What gives cryptocurrencies their value? This question is perhaps the most contentious in the broader blockchain ecosystem, sparking debate far and wide. A new collaborative paper between academics at the University of Toulouse, McGill University, and VU Amsterdam explores this question. Using Kaiko market data, the researchers develop a framework relating the value of Bitcoin to the transactional costs and benefits it provides.
Transactional benefits refer to the overall advantage of transacting with a cryptocurrency versus a fiat currency issued by a central bank. One transactional benefit of cryptocurrencies is that they can be used in monetary transfers across international borders. However, there are numerous transactional costs to offset this (and other) benefits including: limited convertibility into other currencies, transaction costs on exchanges, mining fees, limited use-cases, etc.
Ultimately, investors determine demand for cryptocurrencies based on their expectation of future price and net transactional benefits. However, the relationship between transactional benefits and prices is what distinguishes this asset class from other assets such as stocks or bonds. The researchers relate the transactional benefits of cryptocurrencies to dividends for a stock. Both transactional benefits and dividends affect the price that investors are willing to pay to hold each asset.
However, unlike dividends, the magnitude of transactional benefits depends on the price of the cryptocurrency. Conversely, the price of the cryptocurrency is related to the magnitude of transactional benefits. What we see is a feedback loop from prices to transactional benefits: “agents who expect future prices to be high (resp. low) rationally anticipate high (resp. low) future transactional benefits, which in turn justifies a high (resp. low) price today.”
To summarize, the researchers develop a framework relating price to both real and perceived transactional benefits and costs of cryptocurrencies. They determine that transactional benefits are a legitimate fundamental of cryptocurrencies, serving as a determinant of Bitcoin returns. However, they also find that a large part of Bitcoin volatility is unrelated to fundamentals.
In conclusion, this paper provides a fascinating quantitative exploration of the fundamentals of Bitcoin. Ultimately, Bitcoin’s value is derived from a complex confluence of price perception and market fundamentals. At Kaiko, we are excited to support future research on this topic.
Read the paper here:https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3261063