Bubbly Bitcoin

51 Pages Posted: 16 Dec 2018 Last revised: 11 Jan 2019

See all articles by Feng Dong

Feng Dong

Tsinghua University - School of Economics and Management

Zhiwei Xu

Shanghai Jiao Tong University (SJTU)

Yu Zhang

Peking University - Guanghua School of Management

Date Written: January 2019

Abstract

We construct a model for Bitcoin-like cryptocurrency as risky and costly bubbles in an infinite-horizon production economy with incomplete markets. This model is consistent with the following facts: i) the surging Bitcoin market presents enormous volatility, and ii) its price dynamics are significantly sensitive to both investor sentiment and policy stances, and iii) the Bitcoin market exhibits diverse cyclical features for US and China. Entrepreneurial firms choose to hold Bitcoins as liquid assets to buffer idiosyncratic investment distortions. The intrinsically worthless Bitcoins can emerge as rational bubbles only when market distortion is severe and public sentiment is optimistic enough. On the one hand, bubbly Bitcoins provide market liquidity to facilitate investment in the real sector, while on the other hand, they crowd out production through costly mining activities. Deterioration in market sentiment depresses Bitcoin prices but ambiguously affects aggregate output and investment. Moreover, our quantitative exercise is able to produce various cyclical features, as shown in the data. Finally, the collapse of Bitcoin bubbles is shown to improve social welfare by decreasing distortion-driven real investment.

Keywords: Bitcoin, Cryptocurrency, Liquidity Constraint, Stochastic Bubbles, Market Sentiment, Store of Value

JEL Classification: D84, E30, E60, G10

Suggested Citation

Dong, Feng and Xu, Zhiwei and Zhang, Yu, Bubbly Bitcoin (January 2019). Available at SSRN: https://ssrn.com/abstract=3290125 or http://dx.doi.org/10.2139/ssrn.3290125

Feng Dong

Tsinghua University - School of Economics and Management ( email )

School of Economics and Management
Tsinghua University
Beijing, Beijing 100084
China

HOME PAGE: http://fengdongecon.weebly.com

Zhiwei Xu (Contact Author)

Shanghai Jiao Tong University (SJTU) ( email )

1954 Huashan Rd
Shanghai, 200030
China

Yu Zhang

Peking University - Guanghua School of Management ( email )

Peking University
Beijing, Beijing 100871
China

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