of their being used to generate Bitcoins, many botnets are hired out on a commercial basis to send spam or host phishing websites – and that may be more profitable, directly, than creating the currency. The value of Bitcoins, the “cryptocurrency” that some had thought would take over from more traditional currencies, has plummeted across exchanges – to a level where it costs more to “mine” them than they are worth. On the other side of the market, large merchants may experience considerable private benefits from avoiding high fees charged by traditional payment providers. Internet stores may gain as well, since they face relatively low implementation costs when accepting virtual currencies. That, in turn, makes it hard to calculate how many people are using them. But graphs on a Belgian site that tracks the computational power being applied to Bitcoin mining suggest that the amount dedicated to it peaked in mid-August, and has fallen since then. That would indicate that fewer people are trying to mine Bitcoins – even though only one-third of those that could be discovered have been.

In anticipation of future transactional usage, investors rationally choose to hoard these currencies. This drives up the exchange rate even before widespread transactional usage emerges. The orange line is based on our model, and shows a downward correction of the actual exchange rate to account for virtual currency held by speculators. Virtual currency not only represents the emergence of a new form of currency but also a new payment technology for purchasing goods and services (Böhme et al. 2015, Dwyer 2015). The key innovation is cryptographic identification in a distributed ledger – the blockchain – that allows payment tracking.

The larger the initial dollar amount of real transactions using virtual currency, the larger the amount of virtual currency that will be freed up for any given increase in the exchange rate, and, hence, the larger the adjustment in the quantity domain. This means that adjustments in the price of virtual currency due to shocks in speculative demand will be lower when transactional demand is higher. Bitcoin, the best-known virtual currency, continues to attract attention from the financial press, economists, central banks and governments. This was fuelled by the explosion and volatility of the bitcoin exchange rate by the end of 2013. Bitcoins had begun trading for less than $0.10 in 2010 but, by November 2013, the exchange rate was higher than $1,000 per bitcoin. During 2014 the exchange rate fell, settling at around $250 in March 2015, after which it surged to almost $20,000 by the end of December 2017. The ‘bubble-like’ behaviour may be a concern for the feasibility of bitcoin as a currency .

Bitcoins, which are in fact just very long strings of numbers, are “produced” by a processor-intensive calculation which requires increasing amounts of computing power to create each one. There is also a limit on how many can ultimately be produced, according to the algorithm which generates them. The black line in Figure 1 gives a first impression of what the exchange rate of bitcoin might have looked like in the absence of speculation. A few days later MTGox itself was attacked when someone tried to sell more than 400,000 Bitcoins, which would have been worth about $9m.