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Can We Stabilize the Price of a Cryptocurrency?: Understanding the Design of Bitcoin and Its Potential to Compete with Central Bank Money

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This paper discusses the potential and limitations of Bitcoin as a digital currency. Bitcoin as a digital asset has been extensively discussed from the viewpoints of engineering and security design. But there are few economic analyses of Bitcoin as a currency. Bitcoin was designed as a payments vehicle and as a store of value (or speculation). It has no use bar as money or currency. Despite recent enthusiasm for Bitcoin, it seems very unlikely that currencies provided by central banks are at risk of being replaced, primarily because of the market price instability of Bitcoin (i.e. the exchange rate against the major currencies). We diagnose the instability of market price of Bitcoin as being a symptom of the lack of flexibility in the Bitcoin supply schedule ‐ a predetermined algorithm in which the proof of work is the major driving force. This paper explores the problem of instability from the viewpoint of economics and suggests a new monetary policy rule (i.e. monetary policy without a central bank) for stabilizing the values of Bitcoin and other cryptocurrencies.
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Discussion Paper Series A No.617
Can We Stabilize the Price of a Cryptocurrency?:
Understanding the Design of Bitcoin and Its Potential to
Compete with Central Bank Money
Mitsuru Iwamura
(Graduate School of Commerce, Waseda University)
Yukinobu Kitamura
(Institute of Economic Research, Hitotsubashi University)
Tsutomu Matsumoto
(Faculty of Environment and Information Science,
Yokohama National University)
and
Kenji Saito
(Keio Research Institute at SFC, Keio University)
November, 2014
Institute of Economic Research
Hitotsubashi University
Kunitachi, Tokyo, 186-8603 Japan
1
CanwestabilizethepriceofaCryptocurrency?:
UnderstandingthedesignofBitcoinanditspotentialto
competewithCentralBankmoney
MitsuruIwamura,YukinobuKitamura, 
TsutomuMatsumotoandKenjiSaito
October25,2014
Abstract
ThispaperdiscussesthepotentialandlimitationsofBitcoinasadigital
currency.Bitcoinasadigitalassethasbeenextensivelydiscussedfrom
the viewpoints of engineering and security design. But there are few
economicanalysesofBitcoinasacurrency.  Bitcoinwasdesignedasa
paymentsvehicleandasastoreofvalue(orspeculation).Ithasnouse
bar as money or currency. Despite recent enthusiasmfor Bitcoin, it
seems very unlikely that currencies provided by central banks are at
riskofbeingreplaced,primarilybecauseofthemarketpriceinstability
ofBitcoin(i.e.theexchangerateagainstthemajorcurrencies).  We
diagnosetheinstabilityofmarketpriceofBitcoinasbeingasymptom
ofthelackofflexibilityintheBitcoinsupplyschedule‐apredetermined
algorithminwhichtheproofofworkisthemajordrivingforce. This
paper explores the problem of instability from the viewpoint of
economics and suggests a new monetary policy rule (i.e. monetary
policywithoutacentralbank)forstabilizingthevaluesofBitcoin and
othercryptocurrencies.
Keywords:Bitcoin,Cryptocurrency,Currencycompetition,FriedrichA.Hayek,Proofofwork. 
JELclassification:B31,E42,E51

MitsuruIwamuraisaprofessorattheGraduateSchoolofCommerce, Waseda University
(Address: 1‐6‐1 Nishi Waseda, Shinjuku‐ku, Tokyo 169‐8050, Japan) Yukinobu Kitamura is a
professor at the Institute of Economic Research, Hitotsubashi University(Address:21Naka,
Kunitachi‐shi, Tokyo 186‐8603, Japan), Tsutomu Matsumoto is a professor at the Faculty of
Environment and Information Sciences, Yokohama National University (Address: 79‐7
Tokiwadai, Hodogaya‐ku, Yokohama, Kanagawa, 240‐8501, Japan) and KenjiSaito is a visiting
seniorresearcheratKeioResearchInstituteatSFC,KeioUniversity (Address: 5322 Endo,
Fujisawa‐shi,Kanagawa,252‐0882,Japan).Addresscorrespondencetokitamura@ier.hit‐u.ac.jp
2
1. Bitcoinasavirtualregistrysystem
Circulation of Bitcoin 1 as digital asset is guaranteed by
authenticationprocessbetweentraders.Thisprocessconsistsof both
anasymmetrickeycryptosystemandbycompetitionbetween
coinreleasing‘minerswhovalidatetransactionstopreventdouble
spendsbytraders.Itisimportanttorecognizethatitisoperationally
feasiblefortraderstoauthorizetransactionsbymeansofadigital
signature,basedonaasymmetrickeycryptosystem.Itisbyfarmore
difficulttovalidatetransactionsofBitcoin,orotherdigitalassets,whilst
preventing double spending of assets. For paper money and checks
anti‐counterfeittechnology,suchashologramsandsignatures,prevents
forgery.  Butthestateofdigitalassetsneverdeterioratesanditisnota
simpletasktoidentifyagenuinetransactionfromaforgedone.
Many electronic securities and electronic money systems employ
eitheracentralized(anodewithhubfunction)tradingsystemoranIC
cardsystemwithsecretkeythatpreventssuchdoubledspending. The
formersystemrequiresacentralizedadministrationwithareasonable
governancestructure.  ThelattersystemrequiresanICcardoperation. 
These systems may transfer incidents of regulation and other
institutionalriskstotheownersofdigitalassets.  
In Bitcoin the validation of transactions (preventing double
spending) is made possible by sharing the virtual registry bookthat
containsallinformationontransactionsandownershipofBitcoin. 
Thevirtualregistrybookisalwaysopentoeveryparticipant,so any
doublespendiseasilyidentified.  Bitcoingivestheimpressionthatitis
asetofindependentgoldlikecoinageassetswithitscooption of
‘mining’and‘coin’ phrases.  ButBitcoinmorecloselyresemblesareal
estateregisterorrecordinwhichthenewownerofeachlotofreal
estate is recorded whenever a new transaction is taken place. This
virtualrealestateregisterrecordcontains21millionlots(i.e.21million

1 Inthispaper,werefertoBitcoinaseitherasoftwarepackagethatcanbuyandsellBitcoinor
anoperationalsystemunderwhichminersarevoluntarilyinvolved.  It does not necessarily
reflecttheoriginalideaofSatoshiNakamoto(2008).
3
BTCs)beforesub‐dividing2. ToissueBitcoin is toattachan IDnumber
to each BTC lot, a settlement BTC is to replace an ID number bynew
number3. 
  As of July 20, 2014, 13.04 million BTCs have been issued in the
marketwithIDnumbers(about62%of21millionBTCs).Roughly
every ten minutes, 25 BTCs are being issued with new IDs.  This
procedure of new issue is implemented as a reward for the first
person/grouptovalidatetransactionswithoutdoublespendsthathave
beencollectedinablock.Thisisacompetitionofvalidationvia
computation,withtheaimofsolvingaspecificmathematicalproblem4.
Thiscomputationisdescribedasmining,andthosewhoconduct
mining are miners. The speed of new issue of Bitcoin on the register
recordis set tobe halvedin every fouryears. Atthe beginning of the
Bitcoin system in January 2009, the reward was 50 BTCs per ten
minutes, it was halved to 25 BTCs per ten minutes on November 25,
2012.Itremainsthesamerewardpertenminutestillnow5.Itwillbe
halvedto12.5BTCspertenminutesinaroundNovember2016,and
this halving process will continue until 2140 when new issue ofBTC
willbeterminated.  TotalcirculationofBTCwillbefixedat21million
BTCs.
  Thereare differencesbetween areal estate registrysystem andthe
Bitcoinsystem.  InJapan,forinstance,therealestateregistrysystemis
maintainedandadministered solelyby the LegalAffairs Bureau.The
real estate register record is kept exclusively by the Legal Affairs
Bureauandthepublicisonlyallowedtoreadtherecord.Incontrast,
thevirtualregistrybookthatcontainsallinformationonBitcoin
transactions and ownership is maintained individually among
participants.  This decentralized nature of virtual registry

