Featured Product

    BoE Paper Examines Blockchain Structure and Cryptocurrency Prices

    February 14, 2020

    BoE published a staff working paper that models both the financial market for cryptocurrency and the market for blockchain space, to explore the interactions between them. The paper presents a model of cryptocurrency price formation that endogenizes the financial market for coins and the fee-based market for blockchain space. It shows that blockchain congestion leads to novel interactions between cryptocurrency speculation, monetary usage, and prices. The paper explains why blockchain usage and fees tend to be driven by speculative trading, rather than payments activity. The results of the study have implications for the long-term future of cryptocurrencies.

    The paper provides an overview of the key features of a cryptocurrency that are useful for understanding the model, including blockchain technology, the trading environment, and the use of cryptocurrency as money. The paper highlights the two distinctive features of cryptocurrency: a price determined by the extent of its usage as money and a blockchain structure that restricts settlement capacity. It then describes the model and explores how speculative trading affects price formation and volatility. Next, the paper examines a variant of the model in which agents have imperfect information about the cryptocurrency technology. Finally, it concludes with a discussion of how the results may be verified empirically, also providing all proofs in the Appendix. 

    The results have implications for the long-term future of cryptocurrencies. Short-term speculation can crowd out usage. Hype results in speculative pressure, making cryptocurrency less useful as money and, paradoxically, hampering adoption. In the longer run, as private information is incorporated into the price, the gains from trading decrease, and speculative activity falls. Reduced competition for blockchain space then allows cryptocurrency to function better as a means of payment, and to fulfill its potential. The model cannot predict whether cryptocurrencies will eventually be adopted as money, but it does suggest that such an outcome would be consistent with the history observed so far.

    By competing for limited blockchain space, speculators impose an externality on monetary users that we do not see with other forms of money. The study shows that limited settlement space creates competition between users of the currency; therefore, speculative activity can crowd out monetary usage. This crowding-out undermines the ability of a cryptocurrency to act as a medium of payment, lowering its value. Hence, higher speculative demand can reduce prices, contrary to standard economic models. Crowding-out also raises the riskiness of investing in cryptocurrency, explaining the high observed price volatility. 

     

    Related Link: Working Paper

     

    Keywords: Europe, UK, Banking, Insurance, Securities, Cryptocurrencies, Blockchain, Fintech, Crypto Assets, BoE

    Related Articles
    News

    BIS Quarterly Review Discusses Developments in Fintech and ESG Space

    BIS published the September issue of the Quarterly Review, which contains special features that analyze the rapid rise in equity funding for financial technology firms, the effectiveness of policy measures in response to pandemic, and the evolution of international banking.

    September 20, 2021 WebPage Regulatory News
    News

    BCBS to Consult on Supervisory Practices for Climate Risks by Year-End

    The Basel Committee for Banking Supervision (BCBS) met in September 2021 and reviewed climate-related financial risks, discussed impact of digitalization, and welcomed efforts by the International Financial Reporting Standards (IFRS) Foundation to develop a common set of sustainability reporting standards

    September 20, 2021 WebPage Regulatory News
    News

    OCC Identifies Operational Risk Deficiencies in MUFG Union Bank

    The Office of the Comptroller of the Currency (OCC) issued a Cease and Desist Order against MUFG Union Bank for deficiencies in technology and operational risk governance.

    September 20, 2021 WebPage Regulatory News
    News

    EC Rule on Contractual Recognition of Write Down and Conversion Powers

    The European Commission (EC) published the Delegated Regulation 2021/1527 with regard to the regulatory technical standards for the contractual recognition of write down and conversion powers.

    September 17, 2021 WebPage Regulatory News
    News

    ECB to Consider Climate Risks When Reviewing Collateral Framework

    In a response to the questions posed by a member of the European Parliament, the President Christine Lagarde highlighted the commitment of the European Central Bank (ECB) to an ambitious climate-related action plan along with a roadmap, which was published in July 2021.

    September 17, 2021 WebPage Regulatory News
    News

    SRB Provides Update on Approach to Prior Permissions Regime

    The Single Resolution Board (SRB) published a Communication on the application of regulatory technical standard provisions on prior permission for reducing eligible liabilities instruments as of January 01, 2022.

    September 16, 2021 WebPage Regulatory News
    News

    APRA Issues Further Guidance on Application of Securitization Standard

    The Australian Prudential Regulation Authority (APRA) published a new set of frequently asked questions (FAQs) to provide guidance to authorized deposit-taking institutions on the interpretation of APS 120, the prudential standard on securitization.

    September 16, 2021 WebPage Regulatory News
    News

    ACPR Publishes Corrective Version of RUBA Taxonomy

    The French Prudential Control and Resolution Authority (ACPR) published the corrective version of the RUBA taxonomy Version 1.0.1, which will come into force from the decree of January 31, 2022.

    September 15, 2021 WebPage Regulatory News
    News

    Nordea Bank and EIB Sign Agreement to Fund Green Projects in Nordics

    The European Commission (EC) announced that Nordea Bank has signed a guarantee agreement with the European Investment Bank (EIB) Group to support the sustainable transformation of businesses in the Nordics.

    September 15, 2021 WebPage Regulatory News
    News

    APRA Publishes FAQs on Capital Treatment of Overseas Subsidiaries

    The Australian Prudential Regulation Authority (APRA) published a new set of frequently asked questions (FAQs) to clarify the regulatory capital treatment of investments in the overseas deposit-taking and insurance subsidiaries.

    September 15, 2021 WebPage Regulatory News
    RESULTS 1 - 10 OF 7487