BoE Paper Examines Blockchain Structure and Cryptocurrency Prices
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
Previous Article
MAS Amends Notices on NSFR and Guide on Margin Rules for DerivativesRelated Articles
BIS and Central Banks Experiment with GenAI to Assess Climate Risks
A recent report from the Bank for International Settlements (BIS) Innovation Hub details Project Gaia, a collaboration between the BIS Innovation Hub Eurosystem Center and certain central banks in Europe
Nearly 25% G-SIBs Commit to Adopting TNFD Nature-Related Disclosures
Nature-related risks are increasing in severity and frequency, affecting businesses, capital providers, financial systems, and economies.
Singapore to Mandate Climate Disclosures from FY2025
Singapore recently took a significant step toward turning climate ambition into action, with the introduction of mandatory climate-related disclosures for listed and large non-listed companies
SEC Finalizes Climate-Related Disclosures Rule
The U.S. Securities and Exchange Commission (SEC) has finalized the long-awaited rule that mandates climate-related disclosures for domestic and foreign publicly listed companies in the U.S.
EBA Proposes Standards Related to Standardized Credit Risk Approach
The European Banking Authority (EBA) has been taking significant steps toward implementing the Basel III framework and strengthening the regulatory framework for credit institutions in the EU
US Regulators Release Stress Test Scenarios for Banks
The U.S. regulators recently released baseline and severely adverse scenarios, along with other details, for stress testing the banks in 2024. The relevant U.S. banking regulators are the Federal Reserve Bank (FED), the Federal Deposit Insurance Corporation (FDIC), and the Office of the Comptroller of the Currency (OCC).
Asian Governments Aim for Interoperability in AI Governance Frameworks
The regulatory landscape for artificial intelligence (AI), including the generative kind, is evolving rapidly, with governments and regulators aiming to address the challenges and opportunities presented by this transformative technology.
EBA Proposes Operational Risk Standards Under Final Basel III Package
The European Union (EU) has been working on the final elements of Basel III standards, with endorsement of the Banking Package and the publication of the European Banking Authority (EBA) roadmap on Basel III implementation in December 2023.
EFRAG Proposes XBRL Taxonomy and Standard for Listed SMEs Under ESRS
The European Financial Reporting Advisory Group (EFRAG), which plays a crucial role in shaping corporate reporting standards in European Union (EU), is seeking comments, until May 21, 2024, on the Exposure Draft ESRS for listed SMEs.
ECB to Expand Climate Change Work in 2024-2025
Banking regulators worldwide are increasingly focusing on addressing, monitoring, and supervising the institutions' exposure to climate and environmental risks.