2 TheminimumunitofBTCisnot1BTC,butitcanbedividedinto1/108unitsofBTC. 
3 Infact,settlementismadeover(multiple)partoflotsthatcanonlybeidentifiedasquantities.
Butwebelievethat thismetaphor by a realestate register record captures an essence of BTC
trading.
4 WewilldiscussthisproblemindetailinSection2.
5 Four years after January 2009 must be January 2013. The actualeventseemstohappen
quickerthantheoriginalstatement.Thisisduetotheprogramthatsetsarewardtobehalvedin
every210thousandBTCblockextensions,i.e.aminingrewardishalvednotbycalendar,butby
theblockextensionnumbers.Insection2,themeaningofblockextensionisfullyexplained.   
4
book‐keeping activity may create some inconsistencies among
participants.IntheBitcoinprotocol,whenanidenticalBitcoinsegment
is used twice for different payments –leading to a Bitcoin segment
having two branches (double spends) ‐ the majority decision rule is
used to determine which payment is genuine. The advantage of
majoritydecisionruleistosolveadeadlocksituationinwhich two
partiesdisagreewitheachother.However,asEyalandSirer(2013)
argue, the majority decision is not enough to protect against selfish
miningpoolsthatcommandlessthan1/4oftheresources,giventhe
delayedfinalityconfirmationstructure6.
  To be more precise, the Bitcoin protocol authenticates a genuine
Bitcoinregistrybookinwhichablockchain,afterbranching,extends
the longest7.  This decision rule works due to the delayed finality
confirmationstructure.Wewilldiscussthisinthenextsection.
  Thebook‐keepingmethodofownershiptransactionisnot restricted
toatypeofrealestateregistrysysteminwhichthe ownershipofeach
segmentisrecorded.   Depositaccountdatainabankingsystemkeeps
transactionandbalancerecordsforindividuals;inBitcoinphrasing,this
isequivalenttothenumberofsegmentsthedepositaccountholderhas
previouslyusedandcancurrentlyuse.Theadvantageofthismethod
isthatitallowsthemanagementofalargenumberof segments with a
relatively small number of accounts8. The reason why the Bitcoin
protocol employs the real estate‐like registry system, rather than the
bank deposit‐like account system is probably because Mr. Nakamoto
andhiscollaboratorsthinkthatitissuitablefordecentralized
processing.  
  TheBitcoinprotocolusesahashvalueofabeneficiary’spublickeyas
itsIDnumber.Ahashvalueisasortofdigestoforiginaldata,whichis

6 Eyaland Sirer (2013) illustrates that Bitcoin’sminingalgorithmisnotincentivecompatible,
and that the Bitcoin ecosystem is open to manipulation, and potential takeover, by miners
seekingtomaximizetheirrewards(p.15).
7 According to Nakamoto (2009), the system is supposed to authenticate the longest
block‐chain,inpractice,however,thechainwhose“totaldifficulty”isthegreatestprevails. 
8 Forexample,incaseoftentrillionyendepositsby1000millionpeople,itcanbepossibleto
keeptheownershiprecordsofeachyen,itmayrequireaverylargecomputationaland
maintenancecosts.Designofsuchasystemisfarmorecomplexthanabankaccounttypeof
recordkeeping.
5
obtained after a designated calculation process by some specific
algorithm(we will comebackto thislater).  Byusing a hashvalue as
anIDnumber,togetherwith  apublickeyitself,theBitcoinprotocolis
abletomaintainanonymitywithaswellastrustworthinessoftrade. 
The Bitcoin protocol recommends owners utilize asymmetric key
cryptography9.
2. Miners’important,exhaustingrole
The essence of the Bitcoin protocol is its structure that guarantees
theuniquenessofthesegmentinformation‘registrybook.This
confirmation process broadly corresponds to one provided by the
centralized payment system in the case of traditional banking. The
Bitcoin protocol validates all transactions by means of open
competition among profit seeking miners as described above.  This
wholeprocessisreferredtoasconfirmationintheBitcoinprotocol.  
The winner of the open competition provides the hash value as a
stamp on the registry book, marking a validation of the trades in the
specific block. At the same time this winner receives newly created
Bitcoin,andisrecordedastheownerofsuchintheregistrybook.This
processiscalledmining.  Inthispaperwedistinguishtheconfirmation
processin which all mining activitiesare involvedfrom thevalidation
processinwhichthewinnerofcompetitionprovidesthehashvalueasa
stampontheregistrybook.
Miners play an important role in the validation of Bitcoin
transactionsthatguaranteestheuniquenessoftheregistrybook.  We
callthemminersbecausetheyarenotatrustedthirdpartythat is
assignedtopreventdoublespendevents,butarevoluntaryparticipants
seeking for a reward from the open competition of validation. Only
thewinnerreceivesBitcoininreward,allotherminersreceivenothing

9 Seehttps://bitcoin.org/en/protect‐your‐privacy. 
6
andmustpaytheirminingcosts.Thisisperhapsacruelsystemfrom
theviewpointofminers.
  This competition of validation is open every (about) ten minutes. 
Tradescollectedbyaminerbeforesuchtenminuteintervalsform a
block.  Afterthevalidation,anewblockisaddedtotheexistingblocks
– a process called extending a block chain. Newly created Bitcoin
received as a reward for validation can be used for payment after
reasonablylongblockchainsareextended(i.e.longenoughto prevent
disputesoverdoublespends)10.TheBitcoinprotocolemploysadelayed
finality confirmation structure in which Bitcoin cannot be used
immediately after a transaction from the other party, even after
validationoftransactionis made. This structure is quite differentfrom
thecentralizedpaymentsystememployedbythebankingsector. 
TheBitcoin protocolsets avariable difficultyof computationfactor,
to be solved by the miners in approximately ten minutes. When the
miners’computationspeedbecomesfaster(i.e.lessthantenminutes),a
parameterthatdeterminesadifficultyofcomputationisresettomakea
blockchainintervalapproximatelytenminutes11.
This delayed finality confirmation structure is regarded as a
weaknessoftheBitcoinsystemfromalternativecryptocurrency
creatorspointofview.However,therecertainlyexistsatrade‐off
between approaching real‐time finality and increasing risk in
alterationsofvalidatedtransactions. 
  Letusclarifythevalidationprocessin the Bitcoinprotocol.This isa
block chain extension process after confirming finality in all past
transactions: 
(1) Thehashvalue12h0intheimmediatelypreviousblock,

10 Bitcoinstransferredbetweenuserscanconventionallybeusedafter6block‐chainextensions
(about one hour later) Generated bitcoins and transaction fees as a rewardfor a block‐chain
extension(wewilldiscussthislater)canonly  beusedafter100block‐chainextensions(about
17hourslater).
11 This parameter adjustment is based on the algorithm for the Bitcoin protocol.  The
algorithm examines thespe ed ofnew block is created in every 2016 block extensions (ifone
blockiscreatedintenminutes,2016blocksareequivalenttotwoweeks)andmakesparameter
adjustment.
12 According to Wikipedia, a hash function is any function that canbeusedtomapdataof
arbitrary size to data of fixed size, with slight differences in input data producing very big
7
(2) Thehashvalueqincludedinalltransactionsinthecurrentblock, 
(3) Searchforavaluerthatsatisfiescertainconditions,and
(4) Newhashvalueh1isgeneratedfromthreeinputs(h0,q,r).Thisnew
hash value h1 is used as a validation stamp on the virtual registry
book(seeFigure1forillustration).
IntheBitcoinprotocol,h0and qare exogenously given (these figures
dependonthepasthistoryoftrades),andminershavetosearch rto
satisfythe conditionh1t(target).Thisexercise iscalled theproof of
work. This concept of proof of work comes from Dwork and Naor
(1992).  Theyprovideacomputational techniquefor combattingjunk
mailandcontrollingaccesstoasharedresource.Theirmain
contributionis requiring a usertocompute amoderatelyhard,butnot
intractable, function in order to gain access to the resource, thus
preventingfrivoloususe.IntheBitcoinsystem,thisconceptisused to
giveconfirmationofthetransactionsviatheminingcompetition. In
exchange the winner of the competition receives a reward. This
incentivemechanismisthe most innovativepart oftheBitcoinsystem
anditworkswell.
3. ProofofWorkorProofofWaste?
Let us clarify the meaning of the problem the Bitcoin protocol
imposesontheminers.Theproblemis“tosearchxtosatisfythe
conditionh1t(targetin256bit)wherethehashvalueh1is
generatedfrom(h0,q,x).Putsolutionxasr.”  Ifwedonotimposeany
restrictiononr(thatis,t=2256‐1), any number would satisfy the
problem.Ifwesetttobesmall,aprobabilityoffindingrinthehash

differences in output data. The values returned by a hash function are called hash values. A
cryptographichashfunctionisahashfunctionwhichisconsidered practically impossible to
invert,that is,to recreatethe input data fromits hashvalue alone. Ahash algorithmturns an
arbitrarily‐largeamountofdataintoafixed‐lengthhash.Thesamehashwillalwaysresultfrom
thesamedata,butmodifying thedatabyevenonebitwill completelychange thehash.Bitcoin
uses the SHA‐256 hash algorithm to generate verifiably "random" numbers in a way that
requiresapredictableamountofCPUeffort. 
8
function would drop sharply13 .Ifthedifficulty(asmeasuredby
parametern)ofthisproblemgoesbeyondacertainpoint,anystandard
personalcomputercannotfindasolutionwithinacertainperiod of
time(tenminutesinthiscase).
This implementation differs from the original design by Nakamoto
(2008). The original design states that “to search a hash valueh1
obtainedform(h0,q,x)whosefirstnbitiszero.Putsolutionxasr.”  In
this design, a difficulty parameter nfortheproofofworkcanbe
adjusted,butallowsonlyforadiscretechange.Thecurrentdesign is
superiorandencompassestheoriginaldesign14.
  Theoriginal design of Nakamoto isintuitive, a description of which
follows.  Note, in this paper, we use tandninterchangeablysince
t=2256‐n1.
  The difficulty parameter n becomes a very useful operational
instrument. 
(1) Ifnisreasonablysmallerthan256,searchvaluer,given h0andq,
canexistalmostinfinitely.
(2) Ifngrowsgraduallylargerfromzero,aprobabilitytofindaserch
valuerbecomesverysmallandultimatelyclosertozero.
Byadjustingthedifficultyparametern, together with exogenous
technological change and miner entry and exit, the speed of a block
formation can be controlled. Parameters torn enable the speed of
blockformationtostaymoreorlessconstantattenminutes.
  Asisclearfromtheabovediscussion,achoiceofparametertornin
the proof of work depends on computational power technological
changeandthenumbersofminers
15. The impact of technological

