Digital currency price formation: a production cost perspective

Article


Gottschalk, S. 2022. Digital currency price formation: a production cost perspective. Quantitative Finance and Economics. 6 (4), pp. 669-695. https://doi.org/10.3934/QFE.2022030
TypeArticle
TitleDigital currency price formation: a production cost perspective
AuthorsGottschalk, S.
Abstract

The paper investigates the long-run relationship between bitcoin and its marginal cost between July 2010 and July 2022. We derive Bitcoin’s marginal cost of production 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 bitcoin’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 bitcoin price dynamics. On the contrary, we found that bitcoin’s price and its marginal cost of production have been cointegrated since its 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 between 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.

Keywordsbitcoin mining; cost of production; asset pricing; time-varying VECM; Bitcoin hardware efficiency
Sustainable Development Goals9 Industry, innovation and infrastructure
Middlesex University ThemeCreativity, Culture & Enterprise
LanguageEnglish
PublisherAIMS Press
JournalQuantitative Finance and Economics
ISSN2573-0134
Publication dates
Print21 Dec 2022
Publication process dates
Deposited16 Dec 2022
Submitted09 Oct 2022
Accepted30 Nov 2022
Output statusPublished
Publisher's version
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Open
Accepted author manuscript
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Restricted
Copyright Statement

© 2022 Sylvia Gottschalk, licensee AIMS Press. This is an open access article distributed under the terms of the Creative Commons Attribution License (http://creativecommons.org/licenses/by/4.0).

Digital Object Identifier (DOI)https://doi.org/10.3934/QFE.2022030
Web of Science identifierWOS:000904894100001
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Has metadatahttps://publons.com/wos-op/publon/57134436/
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