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Bubbly Bitcoin

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“The market that looks most like a bubble to me is Bitcoin and its brethren.”

—Richard Thaler.

Abstract

There has been a burgeoning Fintech literature in the past years, especially on cryptocurrencies. However, there is lack of research handling cryptocurrencies in a mainstream macroeconomic model. To bridge the gap, we develop a model for Bitcoin-like cryptocurrency as risky and costly bubbles in an infinite-horizon production economy. This model is consistent with the following facts: (1) the surging Bitcoin market presents enormous volatility, (2) its price dynamics are significantly sensitive to both market sentiment and policy stances. Entrepreneurial firms choose to hold Bitcoins as liquid assets to buffer idiosyncratic investment distortions. The intrinsically worthless Bitcoins can emerge as rational bubbles when the market sentiment is optimistic enough. On the one hand, bubbly Bitcoins provide market liquidity to facilitate investment in the real sector, while on the other hand, they deteriorate the investment efficiency and crowd out aggregate production. Our quantitative exercise produces various cyclical features of Bitcoin bubbles and find that the collapse of Bitcoin bubbles can improve social welfare by decreasing distortion-driven real investment.

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Authors and Affiliations

  1. School of Economics and Management, Tsinghua University, Beijing, China

    Feng Dong

  2. Peking University HSBC Business School, Shenzhen, China

    Zhiwei Xu

  3. Guanghua School of Management, Peking University, Beijing, China

    Yu Zhang

Authors
  1. Feng Dong
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  2. Zhiwei Xu
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  3. Yu Zhang
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Correspondence to Zhiwei Xu.

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We would like to thank the Editor, the Associate Editor, three anonymous referees, Redouane Elkamhi, Laura Xiaolei Liu, Vincenzo Quadrini, Baolian Wang, Pengfei Wang, Ji Zhang (discussant), Xiaodong Zhu and Yifeng Zhu and the seminar participants at the First Macro-Finance Workshop at Peking University HSBC Business School, Central University of Finance and Economics, and Peking University for their useful discussions and comments. The authors acknowledge the financial support the National Natural Science Foundation of China (72122011, 72022011, 71903126), and thank the Guanghua Blockchain Lab and the Guanghua Research Fund on FinTech for their research support.

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Dong, F., Xu, Z. & Zhang, Y. Bubbly Bitcoin. Econ Theory 74, 973–1015 (2022). https://doi.org/10.1007/s00199-021-01389-y

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  • DOI: https://doi.org/10.1007/s00199-021-01389-y

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