13Ifr is any arbitrary number in 256bit and the hash function used in this protocol can
generate an ideally uniform random diffusion, the probability would be about 1/2256‐log2t. 
Actualprotocolisabitmorecomplex,riscallednoncein32bitvalue,qwouldchangewhena
miner obtains bitcoins as a reward, the hash function (SHA‐256) could generatean identical
outputfromdifferentinputswithaverysmallprobability,actualprobabilitywouldbealittlebit
smallerthan1/2256‐log2t. 
14 Theoriginaldesignof Nakamotoallowsselecta realnumbert such that log2t generates an
integer.InthecurrentBitcoinprotocolallowstoselectanyrealnumberforadifficulty
parameter.  
15 Duetothecharacteristicsofhashfunctionintheproofofworkproblem,anumberoftrades
9
changeisintuitive:ifthecomputationalpowerdoubles,difficultyofthe
problem must double: n must shift to n+1.  Theimpactofnumberof
minersisbasicallysimilar,butmoreimportantinpracticeasitismore
likely the number of miners will double than would computational
power. 
Letusfurtherelaborateupontheissuesrelatedtotheproofofwork.
Theessenceofthisissueisthattowemayassumeaminer’sprobability
offindingasolutiontosomearbitrarilylargenumberofcalculationsis
independent even if there are reasonable numbers of miners. Letus
assumeaminer’srareeventoffindingsomerthatsatisfiestherequired
conditionswithinatenminuteintervalissettoprobability(provided
allminershavethesamecomputationalpower),andMminers
participate in the mining competition, the probability of no miner
findingrwithinanintervalisgivenas(1‐)M,theprobabilityofaminer
finding r within an interval is 1‐(1‐)M.Wealsoassumethata
probability of such a rare independenteventfollowsthePoisson
distribution.  Thenanaveragewaitingtimeforsucharareeventisan
inverseoftheprobabilityofevent,

 (1)
Transformingeq.(1), 




(2)
iisthenumberofminerswhoexperienceevents(i=0,1,2,…),
isavery
smallnumbercomparedwithM,thesecondterminthedenominator
canbeignored,thenwecansimplifyeq.(2)assuch,
≒
 (3)

inablockdoesnotmatterwithnort. If trades use some divisions or mergers of bitcoin
segmentswithinablock,thevalidationprocesscouldbeabitmore complex although
calculationburdendoesnotincreasemuch.Itistruethattransactionfeesarepaidtotheminers
with such additional calculations are involved.  A share of transaction fees in the miners’
rewardsisverysmall(seehttps://en.bitcoin.it/wiki/Transaction_fees).
10
Furthermore,letusassumetheaveragecomputationalpowerofminer
withinanintervalissetconstantK.Byconstructionofthehashfunction,
Kmustbereasonablysmallcomparedwith2256‐n, 
≒
 (4)
PutK/2256=k,eq.(4)becomes
≒2
/ (5)
Thatistosay,theaveragetimeofablockvalidation(theaverage
waitingtimefortheminertofindr)
(1) increasesasdifficultynfortheproofofworkatthespeedof2n.
(2)decreasesininverseproportiontothenumberofminersMand 
(3)decreasesininverseproportiontothecomputationalpower.
ThesearethebasicdeterminantsofBitcoinproductivity. 
The difficulty parameter nfortheproofofworkwas32inJanuary
2009,raised to 40in December 2009,raisedto 62inDecember 2013,
and is 64 as of June 2014.  These changes cannot be explained by
increases in computational technological change, but must reflect the
factthatmanynewminersenteredinminingcompetitionbytheendof
2013andtheyalmoststoppedafter2014.     
  Theseobservationshintatthenatureofproofofworkasthecore
conceptoftheBitcoinsystem.Asshownabove,difficultyparameternis
nothingtodowiththequalityofvalidationofablock.That’swhyncan
beraisedandreducedflexiblywithoutaffectingavalidationprocess.
Thatis,theproofofworkisnotanissueinmaintainingthequalityof
Bitcoin,butisthecosttomaintainasteadyspeedofnewissues of
Bitcoin(atthemoment,itis25BTCsperabouttenminutes).Inorderto
evaluatethenatureofproofofwork,thisrolemustbeexamined.  The
role is properly carried out, it would be considered reasonable.
Otherwiseitwouldnotbetheproofofwork,butitwouldbetheproof
11
ofwastebecauseitwouldbeamechanismtoproviderewardsforthe
miningcompetitionwithexcessivelylargecomputationalcost. 
  ItisessentialtheBitcoinsystemprovidesanincentiveforthosewho
contributetothemaintenanceofthesystem.Incaseofstandard
electronicmoney, anissuer ofelectronic money receivesparticipation
feesdirectly fromthe retailshops; theyare paidnot by theelectronic
moneytheyissue,butbycentralbanknotes.Central banks themselves
paymaintenancecosts andreceiveservice rewards inthemoney they
issue.
  IncaseofBitcoin,theminerwhocontributestothemaintenance of
the system receives Bitcoin as his reward, and so it resembles to the
centralbank system.A differencebetween theBitcoin systemand the
centralbanksystemliesinthefactthattheformergivesarewardtoa
miner who happens to win the mining competition while the latter
receivesareward constantly.  Ifthereisa singleminerin theBitcoin
system,rcanbeanyarbitrary256bitvalue(ncanbezero).  Insucha
case,thecompetitionmechanismthat guaranteesavalidityofproof of
workdoesnotworkandwerequiresomealternative.Ifanalternative
works, it could be sufficient to prevent double spends. This situation
canbedescribedasthemintmodelofcryptocurrency.
ThemintmodeldiffersfromtheBitcoinmodelinasensethatthe
former model uses a finality confirmation structure with legal
enforcement,whilethelattermodelusesafinalityconfirmation
structure via mining competition. Note again that the winner ofthe
competition is the only competitor to be rewarded with Bitcoin.The
probability of winning a reward must be based on the proportional
computationalpowerof anindividualminertothetotalcomputational
powerofallminingparticipants:allminersmayexpecttoreceive
12
rewardsproportional totheir computationalpowerafterareasonable
numberofminingcompetitions16.
  Thenwemustaskourselves,cantheproofofworkcontributetothe
stability of Bitcoin value? Nakamoto(2008) states “once a
predeterminednumberofcoinshaveenteredcirculation,the incentive
cantransitionentirelytotransactionfeesandbecompletelyinflation
free(p.4).
  Answerisno.AsFigure2amplyillustrates,thevaluesofBitcoinas
measuredinU.S.dollarfluctuatewildlycomparedwiththoseofother
foreigncurrencies.Thereasonforthishighvolatilityisapparent. 
Demand for Bitcoin, regardless of the motivation for holding (i.e.
paymentorspeculation),increasesasitspricedecreasesandvice‐versa. 
As Figure 3 shows, the demand curve of Bitcoin, therefore, would be
downwardsloping17 whilesupplycurveofBitcoinatanypointoftime
wouldbevertical.Alldemandshocks(suchasE
*orE
**) must be
absorbedinpriceadjustments(suchasP*orP**).
  WenoteBitcoinpricingdiffersfromthepricingmechanismunderthe
goldstandardintwoaspects.First,thesupplyofgoldasnatural
resourcemustbeadjustedtothemarginalcost(i.e.theminerwouldset
its production so as to make the market value of gold equal to the
marginalcostofgoldmining).Secondly,goldcanbeusedforindustrial
andjewelrypurposesaswellasamoney.  Ifthepriceofgoldcoingoes
up,thegoldusedforindustrialandjewelryuseswouldbeconvertedto
thegoldcoinsandviceversa.
  Goldcoins should consequentlybe expected tomanifest anupward
slopingsupplycurve(see Figure4).Inthiscase,asshowninFigure4,
demand shocks can be absorbed in both prices and quantities.
ComparedwithBitcoin,thepriceofgoldcoinswouldbeconsequently

16 Ofcourse,weneedtoconsiderhowfairminingcompetitionis.Butifthelooserwithlower
computationalpowerwouldhavenochancetowinthecompetition,he/shewouldexitfromthe
competitionafterseveraltrials.Inthe longrun,allcompetitionparticipantsmusthavemoreor
lessthesimilarcomputationalpowers.  
17IfpeopletakeintoaccountofBitcoinpricesandallnewsuptothepreviousperiodsand
expectthecurrentpriceproperly,thentheyformtheirdemandcurvefairlyclose tohorizontal
(i.e.flat).Wedonotdiscusssuchacasehere. 
13
lessvolatileduetothissupplyelasticity18.ThepricevolatilityofBitcoin
mayreflectarathernaïveunderstandingbythedesignersoftheBitcoin
systemthatthemonetaryvalueofBitcoinwouldbestabilizedwith a
fixedmoneysupplyrule. 
4. DualInstability

