Does Bitcoin Behave As a Currency?: A Standard Monetary Model Approach

43 Pages Posted: 4 Sep 2019 Last revised: 7 May 2021

See all articles by Cho-Hoi Hui

Cho-Hoi Hui

Hong Kong Monetary Authority - Research Department

Chi-Fai Lo

The Chinese University of Hong Kong

Po-Hon Chau

The Chinese University of Hong Kong (CUHK)

Andrew Wong

Hong Kong Monetary Authority

Date Written: May 8, 2020

Abstract

We derive the Bitcoin exchange rate dynamics by solving the exchange rate equation of the standard flexible-price monetary model to investigate any characteristics of Bitcoin like a currency. The dynamics is driven by an asymmetric mean-reverting fundamental shock which can be attributed to a money demand shock. A crash occurs when the exchange rate with a weakened mean-reverting force breaches a lower boundary where a smooth-pasting condition is imposed. The empirical results show the exchange rate dynamics can be calibrated according to the model, in which the mean reversion of the dynamics is positively co-integrated with the Bitcoin transaction volume indicating demand for Bitcoin; and with the risk reversals of the commodity currencies (Australian dollar and Canadian dollar) in currency option markets. The analysis shows that the Bitcoin exchange rate shares some characteristics of commodity currencies with crash risk. This suggests that Bitcoin behaves as a currency between fiat money and a crypto-commodity used for trading and investment purposes.

Keywords: bitcoin, money demand, currency crash, flexible-price monetary model, commodities

JEL Classification: F31, G13

Suggested Citation

Hui, Cho-Hoi and Lo, Chi-Fai and Chau, Po-Hon and Wong, Andrew, Does Bitcoin Behave As a Currency?: A Standard Monetary Model Approach (May 8, 2020). International Review of Financial Analysis, 70 (2020),101518, Available at SSRN: https://ssrn.com/abstract=3447080 or http://dx.doi.org/10.2139/ssrn.3447080

Cho-Hoi Hui (Contact Author)

Hong Kong Monetary Authority - Research Department ( email )

Hong Kong
China

Chi-Fai Lo

The Chinese University of Hong Kong ( email )

Department of Physics
Shatin, N.T., Hong Kong
China

Po-Hon Chau

The Chinese University of Hong Kong (CUHK) ( email )

Shatin, N.T.
Hong Kong
Hong Kong

Andrew Wong

Hong Kong Monetary Authority ( email )

3 Garden Road, 30th Floor
Hong Kong
Hong Kong

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