The Marginal Cost of Mining, Metcalfe's Law and Cryptocurrency Value Formation: Causal Inferences from the Instrumental Variable Approach

Abstract

This paper is the first to rigorously test commonly cited simplistic theories of cryptocurrency pricing, namely, cost-based model and Metcalfe’s law, using causal inferences from the instrumental variables approach on block-level data for six proof-of-work coins. Positive effects of hashrate and transaction count implied by cost-based pricing and Metcalfe’s law, respectively, are non-existent for any of the coins investigated. Negative and insignificant estimators cannot be explained by weak instruments, suggesting previously reported strong positive relationships are spurious due to autocorrelation and endogeneity. The study reinforces the need for a more sophisticated cryptocurrency valuation framework.

Keywords: cryptocurrency, blockchain, hashrate, Metcalfe’s law, cost-based pricing, causal inference, instrumental variable

JEL Classification: C22, C26, E42, G12