  Let us consider the miner’s behavior from a broad cost/benefit
analytic perspective.  Miners voluntarily participate in the mining
competition,andinvestintheircomputationalpower,andwouldexitif
miningcostsexceeditsbenefits.Inprinciple,thissituationofentryand
exit is common to all industries. The only difference from standard
industries is that supply of Bitcoin is independent from miners’ entry
andexit.
To elaborate upon this point, we divide the miners’ computational
powersintoMunits.Mvariesaccordingtominers’entryandexit.But
therewardforthewinnerofminingcompetitionisfixedasaboutZper
hour(atthemoment,25BTCspertenminutes,Zwouldbeabout150)
regardlessofentryandexitofminers
19 .AssumingtheBitcoin
protocolsetsnproperly,Zwouldbefixedforacertainperiodoftime.
ThisfactisreflectedintheverticalsupplycurveofFigure3.
Expectedreward/benefitperunitperhourisZ/M. Ifthemarket
value of Bitcoin is given as P, the market value of expected reward is
PZ/M.  Ifthe miningcostis lowerthan PZ/M,thenthe minersobtain

18 Of course, the price stability of gold coin under the gold standard may not be attributable
solelytothesupplycurveadjustmentmechanism.  Astothegoldpricestabilityinthelate19th
centurytotheearly20thcentury,Keynes(1924)argues“forwhengoldwasrelativelyabundant
andflowedtowardsthem,itwasabsorbed bytheirallowing theirratioof goldreservestorise
slightly;and when it wasrelativelyscarce,the factthat theyhadnointentionofeverutilising
theirgoldreservesforanypracticalpurpose,permittedmostofthemtoviewwithequanimitya
moderateweakeningoftheirproportion.AgreatpartoftheflowofSouthAfricangoldbetween
the end of the Boer War and 1914 wasable to find its way into thecentralgoldreservesof
European and other countries with the minimum effect onprices” (pp.166‐167). The supply
shocksof goldandsilverdiscoverysometimecausevolatility ofthegold andsilvercoins.From
1550to1620,thepricesinWesternEuropeasmeasuredinthesilvercoinsincreased2.5times
(annualinflationrateisabout1.5%)asaresultofnewflowof silver from the American
continent.Thisiscalledthepricerevolutionperiod.
19 We put “about” because the Bitcoin protocol set a time intervalofablock10minuteson
averagebyadjustingdifficultyparametern.  
14
net benefit/return, and vice versa.Letusreflecttheseaspects in the
pastoneyearorso.
(1)If the market valueof expectedreward PZ/Mexceeds the average
costofaddingoneunit(itisgivenexogenouslybyatechnological
change),newentrywouldincrease. ButasMincreasesaccordingly,
theexpectedreward/returnperunit(averageproductivity)woulddrop.
Eventually new entry would cease. This situation is a kind of
equilibriumand remainsuntilnews onthe Bitcoin pricearrives. Good
news,orBitcoinpriceincreases,inducesnewentrywhichcontinuesup
tothepointwhereMequilibratesbetweenthemarginalcostandthe
marketprice.Theproblemhappenswhenbadnewsarrives.
(2)AssumebadnewsarriveswhentheBitcoinsystemequilibrates.If
badnewsreducestheBitcoinmarketprice,theminersnetreturn
would be negative.  If the miners’ computational power can be
reallocatedtotheotherpurposes,migrationfromBitcoinminingwould
happen gradually.  Accordingly, depending on the size of the M
decrease,the expected returnper unitwould recover.  This situation
could happen when the mining is conducted in a spare time of
mainframe computer.  This can describedasthepastoralrealityof
earlyBitcoinmining. 
(3)Butthecurrentrealityisnotpastoralatall.  AsFigure2illustrates,
theBitcoinpriceshotupafterNovember201320.Thisfactrenderedthe
mining business very profitable. As a result, many entrepreneurs
entered into the Bitcoin mining competition equipped with super
powerfulcomputerswithdesignatedICchips21.  Thecurrentsituation

20 The Bitcoin market price was about ten dollars in the early 2013. It shot up above 1000
dollars in the end of November 2013. It is hard to tellthe exact reason for this. We cannot
exclude a possibility of the bubble because the Bitcoin system tends to create babble as the
supply curve stands vertically. If Bitcoin was used to transfercapitalfromCyprusincaseof
financial crisis 2012‐13, the price hike of Bitcoin can be explained reasonably by this event.
Suppose,ifoneBitcoinistendollars,100milliondollartransfersfromCyprusrequire10million
BTCs.  ThatwouldexhaustalmostallBitcoinsinthemarket.   
21 Thismovementisconsistentwithchangeindifficultyparametern.Aseq.(5)indicates,an
increaseinn(fromnton+1)isequivalenttodoublethenumberofminersunitsM. 
15
resemblesaheavyequipmentindustryinwhichitiseasytoenter,butit
difficulttoexitbecauseoflargesunkcosts.
(4) Suppose that the Bitcoin price drops a by substantial, but not a
deadly,margin.  Tobemoreprecise,itfallstosomepricelowerthan
the average cost per unit but above the average variable cost. The
minerswouldcontinueminingbecauseitisrationaltokeepoperations
as long as return/revenue exceeds variable cost (i.e. total cost minus
fixed cost); the eventual operational loss would be smaller than that
incurredbyimmediatestoppage.AccordingtosomereportsonBitcoin
mining,manylarge‐scaleminerswhoenteredaftertheBitcoinboomin
late2013continuerunningtheiroperationsevenwithnegativereturns.
Theymaynotactivelyanticipatethereturnofabove1000
dollar/Bitcoin days, but they might simply assume that eventual
operationallosswouldbeminimizedbycontinuedoperation.
(5) Miners may also migrate to another mine in which they can
continuemining,  should computational powers be convertibletothe
newmine22.Aswementionedbefore,iftheminersmigratetotheother
mines,thesizeofMdecreases,andtheexpectedreturnperunitwould
recover.  Bythismechanism Bitcoinminingcansurvive evenundera
very volatile Bitcoin price.  Ontheotherhand,minerscomputing
equipmentmayreachtheendofitsusefullife,andminersmighthaveto
stopminingbeforetheyrecoveralltheirsunkcosts.
(6)Bitcoinminingmightendanotherway.IftheBitcoinpricedrops
sharply below the average variable cost, all miners would exit from
mining.Manyminers enteredtheBitcoin mining competitionafterthe
Bitcoinboominthelate2013.Theircomputationalpowerwouldbe
expected to be broadly similar23.Ifthatisthecase,theminersexit

22 Manyalternativecryptocurrencies to Bitcoin emergerecently.Iftheoperationalprotocolis
closertothatofBitcoin,itwouldbemucheasiertoconverttheirminingoperationintothenew
cryptocurrency. There already existsaservicetoinformrelative mining profitability among
alternativecryptocurrenciessothattheminerscanmovearoundtheprofitablemines. 
23 MostofcalculationintheBitcoinminingisallocatedtosearchforthevaluertosolvethe
16
strategywouldnotbeagradualone,butcouldbesudden.IftheBitcoin
pricedropsbelowathreshold,theBitcoinsystemasawholemay
collapseortheBitcoinusersarelimitedtoaverysmallnumberofinner
memberswithwhichBitcoinisexchangedataverysmallscale.Onceall
minersleavetheBitcoinmining,noonewouldbeengagedintheproof
ofwork.Avalidationofablockwouldbedelayedorstopped,and in
consequenceBitcoin ceasestobe a useablecurrency. Thistypeof risk
doesn’t’existingoldmining24.
  From the above observations, it is clear that the Bitcoin system
intrinsically manifests dual instability. The first instabilitystemsfrom
an inflexible supply curve of Bitcoin, which amplifies Bitcoin price
volatility;theminers’revenue/rewardfullyabsorbsanypricechanges. 
There is no price stabilization mechanism.  The second instability
comesfromriskstothesustainabilityofmining.DuringaBitcoinprice
boomminersengageinminingactivitywhichguaranteesthesupplyof
Bitcoin.ButduringaBitcoinpricedepression,nosmoothwaytoinduce
exitsfrom miningexists25. Thecurrent situationof theBitcoin system
canbeinterpretedasafreezingequilibriumwithdualinstability.
5. SceneaftertheGoldRush
The dual instability could be accelerated by miners’ strategic
behavior.RememberthattheBitcoinsystemsharesthevirtualregistry
book among all participants, and that everyone can monitor what all
others do.  It is not a big problem when new miners enter mining
activity as a result of the Bitcoin boom. Strategic behavior becomes a
problemwhennoadditionalprofitcanbefoundaftertheminers’rush.

