Cryptocurrencies and the Velocity of Money

Abstract

Velocity of money is central to the quantity theory of money, which relates it to the general price level. While the theory motivated countless empirical studies to include velocity as price determinant, few find a significant relationship in the short or medium run. Since the velocity of money is generally unobservable, these studies were limited to use proxy variables, leaving it unclear whether the lacking relationship refutes the theory or the proxies. Cryptocurrencies on public blockchains, however, visibly record all transactions, and thus allow to measure - rather than approximate - velocity. This paper evaluates most suggested proxies for velocity and also proposes a novel measurement approach. We introduce velocity measures for UTXO-based cryptocurrencies focused on the subset of the money supply effectively in use for the processing of transactions. Our approach thus explicitly addresses the hybrid use of cryptocurrencies as media of exchange and as stores of value, a major distinction in recently proposed theoretical pricing models. We show that each of the velocity estimators is approximated best by the simple ratio of on-chain transaction volume to total coin supply. Moreover, “coin days destroyed”, if used as an approximation for velocity, shows considerable discrepancy from the other approaches.

Keywords: velocity of money, cryptocurrencies, price models