Humboldt-Universität zu Berlin - High Dimensional Nonstationary Time Series

Coins with benefits: on existence, pricing kernel and risk premium of
cryptocurrencies

Cathy Yi-Hsuan Chen
Dmitri Vinogradov

Abstract:
Cryptocurrencies come with benefits, such as anonymity of payments and positive
network effects of user adoption, and transaction risks including unconfirmed
transactions, hacks, and frauds. They compete with central-bank-regulated money
but consumers may prefer one currency over the other. In our arbitrage-free
world utility from consumption depends on benefits, which are governed by
distinct stochastic processes, implying incomplete markets and distinct pricing
kernels. We characterize the cryptocurrency kernels, evaluate the otherwise
unobservable benefits, and show their contribution to pricing. The model
explains both the co-existence of the two currencies and the high volatility of
the cryptocurrency price.

Keywords:
Bitcoin, cryptocurrency, pricing kernel, currency competition

JEL Classification:
A1, D0, E21, G12