problem.ThiscalculationismadebytheBitcoinminingdedicatedICchips(ASIC). 
ComputationalpowerisproportionaltothenumbersofASIC.  Wesupposetheproductivityof
minersintermsofcomputationalpowerperunitismoreorlessequal.
24 ThisfactindicatesthatBitcoinisnotnecessarilyacheappaymenttool.Wehavetorealize
thatBitcoinhasanexternality.WewillcomebacktothisinSection7.
25 Oncethepricefallsintothelevelthat is lowerthantheaveragecostperunitbutabovethe
averagevariablecost,onesolutionfortheminersistoselltheircomputerstotheotherminers. 
ButthisactionmightinduceasharpdropinthepriceofBitcoinminingdedicatedICchip.That,
inturn,makesexitmoredifficult.Thiscouldbetheworstscenariofortheminers.
17
Anexampleisvoluntaryandcollectiveminingpoolformation.Figure5
illustrates how the mining pool occupies the Bitcoin mining business. 
Twolargepoolinggroups(i.e.GHash.IOandDiscusFish)occupyalmost
50%ofitsshares26. 
  Howcan a miningpool be createdeasily in theBitcoin system? The
virtualregistrybookissharedcommonly,soeveryIDnumbercanbe
tracedby allparticipants, enablingminers to form a collectivemining
pool.  Oncethepooliscreated,itiseasyforthepool administrator to
monitor the behavior of all members in the pool27. It becomes very
difficulttoobservefromtheoutsidewhatminingstrategythepooluses. 
Asymmetricinformationbetweentheinsiderandtheoutsiderofthe
pool is generated via a virtual registrybookandsomespecialID
replacementsystem.
  In the long run, any reward/return from mining competition is
probabilisticandrealizedreturnswouldconvergetoexpectedreturns.
Butintheshortrun,fromtheindividualminersviewpointtheriskof
lowreturnisnon‐negligible.  Itisquiterationaltoformaminingpool
to reduce the risk of return volatility without changing the expected
return.Poolmemberminerstypicallyagreetoallocatereturnsin
proportiontotheircontributedcomputationalpower.
  Letus clarifythe rationale forthe miningpool. If thesearch itemis
rare,theminerscandividetheirsearchareabyspacesothattheminers
can avoid inefficiently searching the same space. But Bitcoin can be
consideredas2256‐ncoinsbeingrandomlydistributedoveralargespace
of2256lots.Fromtheviewpointofreducingthewaitingtimebetween
rareeventstohappen,theminingpooldoesnothelp.Butpoolscan
reducetheriskofanindividualminersreturn.
The Bitcoin mining competition is repeated every ten minutes
(equivalent to 144 races with equal odds repeated daily).  If the

26 Eyal and Sirer (2014) points out that pools over 25% can cheat the system with selfish
mining and earn more than theirfair share, over 33% presents risk of unilaterally successful
selfish mining, large pools risk double spends with low confirmations, and over 50% is an
unmitigateddisasterandthatsuchmajorityminersaretoxic.  
27 AsRonandShamir(2013)shows,fromcertaincharacteristicsoftransactions,IDnumbersin
theBitcoinsystemcanbetracedbackwardlyandidentifiedtheownersofBitcoin.  
18
minersriskinmeasurednotineachcompetitionbutinaday,itwould
bereducedto1/12(i.e.thesquarerootof144).Ontheotherhand,if
100minersformaminingpool,theirriskcanbereducedto1/10ofthe
applicablestandarddeviation.Takingintoaccountpooladministration
cost,actualpoolformationmaygobeyondtherationaleforthemining
poolofriskdiversification.  
  Whydowecareabouttheminingpool?Itcanbeasourceofstrategic
andopportunisticbehavior,whichmayinturndamagethecredibilityof
the Bitcoin system.  Firstly, theminersinthepoolcanforcelosses
upontheminersoutsidethepoolandencouragethemtoexitmining28.
Second,ifmultiplenumbersofsizablepoolsexist,eachpoolcanrotate
their mining in proportion to the computational power. In so doing,
each pool can raise their mining efficiency29. As Figure 5 illustrates,
small numbers of mining pools accumulate computational power.
That said, we cannot find any evidence of strategic behavior ofthe
minersinthepool,asindicatedbyEyalandSirer(2013)30.
  ThecurrentsituationofBitcoinminingremainsusofthesceneafter
thegold rush inCalifornia.The minersenteredafter theBitcoinboom
lookexactlylikethe49ers31:mostofthemmadelittleorlostmoney.
 It is true that mass migrations during the gold rush period to
Californialaiddownthefoundationsofeconomicprosperityinlater
years.ThesamecanbesaidofBitcoin,whichattractssubstantialpublic
attention.Ifwetakeadvantageofthisopportunitywecanfoster an
improvedBitcointhatcancompetewithcentralbankmoney.
6. MonetaryPolicywithoutaCentralBank

28 SeeEyalandSirer(2013).
29 Suppose two mining pools are oligopoly, economic efficiency canberaisedbyonepool
miningwhiletheotherresting.Thistypeofcollusioncankeepdifficultyparameterntoremain
loworraisehighastheywish.
30 We do not know exactly that such strategic behaviorhas not been taken place or that the
actionsaretakenbuttheyarenotknowntothepublic. 
31 Thisname is giventothe gold prospectorswhoarrivedinnorthernCaliforniaaround 1849
duringtheCaliforniagoldrush.
19
CryptocurrencieslikeBitcoindonotdepend on acentralbank.With
some amendments to its design, we can use this cryptocurrency (we
callthiscurrency, an extensiontoBitcoin,ImprovedBitcoin orIBC)to
implementsomeequivalentpolicyeffectsasacentralbankconducting
monetarypolicy.It isindeedmonetarypolicywithoutthecentralbank. 
To do so, we need to conquer the dual instability issues discussed in
Section4.  
6‐1.CurrencyBoardsasinspiration
  Asimpleandstraightforwardcurrencysupplyruleisthat‐giventhe
marketvalue/priceofIBCvis‐à‐visU.S.dollarorEuroasabenchmark‐
ifthemarketvalueofIBCincreases,thesystemwouldissueIBCsuntil
themarketvaluereturnstothebenchmarklevel.Thisrulecanbe
describedasthepeggingruleofexchangerates,orthecurrencyboard
system. 
To be more concrete, suppose the market value/price of IBC isP
dollar at the moment. A reward for the proof of work, V is set torise
whenthemarketvaluePisabovethebenchmarkvalueandarewardV
issettobezerowhenPisbelowthebenchmark.Alternativelysome
difficulty parameter n, adjusting the speed of proof of work is to be
changed.  Inthiscase,withoutchangingV,thequantityofnewissueof
`IBCperhourZisadjusted32.Whichruleisbetter?Intheory,bothrules
affectthemarketvalueofIBCequally.  Theabovediscussioncan be
considereda starting pointto considerthe marketvalue stability ofa
cryptocurrency.IntheBitcointypeofcryptocurrency,withoutacentral
authority,thepolicyframeworkformarket value stabilizationmustbe
ruleratherthandiscretionbased.
  Thismethodhasaseriousdefect:toreducethenewissueofIBCto
zeroisnotequivalenttoabsorbingexcessIBCincirculation.  Figure6
illustrates the kinked supply curveofIBC,withcurrentpointE as a
refraction point (for simplicity, let us assume supply and demand
equilibrates at E). A positive demand shock to IBC (increase in IBC

