New York University Professor: Private Digital Currency Brings Benefits to Governments and Citizens

"How does private digital currency affect government policy?"

This issue is the focus of a recent academic paper published by Max Raskin, a professor at New York University School of Law, Fahad Saleh, a professor at McGill University's De Souters School of Management, and David Yermack, a professor at New York University's Stern School of Business.

The paper builds on the research of many scholars who discuss how Bitcoin and other digital currencies interact with free-market, political, and social entities.

In this latest paper, scholars say:

"The existence of private digital currencies such as Bitcoin can bring benefits to governments and citizens."

The paper also emphasizes that Bitcoin has a major impact on corrupt emerging markets (referring to highly volatile economies and governments based on private interests rather than citizen welfare).

The following is a translation of the paper:

How does private digital currency affect government policy?



This paper provides a systematic evaluation of different types of digital currencies.

We are skeptical about the centralized digital currency and therefore focus on economic analysis of private digital currencies. Specifically, we highlight the potential of private digital currencies to improve welfare in an emerging market with selfish government. In this case, we demonstrate that private digital currencies can not only improve citizen welfare, but also encourage local investment to improve government welfare. The fact that private digital currencies can raise government welfare suggests a loose regulatory policy that allows citizens to receive the better benefits previously mentioned.

Keywords: cryptocurrency, digital currency, bitcoin, blockchain

JEL classification: E42, F30, G18, O38

I. Introduction

The currency crisis is nothing new. As long as governments maintain a monopoly on the right to print money, there is a incentive to devalue the national sovereign currency. From the ancient Roman Empire to Zimbabwe in Robert Mugabe, citizens’ loss of confidence in the government’s currency often heralds a recession. In order to alleviate or weather such a crash, individuals in history have turned to alternatives to state-backed currencies. These alternatives include more stable sovereign currencies (such as the US dollar) or commodities such as gold and silver. This article explores a new alternative to state-backed currencies: private digital currencies.

Bitcoin was the first and most successful private cryptocurrency, which was born after the 2007-2008 financial crisis. The first block of the Bitcoin blockchain, which was born on January 3, 2009, contained the title headline of the London Times at the time: "The Chancellor of the Exchequer is on the verge of implementing the second round of bank emergency assistance." The text suggests that Bitcoin creators are skeptical about the government-run banking system. Satoshi Nakamoto, the founder of Bitcoin, said very clearly: "People must trust the central bank not to reduce the value of money, but the history of legal currency is full of damage to this trust. Banks must be trusted to keep us Money, and electronic transfer, but they lend a lot of money in the wave of credit bubbles, while the reserve is only a small part." Nakamoto believes that Bitcoin can become a "crypto-based proof, and There is no need to trust secure electronic money from third-party intermediaries." In other words, the idea is to decentralize and privatize the issuance of digital currencies.

Nakamoto said that the decentralization of money is like the decentralization of data security. Before strong encryption, users must rely on central third parties to store and protect their data. The use of encryption enables individuals to store their data securely without having to trust a third party. This is similar to the Bitcoin blockchain, through which individuals can transfer value without the need for centralized centralization, but instead rely on a network with minimal trust.

This analogy is instructive, because while individuals are technically likely to protect their data, the growth and success of social media companies suggests that this decision is precisely what many people choose not to do. Expanding this analogy, in developed countries, the vast majority of people choose to continue to participate in the government-operated banking system and use government-backed currencies. After the 2007-2008 financial crisis, people were not eager to buy bitcoin or other digital currencies, and the dollar began to strengthen.

At first glance, the vision of Nakamoto has not been realized. However, when we surveyed developing countries, the situation was somewhat different. After the financial crisis, the value of sovereign currency in some developing countries has fallen sharply and is close to the crisis level. Two obvious examples are the Turkish lira and the Argentine peso. Due to Turkey's high account deficit and huge dollar debt, the lira lost about a third of its value in 2018. The Argentine peso lost about half of its value in 2018 because the country is struggling with fiscal and trade deficits.

