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Jonathan Chiu† Bank of Canada
Thorsten V. Koeppl‡. Queen’s University
First version: March, 2017
This version: September, 2018
How well can a cryptocurrency serve as a means of payment? We study the optimal design of
cryptocurrencies and assess quantitatively how well similar currencies can support bilateral trade.
The challenge for cryptocurrencies is to overcome double- spending by counting on competition
to modernize the blockchain( expensive mining) and by delaying agreement. We estimate that the
current Bitcoin scheme generates a large weal loss of1.4 of consumption. This weal loss
can be lowered mainly to0.08 by espousing an optimal design that reduces mining and
relies simply on plutocrat growth rather than sale freights to finance mining prices. We
also point out that cryptocurrencies can potentially challenge retail payment systems handed
scaling limitations can be addressed.
Keywords Cryptocurrency, Blockchain, Bitcoin, Double Spending, Payment Systems
JEL Bracket E4, E5, L5
∗ The views expressed in this paper aren’t inescapably the views of the Bank of Canada. We thank the cult
at numerous forums and conferences for their commentary. This exploration was supported by SSHRC Insight Grant 435-
2014- 1416. The authors declare that they’ve no applicable or material fiscal interests that relate to the exploration
described in this paper.
† Bank of Canada, 234 Wellington St, Ottawa, ON K1A 0H9, Canada(firstname.lastname@example.org).
‡ Queen’s University, Department of Economics, Kingston, K7L 3N6, Canada(email@example.com).
How well can a cryptocurrency serve as a means of payment? Since the creation of Bitcoin in 2009,
numerous critics have denounced cryptocurrencies as fraud or outright bubbles. further nuanced opinions
have argued that similar currencies are only there to support payments for illegal conditioning or simply
waste coffers. lawyers point out, still, that – grounded on cryptographic principles to insure
security – these new currencies can support payments without the need to designate a third- party
that controls the currency or payment instrument conceivably for its own profit.1
We take up this discussion and develop a general equilibrium model of a cryptocurrency that
uses a blockchain as a record- keeping device for payments. Although Bitcoin in its current form
has immense weal costs, an optimally designed cryptocurrency can potentially support payments
rather well. First, using Bitcoin deals data, we show that the weal cost of a cryptocurrency
can be similar to a cash system with moderate affectation. Second, using summary statistics for
US disbenefit card deals, we find that a cryptocurrency can perform nearly as well as a low- value,
retail payment system operating with veritably low freights.2
Economics exploration so far has handed little sapience into the profitable applicability of cryptocurrencies.
utmost being models of cryptocurrencies are erected by computer scientists who substantially concentrate on the
feasibility and security of these systems. pivotal issues similar as the impulses of actors to
cheat and the endogenous nature of some crucial variables similar as the real value of a cryptocurrency
in exchange have been largely ignored. similar considerations, still, are vital for understanding
the optimal design and, hence, the profitable value of cryptocurrency as a means of payment.
Our focus is primarily on understanding how the design of a cryptocurrency influences the inter-
conduct among actors and their impulses to cheat. These impulses arise from a so- called
“ double- spending ” problem. Cryptocurrencies are grounded on digitial records and, therefore, can be copied
fluently and costlessly which means that they can potentially be used several times in deals
1Some central banks have lately started to also explore the relinquishment of cryptocurrency and blockchain technolo-
gies for retail and large- value payments. exemplifications are the People’s Bank of China who aims to develop a civil
digital currency grounded on blockchain technology; the Bank of Canada and the Monetary Authority of Singapore who
are studying its operation for interbank payment systems; and the Deutsche Bundesbank who has developed a primary
prototype for blockchain- grounded agreement of fiscal means.
2This raises the issue that numerous cryptocurrencies presently can not be gauged sufficiently to serve as a true
relief of large retail payment networks. We abstract fully from similar scalability issues that substantially arise from technological constraints.
and operate without a designated third- party to issue the currency. Agarwal and Kimball( 2015)
advocate then that the relinquishment of digital currencies can grease the perpetration of a negative
interest rate policy, while Rogoff( 2016) suggests that phasing out paper currency can undercut
undesirable duty elusion and felonious conditioning. Our findings complements this work as we establish
some implicit bounds on the costs that can be levied on people through central bank issued
digital currency.5 Eventually, Fern´andez- Villaverde and Sanches( 2016) model cryptocurrencies as
intimately issued edict currencies and dissect – in the tradition of the literature on the free banking.