32 HereZ=V/θwhereθistheaveragewaitingtime.
20
demand)can beabsorbed byshifting thesupply curvefrom Lto L*.A
negativedemandshocktoIBC(decrease in IBC demand) cannot be
absorbedbecausethesupplycurveisverticalinthiscase.Consequently
themarketvalueofIBCdropstoP**. 
  Thesupplyofcentralbanknotescaneasilyexpandandcontract.For
a positive demand shock to bank notes (shifting from
consumption/investment to money: i.e. it is a deflationary shock), the
centralbankincreasesmoneysupplybybuyingsecuritiesandforeign
currencies. For a negative demand shock to bank notes, the central
bankabsorbsmoneyincirculationbysellingsecuritiesandotherassets.
IncaseofIBC,thelatteroperationisnotincludedinitsprotocol.Thatis
to say, the cryptocurrency protocolusuallyincludesthecurrency
supply rule, but does not have a currency absorption or write‐off
protocol.Canwereducethisirreversibility? 
6‐2.BuiltinRevaluationRuleforExchangeRate
  It is the irreversibility of cryptocurrency supply that concerns us
most, perhaps because of our obsession of understanding currency
supplyintermsofnumbers.Ifwetrytocontrolcurrencyquantitiesin
terms of real purchasing power, it may not be so difficult to absorb
surplus currencies in circulation. It is possible to include aninflation
rate in the supply rule to amend irreversibility of currency.  If our
basicideaisclosertoacurrencyboard,thisamendmentisanamended
currencyboardwiththebuildinrevaluationruleforexchangerates.
  Ourproposed amendment uses the market value of IBC, P,vis‐à‐vis
the benchmark price as policy indicator to control our policy
instruments,V,Z and n.Theamendmentuses the marketvaluePwith
inflation rate α, i.e. P*exp(ατ) as policy indicator to control policy
instruments,V andn (τis timeperiods sincethe starting point).With
this rule, we can virtually absorb excessive currency or purchasing
powerincirculationduetocurrencydemandshocksorpolicymistakes.
Thatis,wemaynotbeabletoeliminatecurrencyincirculationbutwe
canreduceitsrealvaluebyallowinginflation.
21
  Howcanwedetermineinflationrateα?  Itisclearthatahigherαis
more effective at absorbing demand shocks. Figure 7 illustratesthis
situation.Horizontalaxisis convertedquantity, ratherthan(currency)
quantity.  Convertedquantity measuresthe real purchasing power of
IBCintermsofbenchmarkcurrency.Withhigherα,realpurchasing
poweratthemomentshiftsfromLtoL
** and equilibrium point also
shifts from E to E**. As a result, if a demand shock shifts D curve to
D**curve,thesupplysideabsorbthisshockandstabilizesthemarket
value/priceaccordingly.  
  However,it isnotnecessarilytruethathigherαisbetter. Higherα
impliesthatmonetaryvalue depreciatesquickly.Withhigherα,people
wouldavoidholding IBCperse.If theIBCsystem maintains adelayed
finalityconfirmationstructureliketheBitcoinsystem,participants
mustholdIBCintheirwalletfor a while after receiving IBC as their
rewardforminingorinexchangeforthetransactionofgoodsand
services.  ItwouldbepainfulforIBCholderstoseesuchdepreciation
duringtheirhoardingperiod.
  Inordertomakeourbuilt‐inrevaluationrulepracticallyworkable,it
maybe betterto separate theIBC operationrule fromthe benchmark
price vis‐à‐vis the U.S. dollar. To do so, we need to investigate an
intrinsicvalueforIBC.   
6‐3.MonetaryPolicywithoutaCentralBank
ThefirsttaskistoconstructanIBCsupplyrulethatcanabsorb a
positivedemandshock.FromourdiscussioninSections6‐1and6‐2,if
theIBCsystemcanadjustsupplyproportionaltocomputationalpower,
themarketvalue/priceofIBCwouldriseandnewminerswould
participatein IBCmining. Forthe long run33 we can constructan IBC
supplyschedulesimilartoFigure6. 
RecallinSection3weobtainthefollowingresult,  ≒ 2/.The
current Bitcoin system adjusts difficulty parameter n to stabilize an
averagewaitingtimeθasthenumberofminersMincrease.Whatwill

33 HerethedemandandsupplyadjustmentpresumesnewentryoftheIBCminers. 
22
happen if nisnotadjustedtoanincreaseinM?Fromeq.(5),θ will
shrinkinverselyproportionaltoM.Ifarewardfortheproofof work V
isfixedforacertainperiod, new IBCissueperhour(Z=V/θ)would go
upordowndependingonM.  Ifθbecomestoosmall,ncouldberaised
(i.e. n+1 would double θ)oralternativelyVcouldbedoubled.In
allowingforthedurationofablockformationθtoshortenasM
increases, a duration of finality confirmation would also be shorten.
That has merit, but, at the same time, the risk of admitting double
spends increases.  Recall that the new issue policy Z=V/θ depends
solelyonM34.
  NowtheIBCsystemhasacquiredabuilt‐inrevaluationmechanism35. 
Itisthefirststeptowardsmonetarypolicywithoutacentralbank.The
monetaryvalueofIBCwithsucharulewillbefarmorestableover
time:anupwardchangeinpriceinducesnewentryofminersuptothe
pointwherethemarginal costbecomesequaltothe rewardmeasured
inthepriceofIBC. 

  As discussed in Section 6‐1, the IBC system can accommodate a
positivedemandshock(i.e.anupwardchangeofpriceoradeflationary
shock).Thissystemcannotreact properly toanegativedemandshock
(i.e.adownwardchangeofpriceoraninflationaryshock).Isthereany
remedyforthis?  
6‐4.ImplicitInflationTargetinCryptocurrency
TheansweristosetastructurethatmakestheIBCminingcost
(determinesthe market value/priceof IBC)gradually decreasingover
time.Tobemoreprecise,arewardVforablockformationincreasesat
a designated growth rate of β. Together with a technological change

34 This is somewhat related to the labor theory of value, initiallysuggestedbyAdamSmith,
DavidRicardo,andKarlMarx.ThevalueofIBCisdirectlylinkedwiththeminingwork.  Thatis
tosay, the real economic activity islinkedwithmonetary economy.This is also relatedto the
ideaofthegoldstandardinwhichthegoldisconvertiblewiththepapermoneyatthefixedrate.
Thegoldistherealanchor. 
35 Allowingfortheseamendments,theIBCprotocolhastobecompletelychanged.Forexample,
duetothealterationofsupplyrule,totalamountofIBCsupplyshouldbeinfinite.  Durationofa
blockformationcanbevariable. 
23
rateγ36,theIBCminingcostperhourdecreasesattherateofβγ;market
participantsexpect inflation at exp(βγ)perhourandtherealvalueof
IBC would drop.  As long as a negative demand shock reduces IBC
demand within the range of IBC value depreciation, we can avoid
unexpectedIBCinflationshocks. 
 From Figure 7, the point L**istherealIBCpurchasingpower
discounted by expected inflation. L‐L** is depreciation of purchasing
power.IfanegativedemandshockfallsintherangebetweenDandD**,
suchashockcanbeabsorbedperfectly.Takingintoaccountofinflation
expectationintheIBCvaluation,aninflationaryshockviamonetary
policycanbeoffset.   
We note this rule is closely related to the inflation targeting policy
implementedbymanycentralbanks.  Inflationtargetingiseffectivein
softening an unexpected inflectionally shock37. Thecurrentrulehas
thesameeffect.Wemaycallthisruleanimplicitinflationtarget for
cryptocurrency.Thisrule,however,isdifferentfrominflationtargeting
bythecentralbanks,inthattheirinflationtargetdependsheavily on
expectationsformationbythepublic,andcredibilityofthecentralbank
ingeneralandthegovernorinparticular.Bothdonotnecessarily have
strong linkages with the real economy, as a result, their effects are
sometimesvague and usuallycontroversial. Ourrule, on thecontrary,
dependsonaneconomic principle, i.e.thecoststructureof themining
thatisrealeconomicactivity.   
7. FriedrichA.Hayek’sCurrencyCompetition
WehaveanalyzedtheBitcoinsystemingeneralandtheroleof
miningastheproofofwork. We’veproposed analternativetoBitcoin,
Improved Bitcoin (IBC) that is supposed to overcome the inherent
instabilityofBitcoin.ButcanIBCcompetewithmajorcurrenciesissued

36 Astechnologicalchange increases in k (k=K/2256; K=computationalpower),IBC supply per
hour will increase through shortening θ. We assume the technological change rate γis
exogenouslygiven. 
37 Fordetaileddiscussions,seeIwamuraandWatanabe(2006).  
24
bymajorcentralbanks?Wenoteatleastfourproblemswithsuch
cryptocurrencies.
First, cryptocurrencies are more expensive to produce, and the
productioncostsarehardtoretrieve.  Banknotesissuedbythecentral
banks require some printing and material costs. These costs are
negligiblecomparedwiththeface(nominal)value.  
Second,banknotesarereversiblebetweennewissuesand
absorptionbecausethecentral bank basicallybuysandsells securities
with bank notes.  A cryptocurrency cannot be absorbed, but if
equippedwithabuilt‐invaluestabilizationmechanism,thisshortfallof
irreversibilitycanbesoftened(butnoteliminated)inpractice. 
Third, Bitcoin‐type cryptocurrencies use a delayed finality
confirmationstructuretoavoiddoublespending.Consequentlyit
typicallytakeshourstouseobtainedmoney.  Banknotescanbeused
immediatelyasobtained. 
Fourth, Bitcoin type cryptocurrencies face security risks, suchas
DenialofServiceattacks,morewidelythanbanknotes.

