Introduction

Due to Bitcoin’s growing popular appeal and merchant acceptance, it has become increasingly important to try to under- stand the factors that influence its value formation.1 Presently, the value of all bitcoins in existence represent approximately $7 billion, and more than $60 million of notional value changes hands each day. Having grown rapidly over the past few years, there is now a developing but vibrant marketplace for bitcoin, and a recognition of digital currencies as an emerging asset class. Not only is there a listed and over-the-counter market for bitcoin and other digital currencies, but also an emergent derivatives market. As such, the ability to value bitcoin and related cryptocurrencies is becoming critical to its establishment as a legitimate financial asset. This topic is not only of general importance to the fields of finance and economics, but also intersects with computer science, information systems, and applied cryptography.

A brief overview of Bitcoin

Bitcoin is the first and most popular of what has become known as cryptocurrencies, digital monetary and payment sys- tems that exist online via decentralized, distributed networks that employ a shared ledger data technology known as block- chain coupled with secure encryption.

The low-level technical specifications of the Bitcoin and altcoin protocols are beyond the scope of this paper, however some key points must be understood before going any further, under the assumption that many readers have little to no prior knowledge of this topic. Taking Bitcoin as the generalized digital currency example, one can then extend those concepts to the greater universe of cryptocurrencies. This overview is purposefully brief and meant only to clarify some points that will be referred to in this paper.

Bitcoin is an open source software-based online payment system that emerged in 2008–2009. Payments are recorded in a shared public ledger, known as the blockchain, using its own unit of account, which is also called bitcoin, symbolically rep- resented as either BTC or XBT.

Transactions occur over a peer-to-peer network without a central repository or single administrator – it is a truly decen- tralized virtual currency where nodes in its network are essentially anonymous. New bitcoins are created as a reward for transaction processing work in which users offer their computing power to verify and record payments into the public led- ger. Also known as ‘‘mining”, individuals or firms engage in this activity in exchange for the chance to earn newly created blocks of bitcoins.

Mining is a necessary component of a cryptocurrency network that is open to the public and which does not censor par- ticipants from transacting in it. This purposefully resource-intensive validation activity is meant to deter anonymous partic- ipants from acting badly and undermining the system. In other words, the protocol operates under the assumption that any and all nodes will be controlled by fraudsters and thieves, and preempts efforts to scam or steal by making it insurmountably expensive to exploit or attack the network.

Survey of relevant literature

There is a small but emerging academic literature regarding the valuation of cryptocurrencies, with most emphasis sur- rounding Bitcoin itself. Much of the economic study undertaken has attempted to address the ‘‘moneyness” of bitcoin or whether it is more analogous to a fiat versus commodity money, like a ’digital gold’ (Gertchev, 2013; Harwick, 2014; Bergstra, 2014).

Yermack (2013) looks at bitcoin’s moneyness and points out weaknesses in bitcoin as a currency. He claims that bitcoin (and all cryptocurrencies by association) have no intrinsic value. I consider the potential that while its characteristics are intangible and the labor employed to mine for them is computational rather than human or mechanical, a bitcoin does indeed have an intrinsic value, albeit virtual, which cannot be directly compared to tangible intrinsic value possessed by gold, for example. I don’t disagree with the premise that bitcoin and its cousins are not money in the strict sense and that many issues stand in the way of it moving toward mass acceptance and appeal. Yermack makes a valid point that the price volatility of bitcoin as expressed in dollars is quite high and that its dollar price may vary significantly among the various exchanges. He mentions that this can cause problems when trying to analyze price data.

For this paper, I have used bitcoin rather than dollars as the denomination for the various cryptocurrency prices. One can then transpose all prices to dollars using a current dollar-bitcoin exchange rate if they chose. Hence, in my analysis a bitcoin is always worth 1 BTC, and all other cryptocurrencies are expressed in decimal form as x.xxxxxxxx BTC. It is worth noting that for many cryptocurrencies there only exists pairwise trading on exchanges between itself and bitcoin (or to a lesser extent another cryptocurrency); there are far less altcoin-dollar trading pairs than altcoin-bitcoin pairs. Attempts thus far at valuation, or determining sources of value, have focused almost entirely on bitcoin without consideration to the scope of alternative cryptocurrencies and altcoins.

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