Crytocurrency Valuation – An Asset Pricing Perspective

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Bitcoin, the first cryptocurrency, was originally designed to be a form of electronic cash that enables online payment without intermediation by financial institutions. While Bitcoin and other cryptocurrencies still serve that purpose, they are nowadays widely considered as financial assets and are held as investments or for speculative purposes. The CME and the Cboe, two of the world's largest derivatives exchanges, trade Bitcoin futures, and some authors consider cryptocurrencies a new asset class. Despite their growing popularity cryptocurrencies are not well understood. Why is someone ready to pay a five-digit dollar amount for a piece of data representing a unit of virtual cash? Why is private money without commodity backing valuable at all? Are we simply witnessing an enormous bubble or do modern cryptocurrencies rely on unique design features that justify at least part of the demand - for instance, the cryptographic techniques inducing a high degree of counterfeit safety or the protocols that set an upper bound on cryptocurrency supply acting as commitment device not to issue too much virtual money? Are such design features crucial value drivers? What else explains a cryptocurrency’s value and volatility? Although, at a technical level, the unique features of cryptocurrencies and the underlying blockchain (or distributed ledger) technology have been extensively discussed from a computer science and a legal perspective, there is a lack of economic research to answer the questions above. We therefore seek to deepen the understanding of cryptocurrencies from an economic and finance perspective. More specifically: We want to develop an economic model that explains, from economic primitives, why cryptocurrencies have a non-zero value at all and understand which of the various design features of cryptocurrencies affect their value. There are three sub-goals that specify the overriding question: (1) We want to provide an overview and basic understanding of the unique design features of a cryptocurrency and to identify those that are relevant for the pricing and risk profile of cryptocurrencies. At this point, we will rely on both a literature review and an own exploratory empirical analysis of the variety of cryptocurrencies traded. (2) We plan to develop an economic model that allows to formally analyze the effects of those design features that are identified in step 1 as most important for a cryptocurrency’s value and volatility. Within this modelling approach, we intend to consider two main agent groups, the consumers and the miners, and their intergroup dynamics to derive price implications. (3) We seek to empirically assess the relevance of our model predictions using the cross-sectional variation between different cryptocurrencies.The expected outcomes are not only novel from a theoretical perspective, but also highly relevant for informing the ongoing public debate on the merits and dangers of cryptocurrencies.