Bitcoin: A Search-Theoretic Approach
International Journal of Innovation in the Digital Economy, 6(2), pp. 52-71
26 Pages Posted: 7 Mar 2014 Last revised: 11 Jan 2015
Date Written: March 5, 2014
This paper considers whether the stability of Bitcoin in the market as a method of payment using a dual currency money-search model. In the model, there is traditional money and Bitcoin. The two currencies are classified by the storage cost and the probability that sellers accept particular money for payments. Agents are randomly matched for transactions. To consider substitution effect between monies, we allow new entries every period. In the beginning of each period, new entrants come into the matching process with a unit of money of their choice. A certain number of sellers also come into the same process to maintain the population share of sellers at a constant level. With appropriately chosen parameters, we find that there can be stable and unstable equilibria of the share of bitcoiners. In this case, a stable equilibrium is a success (bitcoiners take a large share) while the other (unstable) is a failure (bitcoiners take a marginal share or vanish). However, if the inflation rate of traditional money decreases, the successful equilibrium disappears to start approaching the failure even if Bitcoin is currently widely accepted. Furthermore, welfare comparisons suggest that an increase in the share of bitcoiners has a negative effect; hence, the benefit from reductions in the transaction costs must compensate for the welfare erosion if Bitcoin is accepted as a new kind of payment system. If we are to succeed, the Bitcoin community or the public authorities need to be prepared for protecting the system from several illicit activities.
Keywords: Bitcoin; dual-currency; private money; peer-to-peer payment system
JEL Classification: C78; E41; E42
Suggested Citation: Suggested Citation