This is the first currency crisis since the birth of Bitcoin, so they provide an opportunity to investigate the impact of alternative digital currencies on unstable sovereign currencies. According to speculation, this may indicate that Nakamoto's vision has been achieved. Although private digital currencies do not replace the US dollar, their existence may have counterfactual effects because they exist as supervisors of fiscal and regulatory policies.

And this article will prove this statement.

The paper emphasizes that private digital currencies have a major impact on emerging markets for corruption. We define corrupt emerging markets as highly volatile economies and governments based on private interests without regard to citizen welfare. We simulate the interaction between government and citizens in this environment. We considered endogenous fiscal, monetary, and regulatory policies and then identified three main findings.

Our first discovery proves that citizens can benefit from the existence of private digital currencies. Citizens gain these benefits through two channels: First, as Dyhrberg (2016), Chan, Le, and Wu (2019) study, the existence of private digital currencies offers a variety of options. We have shown that this diversity creates benefits for citizens. Second, private digital currencies act as competitors for local investment, so their existence constrains monetary policy and can result in lower inflation rates.

Our second finding emphasizes that private digital currencies can encourage local investment. This discovery also operates through two channels. First, we show that private digital currencies are often used as supplements by citizens rather than as a substitute for local investment, so when citizens acquire private digital currencies, they not only invest in the currency, but also expand the local economy. investment. Second, the existence of a private digital currency can achieve oversight of monetary policy by creating a substitute for local legal currency. Monetary policy controls reduce inflation and lead to higher returns on investment, which in turn encourages local investment.

Our third finding suggests that the government may benefit from allowing the local economy to use private digital currencies. This finding was made because the government obtained income from citizens through taxation, and the increase in local investment brought higher tax revenue to the government. This finding is especially important because it means that the citizen welfare discussed earlier will increase because of this relationship .

Our papers contribute to the growth of the blockchain economy and cryptocurrency research literature. The earliest related literature can be traced back to Yermack (2015), which provides the first study of Bitcoin return attributes. Since then, the literature has exploded into several sub-areas. Harvey (2016) and Yermack (2017) provide an overview of blockchain and finance. Biais, Bisi'ere, Bouvard, Casamatta (2019), and Saleh (2019a) analyzed the content of consensus agreement game theory. Easley, O'Hara, Basu (2019), Huberman, Leshno, and Moallemi (2019) investigated the role of fees in Bitcoin. Biais, Bisi'ere, Bouvard, Casamatta, and Menkveld (2018) studied cryptocurrency pricing. Hinzen, John, and Saleh (2019) studied and explained the limited use of some cryptocurrencies. Makarov and Schoar (2019) studied arbitrage and price formation in the cryptocurrency market. Cong, He (2019) and Cong, Li, and Wang (2018) studied the economic impact of smart contracts. Howell, Niessner, and Yermack (2019) conducted an empirical analysis of ICO, while Chod and Lyanders (2018) and Li and Mann (2018) developed basic economic theories to understand ICO. Griffin and Shams (2018) and Li, Shin, and Wang (2019) emphasize the price manipulation phenomenon that exists in the cryptocurrency market. Foley, Karlsen, and Putnins (2019) confirmed that a large portion of bitcoin transactions are related to illegal activities.

Our papers are most closely related to the studies of Dyrberg (2016), Chan, Le and Wu (2019), Yu and Zhang (2018) and Saleh (2019b). Dyrberg (2016), Chan, Le, and Wu (2019) empirically determined the hedge value of cryptocurrencies. We theoretically emphasize that such value has important welfare effects for emerging markets. Yu and Zhang (2018) are mainly based on experience and believe that when the local economy encounters difficulties, demand will turn to cryptocurrency. Our theory provides an explanation for this shift. Saleh (2019b) studied the welfare effects of cryptocurrencies in different environments, but also found evidence that cryptocurrencies might increase welfare. Our paper is also closely related to the research work of Raskin and Yermack (2016), who discussed the digital currency in the context of the central bank.