  Thethirdandfourthpointsarerelativeproblems,andalsointrinsic
to Bitcoin‐type currencies.  They are not general problems with
cryptocurrency.Thethirdpointconsidersaproblemdirectlycompared
withbank notesfor directtransactions. Consideringtransactions with
Bitcoin‐type currency may occur over a remote distance, finality
confirmation may be quicker and much cheaper with a Bitcoin‐type
currencythanthatthroughabank.  Thefourthpointiscloselyrelated
totheprotocoldesignofaBitcoin‐typecurrency,andisnotageneral
cryptocurrency issue.  The instability associated with mining pools
due to strategic behaviors between and within pools can be reduced
substantially if the valuation system is improved in line with our
suggestions. 
Thefirstandsecondpointsarefundamentalshortfallsof
cryptocurrency. As currently described, cryptocurrency values are
25
based on associated production costs. This mechanism is similar to
commoditymoney,notablygoldandsilvercoins.  Historicallygoldand
silvercoinshavebeenreplacedbycredit(orfiat)moneybasically
becauseoftheabove‐mentionedfirstandsecondpoints.
  AsVanceandStone(2014)reports,theproductioncostofBitcoinare
the mainly variable costs of equipment and electricity. In general
Bitcoinminingappearstobealoss‐makingbutstableindustry(i.e.no
net entry). Under these circumstances, the Bitcoin reward per hour
reflectsthemarginalcostofmining.Forexample,ifthemarketvalueof
BitcoinisUSD$600,  then the Bitcoinsystemis maintainedbyissuing
25*600 =$15000 dollarsper tenminutes (i.e. 90 thousand dollarper
hour, 2.16 million dollar per day). This is not a small amount.The
Bitcoinsystem isoftendescribedasinexpensivebecausemaintenance
costsarenotchargedtotheBitcoinusers,butaregeneratedasreward
tomining.  Inshort,Bitcoinisbasedonasystemthattakesadvantage
ofanexternality.Itisnotacheapsystematall.
  Thiscapitalization‐by‐externality willbe liquidatedsometime inthe
future. A collapse in Bitcoin value might happen in the near future.
Whopaysthisbill?
  Ourproposed amendedsupply schedule,i.e. thebuilt‐inrevaluation
mechanism and the implicit inflation target has an implication beside
the value stabilization of IBC. These rules would prevent excessive
currencydemandduetotheexternality.  Thesameistrueofgoldand
silvercoins: itis trulywaste of limited resources if such arekept ina
safeorincomputersafterexpendingalargeproductionorminingcost.
Thencanwesaybanknotesaresuperiortocryptocurrencies?Notwith
anycertainty. 
  Directproduction costsof banknotes arenot high.  Butwe cannot
ignoretheimplicitcostsgenerated dependence of monetary value on
policy decisions by governments or central banks. The central bank
alwayshasanoptiontoengageinanunexpectedpolicychange.Many
economists agree that perfectly expected inflation is welfare neutral. 
26
But under the name of a bold policy initiative, monetary policymay
generate welfare losses due to unexpected inflationary and/or
deflationarypressures. 
  Reversibilityofbanknotes‐betweennewissuesandabsorption‐is
basedontheexchangebetweenbanknotesandgovernmentbondsat
somepointintime.Thisisnothingtobeproudof.  Ifthecredibilityof
governmentbondsisshaken,thatofbanknoteswouldbealsoshaken. 
Onthecontrary,ifgovernmentbondsdominatethecapitalmarket,the
centralbank,simply monetizing it,hastoworryaboutever‐expanding
its balance sheet 38 .Reversibilityofbanknoteshasmerit,and
inescapablecosts. 
Shall we prefer bank notes or a cryptocurrency? There is no
unconditional answer. Bitcoin‐type cryptocurrencies, with some
amendments,canbereasonablycompetitivewithcentralbanknotesin
terms of value/price stability. Currency competition in a senseof
FridrichA.Hayekisdesirable.Suchcompetitionmustbeencouraged,
notonlybetweencentralbanknotesandacryptocurrency,butalso
betweencentralbanknotesandamongdifferentcryptocurrencies. 
Indeed, currency competitions among cryptocurrencies are already
takingplace.Somehundredsofcryptocurrencies already exist,
followingthesensationalsuccessofBitcoin.  Ifthiswasthe‘bigbang’
of currency competition among cryptocurrencies, a better designed
cryptocurrency(suchasanIBC)mayemergeandbecomestrong
contendertothecentralbanknotes.
Howaboutcentralbanknotes?Centralbankersarekeenon
international cooperation, but not so keen currency competition. The
currentgenerationofcentralbankersinU.S.,EuropeandJapanindicate
tomarketsthattheycaremoreforbusinessthanforpricestability.   It
isincreasinglyacceptedthatpricestabilitymaynotbetheonlygoalof
central bankers. Excessive international cooperation may obstruct

38 Fiscaltheoryofthepricelevel(FTPL)discussestheseissues.SeeIwamuraandWatanabe
(2002)forafulldiscussion. 
27
capitalsexit;ifinvestorsworryaboutthefutureoftheyen,thenthe
prospectsoftheEuroordollararenotsodifferentunderthecurrent
setof circumstances.  Some investorshaveconsequently shiftedtheir
capital to Bitcoin, in which thepriceisveryvolatileandnocredible
authorityguaranteesitsvalue.  
  Centralbankersshouldnotindulgeinponderinghowtogiveminor
shocks to markets, given limited usages of money, but they should
investigate why people are so attracted to Bitcoin and what features
canbeusedinmonetarypolicy. 
 The key differentiation of Bitcoin from central bank notes and
existingdigitalcashtypeelectronicmoneyisaframeworkinwhichall
vintage information of each segment of Bitcoin are recorded39. Not
manypeopleareawareofthisusefulfeatureofBitcoin.  Ifthisfeature
isintroducedintobanknotelikeelectronicmoney,eachatomofbank
note‐likeelectronicmoneywithitsvintageinformationcanreflecttime
value, i.e. each note is priced differently according to the time passed
sinceits issuance.  In otherwords,we can provideinterestwith each
note. This system implies that owners of bank note‐like electronic
money can receive interest or pay some penalty, depending on
economic conditions. In the current central banking system, these
benefitsaretransferredtothegovernmentasseigniorage.Notethatthe
monetaryinterestrate,asmeasuredaunitofmoneytoday,ishow
muchthesameamountisanticipatedtobeworthoneyearfromnow.It
isdifferentfromnominalinterestratethatisareturnfrominvestment
ofzerointerestbearingmoney40.
If the legal system permits, these bank note‐like electronic moneys
can provide a substantial business opportunity. Strangely, the current
generationofcentralbankersdonotpayalotofattentiontothe

39 In practice, when Bitcoin is issued, all vintage information is recorded. After some
transactions, divisions and merges are repeated so that original vintage information can no
longercarryover.  Adesignofelectronicmoneythat can keepallvintageinformationcannot
beusedintheBitcoinsystemasitisnow.Wesupposethereisawaytomaintainallvintage
informationevenafterrepeatedtransactions.Itisanimportantresearchquestion.
40 SilvioGesell(1918)advocatedthe ideaofstamped money.Hisideaisusedinsomeregional
moneysnow.Alas,mostofthesemoneysemployonlyintheregionofnegativeinterestrate(i.e.
penaltycharge). It is alsoworthwhilepointingout that Keynes (1936) spares hisChapter 23,
Section6todiscussandevaluateGesell’sideaofstampedmoneypositively.
28
associatedopportunities:toexpandtheflexibilityofmonetarypolicyby
convertingfrompapermoneytobank note‐likeelectronic money with
vintageinformation.With this framework,centralbanksare nolonger
vulnerableto Keynes’ (1936)liquidity trap,byavoidance ofthe  zero
lowerboundinterestrate41.
8. Conclusion
Why Bitcoin did not exist until recently? Decentralized money
provision, and similar economic systems with P2P technology, were
proposedwellbeforeBitcoin.Butthesetrialsfailedtogrowlike
Bitcoin. Perhaps early challengers may take the nature of moneyand
autonomyofeconomicactivitytooseriously.
The major drivers behind Bitcoins success are (1) a naïve
understandingofcurrency,(2)theemploymentofan
easy‐to‐understand asymmetric key cryptosystem for validation of
transactions and a virtual register system, and (3) the creation of a
participatory system with a P2P network maintained by the elliptic
curvedigitalsignaturealgorithmandahashfunction.  Thisframework
hasattractedmanyprogrammersandcollaboratorstoimproveuser
softwareandthat,inturn,attractmanyusersofBitcoin.  
In addition, the originator of Bitcoin ‐ Satoshi Nakamoto ‐ and his
collaborators demonstrated they can create a currency without a
centralbankviaproofofwork,andthatthereexistsdemandforsucha
currency.  
  AunexpectedfeatureofBitcoinisthat,contrarytotheoriginalbelief
of Satoshi Nakamoto that he can create currency without inflation by
meansofcontrollingandpreannouncingtotalsupplyofBitcoin,the
marketvalue/priceofBitcoinfluctuatesup(deflationorthevalue of
Bitcoingoesup)anddown(inflationorthevalueofBitcoingoesdown).

