Digital Currency Price Formation: A Production Cost Perspective

33 Pages Posted: 18 Oct 2022

See all articles by Sylvia Gottschalk

Sylvia Gottschalk

Middlesex University - Business School

Date Written: October 10, 2022


The paper investigates the long-run relationship between the bitcoin-USD exchange rate and its marginal cost between July 2010 and July 2022. We derive Bitcoin's marginal cost from a model of Bitcoin mining grounded in the Bitcoin code, and show that its production cost is a function of only two variables, the electricity price and the mining hardware efficiency. We then estimate a time-varying vector error correction model, and also the cointegration between bitcoin's price and Bitcoin network's hash rate, a commonly used production cost proxy. Our results show that the time-varying cointegration between the cryptocurrency's price and its hash rate is permanently in disequilibrium, bar a short time interval between March 2017 and January 2018. Consequently, although bitcoin's price and the hash rate are cointegrated, it is clear that the latter does not function as a stable long-run explanatory variable for its price. On the contrary, we found that bitcoin and its marginal cost of production have been cointegrated since inception, and that their time-varying long-run relationship always reverts towards equilibrium - and often to equilibrium- after long periods of divergence. These results contrast with most of the empirical literature that attempted to model the relationship betweeen bitcoin and its fundamentals in a time-invariant framework, but are consistent with recent research showing a significant role for production cost in the determination of bitcoin's price dynamics.

Keywords: Bitcoin's price formation, production cost, time-varying VECM, mining hardware efficiency

JEL Classification: G12, D21, D22

Suggested Citation

Gottschalk, Sylvia, Digital Currency Price Formation: A Production Cost Perspective (October 10, 2022). Available at SSRN: or

Sylvia Gottschalk (Contact Author)

Middlesex University - Business School ( email )

The Burroughs
London, NW4 4BT
United Kingdom

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