The rest of this paper is organized as follows: Section 2 categorizes existing digital currencies. This type of typology not only contributes to the purpose of this article, but also to future research. The focus of this article is on private decentralized digital currency, a unique innovation born from the creation of bitcoin and blockchain. The article will briefly discuss the centralization of public digital currency (also known as the central bank digital currency). The paper expresses doubts about the novelty of the central bank's digital currency, which in many respects only mimics the existing financial system. Section 3 provides a formal economic analysis of the impact of private digital currencies on emerging markets in corruption. We found that private digital currencies have improved citizen welfare, encouraged local investment, and induced a loose regulatory policy. Section 4 is a summary.

Second, digital currency typology

Before analyzing the impact of digital currencies in an unstable monetary system, it is necessary to classify these tools. This paper proposes two axes of digital currency: whether it is state-sponsorship and whether it is centralization.

In the case of state-sponsorship axes, digital currencies can be public or private. Public digital currencies have some relationship with sovereign states, while private digital currencies have nothing to do with sovereign states, which are managed by private or entities. The key differences here will be discussed later, which are related to law enforcement. The state-sponsorship currency has an entity that can enforce the law that gives money privileges. There are many ways to give sovereign currency privileges, such as fiat currency law or taxation on competitive currencies. Regardless of the method used, public currencies have certain legal privileges relative to other currencies.

The second axis of typology is whether it is centralization. Digital currency can be centralized or decentralized. There are many definitions of centralization. For example, some people use mathematical calculations for centralization based on the number of market participants, nodes, miners, or other indicators. This paper uses different definitions.

If the digital currency has a formal barrier to entry, it blocks the software writing and verification process of participating in the network, then it is centralized. This definition asks if the code can be changed by some consensus mechanism. If one party is not blocked from participating in the network or no one is preventing the party from participating in the network, the network is decentralized. This is a qualitative understanding of centralization, and there are similarities in antitrust theory. In assessing barriers to entry in specific industries, there are both formal barriers to entry and economic barriers to entry. Formal barriers to entry may be legally prohibited or prevent new entrants from challenging the requirements of the incumbent. Economic barriers are phenomena such as economies of scale or upfront capital investments that can cost new entrants who want to challenge existing businesses.

This analysis also applies to digital currencies. Formal barriers to entry refer to centralized currency, which may prevent nodes from verifying transactions or prevent individuals from accessing and proposing changes to the code base. This article focuses on formal barriers to entry because of the ability to provide competitive alternatives in the context of emerging markets with unstable monetary institutions. Whether these alternatives are economically viable (especially compared to the currency of these economies) is one of the themes of this article.

Finally, it is worth noting that these distinctions are confirmed by the Securities and Exchange Commission ("SEC") " Digital Assets" investment contract "Framework Analysis ." The jurisdiction of the US Securities and Exchange Commission (SEC) is governed by a statutory language that enables it to take enforcement action against securities and all-encompassing "investment contracts."

When defining which digital assets are securities and which are currencies, the SEC must clarify some principles. Hinman (2018), Henderson, and Raskin (2019) pointed out that decentralization is one of the important principles for classifying digital assets as digital currencies. This decentralization is formal, not economic.

2, the application of typology

In applying this typology, the first category that exists is private decentralized digital currency , a typical example being bitcoin. Bitcoin has no privilege or legal protection provided by the government. It is decentralized because it is written and maintained in an open source manner and there are no formal barriers to participation in the Bitcoin blockchain network. Anyone with computing power can act as both a node and a miner. Litecoin and Ethereum are other examples of private decentralized digital currencies. This type of currency has properties similar to those of precious metals, and gold and silver do not have any privilege or endorsement by the government, and anyone can mine these precious metals.

The second category is privately centralized digital currency . These currencies are usually run by a holding company or consortium that controls the agreement to issue and maintain currency. Create and manage networks of these currencies to provide formal privileges for certain participants, not others. Those involved in currency distribution trust some of the characteristics of third parties, including supply, security, and replaceability. Examples of such currencies include managed currency, Libra and e-gold.

