A study of the relationship between economic and technical aspects of bitcoin

Abstract

This study investigates the cryptocurrency called bitcoin. A cryptocurrency is a type of currency that depends on cryptography to issue new units instead of depending on government decree like fiat currencies. The study will first explain some of the technical details that make bitcoin work. This is necessary to lay groundwork to get to the actual aim of the study, namely investigating the economic aspects of bitcoin. The study will evaluate bitcoin, and other cryptocurrencies, along with fiat currencies against certain definitions. In the process it will introduce a new subclass of cryptocurrency - the sovereign cryptocurrency. Bitcoin’s implied monetary policy will also be discussed, as well as the problems it creates for central banks. A hypothesis on the behaviour of the bitcoin price will be explained and research will be provided to support the acceptance of the hypothesis. Using this hypothesis, a stochastic pricing model for bitcoin will be derived. Arbitrage trading strategies will also be provided that explain certain price constraints that operate in the bitcoin market. The dissertation will also introduce a means to improve the anonymity of a user of bitcoin and will reason that improvements such as these and others will increase the use of bitcoin. Therefore, improvements to anonymity will increase the economic relevance of bitcoin and increase its competitive edge over the traditional banking system. It will be reasoned, based on the possible problems created by bitcoin’s monetary policy, as well as the growth projections implied by the stochastic pricing model, and the increased economic relevance due to improvements in anonymity, that central banks would need to create their own cryptocurrency that conforms to certain requirements – the previously introduced sovereign cryptocurrency. The study will conclude by explaining the technical changes needed for a fork of bitcoin to become a sovereign cryptocurrency, as well as a mathematical model to control the monetary policy of the sovereign cryptocurrency. As its aim, adaptive monetary policy will have stable prices for the economy using the sovereign cryptocurrency to price its goods and services. Please note, that while every effort was made to use published references, the field of cryptocurrencies is very young and changing constantly. Thus, most publications on the subject are simply placed on websites on the internet. This is especially true for the work relating to the founding of the field, and the data sources of the operation of the cryptocurrencies. Therefore a lot of the references do refer to websites on the internet.