In a novel model of an endowment economy, we analyze coexistence and competition between traditional fiat money (Dollar) and another intrinsically worthless medium of exchange, not controlled by a central bank, such as Bitcoin. Agents can trade consumption goods in either currency or hold on to currency for speculative purposes. A central bank ensures a Dollar inflation target, while Bitcoin mining is decentralized via proof-of-work. We analyze Bitcoin price evolution and interaction between the Bitcoin price and monetary policy which targets the Dollar. We obtain a fundamental pricing equation, which in its simplest form implies that Bitcoin prices form a martingale. We derive conditions, under which Bitcoin speculation cannot happen, and the fundamental pricing equation must hold. We show that the block rewards are not a tax on Bitcoin holders: they are financed by Dollar taxes imposed by the Dollar central bank. We discuss monetary policy implications and characterize the range of equilibria.

More Research From These Scholars

BFI Working Paper May 1, 2011

Fiscal Stimulus and Distortionary Taxation

Thorsten Drautzburg
Topics:  Fiscal Studies, Monetary Policy
BFI Working Paper Feb 1, 2012

How Do Laffer Curves Differ Across Countries?

Harald Uhlig, Mathias Trabandt
Topics:  Fiscal Studies, Monetary Policy
BFI Working Paper May 8, 2018

The Dynamics of Sovereign Debt Crises and Bailouts

Francisco Roch, Harald Uhlig
Topics:  Fiscal Studies, Monetary Policy