The third category is public centralized digital currency . Some sovereign countries have announced plans to issue their own digital currency. This article will discuss these proposals in depth, and their common features are sovereign control protocols, code bases, and interactions with the network. Basically all sovereign currencies today are publicly centralized digital currencies, which are digital. Their support and management is achieved by sovereign states with legal protection and privileges. For example, only institutions such as the Federal Reserve can issue US dollars, and no other entity can formally participate in the US dollar monetary policy.

The fourth is public decentralized digital currency . These currencies are supported by sovereign states, but sovereign states do not seek to exercise control over the currency. In the digital arena, this currency does not currently exist. The closest analogs would be gold, silver or commodity standards, which were adopted by the government at some point in history. For example, one of the basic principles behind the gold standard is that the state will give the dominant power to a currency that is not under its control, and the other is that they will be committed to non-discretionary monetary policy. The liquidity of gold and its characteristics cannot be controlled by a central government. The central government still grants gold privileges, similar to a developing country that uses the dollar as its standard. The gold standard or any public decentralized currency refers to the position of the government accepting the market or certain external entities can produce a better currency than it.

This paper takes public-centralized currency and private decentralized currency as the object of economic analysis. We will first discuss the digital currency proposals of central banks.

2, 2 central bank digital currency

At first glance, the concept of central bank digital currency is in opposition to bitcoin and other digital currencies. As mentioned earlier, the creation block of the Bitcoin blockchain refers to the instability of part of the reserve banking system and the state's sponsorship of financial institutions.

Some countries have announced plans to issue or study central bank digital currencies, examples include Sweden, China, Russia, Venezuela and the Marshall Islands. It is clear that the central bank's digital currency proposal is public and central. These proposals are very similar to the “Chicago Plan”, which is to reduce the size of the banking system by allowing individuals and small institutions to hold deposits directly in the central bank. The Fed is also re-launching such plans, and such proposals have both advantages and disadvantages. .

It is almost certain that the reduction of the banking system does not require the use of blockchains. Governments can use more traditional databases and technology solutions to track their digital currency. This may be similar to the technology used by existing centralized financial services companies PayPal and VISA.

Taking a specific case study, the Swedish central bank said in 2016 that it would launch an e-krona issued by the central bank. As with all similar programs, the details of the proposal are few, but the focus is on accelerating Sweden's exit from cash. According to the Swedish central bank: “Last month, nine out of ten people in Sweden used cash as a means of payment, and the corresponding figure in 2016 was eight out of ten.” The government hopes to replace cash for a number of reasons, including Tax evasion and taxation, as well as monitoring citizens' financial activities. Privacy advocates are skeptical about this mandatory cash transfer proposal, and they believe that if the market has a need for such a transfer, then the transfer should happen naturally.

The innovation of cryptocurrencies has never been because they are in digital form. In fact, digital currencies exist almost as long as computers. The innovation of these new private currencies is that they do not require a central authority to verify transactions and maintain the security and reliability of the system. When studying the central bank's digital currency, the key question that must be asked is: "Who is maintaining the code base of the central bank's digital currency?" If it is the central bank itself, then the issuance of central bank digital currency is not fundamentally different from the existing monetary system. The difference is whether an individual can open an account with the central bank. If it is private node maintenance, then monetary policy is not governed by the central bank, so it can not be regarded as the central bank digital currency.

2, 3 private digital currency competition

Private digital currencies face many legal obstacles that indicate why they have the potential to influence sovereign monetary policy. As with all monopoly privileges, the underlying reason behind entry barriers is to protect the incumbent's rate of return. In terms of monetary policy, it sets obstacles to competitive currencies and can support the central bank's own currency.

Raskin and Yermack (2016) discuss fiat currency law as one of these obstacles. However, the legal currency law only explains how a public currency initially replaced private money. Graham's law is widely described as "bad money expelling good money," which explains, if so, that people want to pay and trade in depreciating currencies. Selgin (1996) describes “putting buyers and sellers in the prisoner's dilemma. In this dilemma, the use of bad money represents a unique non-cooperative game.” Once the state-backed currency is controlled, the currency's network effect will It works, unless the central bank itself has any major mistakes, it will become a generally accepted exchange medium. While assuming the abolition of the legal currency law, some people suspect that competition in other currencies will become very intense.