41 It is possible to add vintage information to the current paper money by printing the issue
date.Itwouldbefartroublesometohandleeachnotedifferently.  Ifincaseofdigitalcurrency,
thatproblemcanbesolvedeasily.  
29
We hope that Satoshi Nakamoto’s important contributions can nullify
his misunderstandings. We are grateful to Satoshi for his imperfect
Bitcoininnovation.  There remainsmuchroomforimprovement,and
fordiscussionofourfuturemonetarysystem. 
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Figure1FlowChartoftheProofofWork
Figure2MarketPriceofBitcoininUSDasofOctober25,2014
Source: blockchain.info.
Figure3.SupplyandDemandofBitcoin:CaseofaVerticalSupplyCurve
D**
D D*
P*
P**
P
L
S
E
E*
E**
O
Value
Quantity
Figure4.SupplyandDemandoftheGoldCoin:CaseofUpwardSloping
SupplyCurve
D**
D D*
P*
P**
P
S
E
E**
E*
O
Value
Quantity
Figure5.ShareofMiningPoolasofOctober25,2014.
Source: blockchain.info
Figure6.SupplyandDemandofImprovedBitcoin:CaseofKinkedSupply
Curve
D**
DD*
P**
P
L
S
L*
EE*
E**
O
Value
Quantity
Figure7.SupplyandDemandofImprovedBitcoin:CaseofAmended
SupplyCurve
D**
D D*
P
L
S
L*
EE*E**
L**
O
Value
Converted Quantity
... One problem with the early studies on the prices of Bitcoin is that there is barely enough data to set up the model to predict the evolution of Bitcoin from the stances of macroeconomics. Nevertheless, combining the findings from Harwick and the U.S. market price data of the Bitcoin, Iwamura was able to find that inflation somehow does affect the cryptocurrency but acts differently as inflation affects gold [5][6][7][8]. As a young and Advances in Economics, Business and Management Research,volume 190 evolving type of currency, there is not enough research about the relationship between certain factors and the value of the cryptocurrency. ...
... As Harwickproved that cryptocurrency does have the qualities of a useful commodity for exchange, this paper assumed that Bitcoin can become a new currency in the U.S [5]. Taking account of Sovbetov's idea and combining with the finding of Iwamura, since inflation rate (inflation), current account balance (current account), and interest rate (interest) are all factors that will affect the value of a currency, one additional hypothesis was that Bitcoin may also be affected by these variables [7,8]. ...
... Iwamura et al. [137,231] propose a combination of dynamic mining reward and automatic inflation of coins. In a different approach, Caginalp et al. argue [48] that since cryptocurrencies have no underlying value measured by "traditional techniques" that are used to value stocks, bonds or derivatives, new models are necessary. ...
Thesis
Die Erfindung von Bitcoin hat ein großes Interesse an dezentralen Systemen geweckt. Eine häufige Zuschreibung an dezentrale Systeme ist dabei, dass eine Dezentralisierung automatisch zu einer höheren Sicherheit und Widerstandsfähigkeit gegenüber Angriffen führt. Diese Dissertation widmet sich dieser Zuschreibung, indem untersucht wird, ob dezentralisierte Anwendungen tatsächlich so robust sind. Dafür werden exemplarisch drei Systeme untersucht, die häufig als Komponenten in komplexen Blockchain-Anwendungen benutzt werden: Ethereum als Infrastruktur, IPFS zur verteilten Datenspeicherung und schließlich "Stablecoins" als Tokens mit Wertstabilität. Die Sicherheit und Robustheit dieser einzelnen Komponenten bestimmt maßgeblich die Sicherheit des Gesamtsystems in dem sie verwendet werden; darüber hinaus erlaubt der Fokus auf Komponenten Schlussfolgerungen über individuelle Anwendungen hinaus. Für die entsprechende Analyse bedient sich diese Arbeit einer empirisch motivierten, meist Netzwerklayer-basierten Perspektive -- angereichert mit einer ökonomischen im Kontext von Wertstabilen Tokens. Dieses empirische Verständnis ermöglicht es Aussagen über die inhärenten Eigenschaften der studierten Systeme zu treffen. Ein zentrales Ergebnis dieser Arbeit ist die Entdeckung und Demonstration einer "Eclipse-Attack" auf das Ethereum Overlay. Mittels eines solchen Angriffs kann ein Angreifer die Verbreitung von Transaktionen und Blöcken behindern und Netzwerkteilnehmer aus dem Overlay ausschließen. Des weiteren wird das IPFS-Netzwerk umfassend analysiert und kartografiert mithilfe (1) systematischer Crawls der DHT sowie (2) des Mitschneidens von Anfragenachrichten für Daten. Erkenntlich wird hierbei, dass die hybride Overlay-Struktur von IPFS Segen und Fluch zugleich ist, da das Gesamtsystem zwar robust gegen Angriffe ist, gleichzeitig aber eine umfassende Überwachung der Netzwerkteilnehmer ermöglicht wird. Im Rahmen der wertstabilen Kryptowährungen wird ein Klassifikations-Framework vorgestellt und auf aktuelle Entwicklungen im Gebiet der "Stablecoins" angewandt. Mit diesem Framework wird somit (1) der aktuelle Zustand der Stablecoin-Landschaft sortiert und (2) ein Mittel zur Verfügung gestellt, um auch zukünftige Designs einzuordnen und zu verstehen.
... The other is to act as a new kind of asset which allows hedging against uncertainty, stocks, and the US dollar [3][4][5][6] and to present an opportunity to build well-diversified portfolios [7,8]. However, some researchers claim that Bitcoin possesses more characteristics of being a digital asset rather than an alternative currency because it exhibits large average returns and high volatility [9][10][11]. Given that it has a low correlation with traditional assets [12][13][14] in forming well-diversified portfolios and is highly volatile and speculative compared to other currencies [15,16], forecasting the volatility of Bitcoin is of paramount importance for investors in optimal hedging, option pricing and portfolio diversification. ...
Article
Modelling the volatility of Bitcoin, the cryptocurrency with the largest market share, has recently attracted considerable attention from researchers, practitioners and investors in financial markets and portfolio management. For this purpose, a wide variety of GARCH-type models have been employed. However, there is no consensus in the literature on which specification arising from the volatility equation and the assumed error distribution is better in an out-of-sample performance. This study tries to fill this gap by comparing the forecasting performances of 110 GARCH-type models for Bitcoin volatility. Furthermore, it proposes a new combining method based on support vector machines (SVM). This method effectively selects the set of superior models to perform meta-learning. The results indicate that the best performing GARCH specification depends on the loss function chosen, and the proposed method leads to more accurate volatility forecasts than those of the best GARCH-type models and other combining methods investigated.
... He first analyzed Proof-of-Work by the overlapping-generations model [55]-a framework used in economics-and pointed out that it can cause exceptional price volatility and welfare impairment. To solve the problem, Saleh [54] recommends us to adopt Proof-of-Burn algorithm 23 in which, to create new blocks, miners need to send a certain amount of their coins to an unspendable (locked) 16 See also Iwamura et al. [53]. 17 Note that these studies based on the Bitcoin protocol do not apply to stablecoin in the definition by Lund [15], as they do not envision pegging their value to another asset. ...
Thesis
Les impacts du processus de numérisation de l’économie sur la fiscalité sont devenus le thème central du droit fiscal international ces dernières années, provoquant plusieurs réactions parmi les acteurs de ce champ. L’OCDE est devenue le principal forum de débat, faisant graviter autour des textes de l’organisation les organismes gouvernementaux, les contribuables et l’académie. Cependant, ce débat n’a cessé d’évoluer, adoptant de nouveaux éléments de langage et des perspectives différentes. D’un débat juridique formel concernant la caractérisation des paiements pour appliquer les conventions fiscales internationales, la discussion est passée à une perspective qui met l’accent sur la substance économique. Enfin, le débat sur l’économie numérique a pris une connotation politique manifeste, remettant en cause le champ fiscal international lui-même. Cette thèse vise à comprendre comment et pourquoi la numérisation de l’économie a réussi à impacter les fondamentaux qui soutiennent le champ fiscal international. Cette thèse adopte une perspective juridique, réaliste et discursive pour atteindre son objectif, concevant le droit fiscal international comme un champ formé d’événements historiquement identifiables. Dans ce cas, en tant que phénomène social, la fiscalité internationale est l’objet central d’un projet qui se manifeste tant au niveau institutionnel qu’intellectuel. À son tour, la numérisation de l’économie résulte d’une révolution technologique caractérisée par la primauté de la phénoménologie informationnelle. Cette primauté est responsable d’un processus de transformation sociale qui touche non seulement le plan institutionnel du champ fiscal mais également sa dimension intellectuelle. Dans ce scénario, les acteurs du champ perçoivent leur incapacité à faire face à la nouvelle réalité numérique à partir des outils conceptuels fournis par le discours juridique fiscal. Le résultat est un changement de paradigme avec le potentiel d’affecter non seulement la pratique sociale du champ, mais sa propre signification au sein d’un projet intellectuel de construction de la dimension humaine.
Conference Paper
This work investigates the factors determining the Kazakh energy crisis which occurred in the second half of 2021. From the correlation observed among some data gathered to the purpose of the analysis, the relevant role played in this by cryptocurrency mining factories is identified. Beginning from June 2021, a massive number of them were relocated to Kazakhstan from the Popular Republic of China (PRC) because of normative restrictions introduced by the latter. The work also develops a reflection aimed at understanding the economic and environmental impact which has been produced by this relocation. The descriptive analysis will proceed as follows: the first section of the article will focus on the regulation of cryptocurrencies; the second section will focus on final electricity consumption and sup-porting empirical evidence and is closely related to the third and last section; the latter will focus on primary macro-economic indicators in relation to the increase in CO2 emissions in the Kazakh republic. To this end, it is useful to demonstrate a correlation between the energy crisis, the transfer of cryptocurrency mining to Kazakhstan, and to fuel the discussion regarding the need for a supranational institution with the aim of codifying a common international legislation, thus reinforcing the efforts made so far in this direction. Present and future implications and scenarios de-rived by the analysis are also introduced.
Preprint
This study attempts to study cryptocurrency's public perception through exploring factors of cryptocurrency commercialization in the United States. We focus on two major applications of cryptocurrency, cryptocurrency as a payment method and cryptocurrency as an alternative currency. Given that the scope of the success of cryptocurrency is dependent on gaining public acceptance, the Technology Acceptance Model (TAM) was adopted and utilized to quantify several subjective adoption factors such as perception. An online survey