On the Value of Virtual Currencies

Abstract

Our economic framework suggests that the exchange rate of virtual currency is determined by three components. First, the current value of transactions in virtual currency which absorb part of the exchange rate risk. Second, the decisions and expectations of forward-looking investors to buy virtual currency (thereby effectively regulating its supply). Third, the elements that jointly drive future consumer adoption and merchant acceptance of virtual currency. The model predicts that, as virtual currency becomes more established, the exchange rate will become less sensitive to the impact of shocks to speculators' beliefs. This undermines the notion that excessive exchange rate volatility will prohibit widespread use of virtual currency.