Cryptocurrencies A detail preface
Our ultramodern frugality relies heavily on digital means of payments. Trade in the form ofe-commerce
for illustration necessitates the operation of digital commemoratives. In a digital currency system, the means of
payment is simply a string of bits. This poses a problem, as these strings of bits as any other
digital record can fluently be copied andre-used for payment. Basically, the digital commemorative can be
counterfeited by using it doubly which is the so- called double- spending problem.
Traditionally, this problem has been overcome by counting on a trusted third- party who manages
for a figure a centralized tally and transfers balances by crediting and debiting buyers and merchandisers ’
accounts. This third- party is frequently the issuer of the digital currency itself, one prominent illustration
being PayPal, and the value of the currency derives from the fact that druggies trust the third- party
to enjoin double- spending( top of Figure2.1).
Cryptocurrencies similar as Bitcoin go a step further and remove the need for a trusted third- party.
rather, they calculate on a decentralized network of( conceivably anonymous) validators to maintain and
update clones of the tally( bottom of Figure2.1). This necessitates that agreement between the
validators is maintained about the correct record of deals so that the druggies can be sure to
admit and keep power of balances. But such a agreement eventually requires that( i) druggies do
not double- spend the currency and( ii) that druggies can trust the validators to directly modernize the
How do cryptocurrencies similar as Bitcoin attack these challenges? Trust in the currency is grounded
on a blockchain which ensures the distributed verification, streamlining and storehouse of the record of
sale histories.6 This is done by forming a blockchain. A block is a set of deals
that have been conducted between the druggies of the cryptocurrency. A chain is created from these
blocks containing the history of once deals that allows one to produce a tally where one
can intimately corroborate the quantum of balances or currency a stoner owns. Hence, a blockchain is like a
book containing the tally of all once deals with a block being a new runner recording all the
Figure2.2 illustrates how the blockchain is streamlined. To insure agreement, validators contend for
In this sense it’s different from traditional plutocrat which is simply a partial memory of once deals as it
only records the current distribution of balances and doesn’t record how once deals induce the current
for a more detailed description see Section 2 below). We formalize this double- spending problem
and show how this problem is being addressed by( i) a resource- ferocious competition for streamlining
the records of sale – a process generally appertained to as mining – and( ii) by introducing con-
firmation lags for settling deals in cryptocurrency. This implies that a cryptocurrency faces
a trade- off between how fast deals settle and a guarantee( or “ futurity ”) for their agreement.
Accordingly, crytocurrencies can not achieve immediate and final agreement of deals.
A strength of our analysis is that we take into account the costs of operating a cryptocurrency
that prohibits double- spending. This allows us to quantitatively assess how effective Bitcoin as a
medium of exchange can be relative to being means of payment. Calibrating our model to Bitcoin
data, we find that from a social weal perspective using Bitcoin is close to 500 times more expensive
than using traditional currency in a low affectation terrain.
This is, still, a result of the hamstrung design of Bitcoin as a cryptocurrency. Bitcoin uses
both currency growth and sale freights to induce prices for mining. In its current form, the
cryptocurrency price structure is too generous so that too numerous coffers are being used to rule
out double- spending and making it a secure form of payment. We show that the optimal way of
furnishing prices for mining is simply via currency creation at a veritably low rate rather than by
using sale freights. The optimal design of Bitcoin would induce a weal cost of only about
of consumption which is original to a cash system with moderate affectation.
We also estimate the effectiveness of using a cryptocurrency system to support large- value and retail
deals. Using summary data for Fedwire and US disbenefit cards, we confirm that cryptocur-
rencies are a much better volition for low value, high- volume deals than for large value
payments. This is intuitive, as double spending impulses increase with the size of deals.
Hence, further mining and longer evidence lags( which are both expensive) are needed when drag-
porting large- value payments in a cryptocurrency. Our exercise shows that cryptocurrency systems
can potentially be a valid volition to retail payment systems that operate at veritably low freights, as
soon as limits on the scale of similar systems can be resolved.
The profitable literature on cryptocurrencies is veritably thin. We aren’t apprehensive of any work that
has homogenized the design features of a cryptocurrency and that has studied its optimal design
under the trouble of double spending attacks. We model bilateral exchange grounded on plutocrat, we
follow the lately promoted frame of Lagos and Wright( 2005) and enrich it by modelling a
mining competition to modernize the blockchain. For standardizing the blockchain itself, we calculate on the theoretical literature of payment systems as a record- keeping device.3
Our work is therefore a first attempt to explicitly model the distinctive technological features of a
cryptocurrency system which are a blockchain, mining and double- spending impulses within a
quantitative profitable model. We’re also first to theoretically dissect the optimal design of a
cryptocurrency and giving a quantitative answer to the effectiveness parcels of cryptocurrencies.
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