Towards Proof-of-Work Cryptocurrency Valuation: Mining Games, Network Effects and the Social Value of Blockchain
32 Pages Posted: 5 Apr 2019
Date Written: March 8, 2019
In this study, a mathematical model of proof-of-work cryptocurrency valuation is developed based on the concepts of simultaneous equilibria in two mining games, the purchasing power parity in the system of equations of exchange and the network effects of transaction cost optimisation in the economy where agents utilise both conventional and digital currencies to process payments. The model lays the foundation for rigorous long-term proof-of-work cryptocurrency valuation superior to existing approaches that are solely based on variations of Metcalfe’s law or costs of mining. Based on the model, the long-term Bitcoin equilibrium price conditional on current block size limit is $106, while if the block size limit is abandoned, the conditional equilibrium price is $6725. Network hashrate is consistent with the no-limit scenario, while the transaction fees are consistent with the status quo, revealing an important source of uncertainty on the market. The developed framework is also applied to the measure the net social value of proof-of-work cryptocurrencies, and Bitcoin long-term social value of equilibrium is shown to be positive at $126,200 per block. The comparison of equilibrium and optimal cases shows that external intervention is not necessary to guarantee socially beneficial outcomes.
Keywords: cryptocurrency, valuation, proof-of-work, bitcoin, network effects, transaction costs, alternative investments, simultaneous equilibria, social value of blockchain
JEL Classification: C62, D53, D61, E42, G12, G19
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