Without considering the relative effectiveness of these barriers, the paper also discusses two barriers to private currency competition: tax treatment and banking regulation .

In terms of tax treatment, we will use the United States as an example to illustrate how taxation rights put private money at a disadvantage. When an individual's dollar appreciates, the individual does not have to pay capital gains tax or personal income tax, while other competing currencies do not. If the individual's bitcoin, gold or euro value increases and is sold, this is a taxable event. The US Internal Revenue Service (IRS) ruled that bitcoin is property and the federal government has the right to tax citizens. Any disposition must be reported in Schedule D of Form 1040, depending on whether the asset is held for more than one year, and the income is taxed on short-term or long-term capital gains.

This hinders the use of private money as an exchange medium in two main ways.

First, it increases the actual cost of the transaction; second, it raises reporting requirements and thus there is greater friction in the use of dollar substitutes.

Another legal barrier to adopting private digital currencies is the banking regulatory system. There are many laws and regulations that are blocking.

One of the obstacles is getting a banking license from the Office of the Comptroller of the Currency (OCC). Another aspect of banking regulation is the money transmission law. In the United States, these state-level laws impose certain requirements on entities that transfer funds on behalf of others. These requirements include a letter of assurance, a reporting requirement, and a compliance system. Finally, at the federal level, the Bank Secrecy Act and other national security considerations require financial institutions to register as money services, establish and maintain anti-money laundering and knowledge of your customers (KYC) procedures, which further increases costs. For established participants, these regulatory barriers are the cost of integration, and in some cases larger existing participants will welcome these regulations and help draft them to protect themselves from competition.

Whether this obstacle is good or bad is beyond the scope of this paper. In the following content of the paper, we propose another view that competitive private digital currency is a constraint mechanism of government monetary policy.

Third, theoretical analysis

This section simulates the interaction between citizens and government in a corrupt emerging market economy. Our analysis shows that private digital currencies have increased citizen welfare and encouraged local investment. In addition, the government will find that allowing private digital currencies is beneficial to governments and citizens.

Our results arise because private digital currencies enable citizens to benefit from diversification, and the existence of private digital currencies can constrain monetary policy. In turn, this diverse and supervised monetary policy encourages citizens to increase local investment. And increased local investment can benefit the government through taxation, so even a selfish government would prefer to allow rather than ban private digital currencies. The remainder of this section will demonstrate the above conclusions.

3, 1 model

We focus on the first two dates of the infinite horizon economy, t = 0, 1. This economy is made up of fleeting citizens and governments. At the initial date t = 0, the government develops fiscal and regulatory policies, and citizens recognize government policy decisions and then make investment decisions. Subsequently, the uncertainty was resolved, the government formulated monetary policy, and the government and citizens accepted the results together.


Question 1 illustrates the issue of citizenship. Citizens have a mean-variance preference for risk aversion (γ > 0), and she must allocate her wealth (ω0 > 0) to no more than three assets: production capital, non-productive assets, and a digital currency. We use rx to represent the actual net income of pre-tax production capital, so (1-r)rk-tπ represents the actual net income of after-tax production capital, where t represents the nominal profit tax rate and π represents the inflation rate. We use rdc represent the actual net income of the pre-tax digital currency and assume that there is no tax on the holding of the digital currency, so rdc also represents the actual net income of the post-tax digital currency. We assume that there is no tax on digital currency to capture the relative difficulty of taxing private digital currencies. We assume that the probability of non-productive assets without actual net income is 1.

Citizens may always invest in productive capital or non-productive assets. But when the government allows citizens to hold digital currencies, citizens may also invest in digital currencies. Inp said whether the government allows citizens to hold indicators of digital currency.


Question 2 illustrates the government issue. The government chooses the tax rate r and allows digital currency transactions to be made on the initial dates t = 0 and Inp. After solving the uncertainty (t = 1), the government chose an inflation rate (π "0").


This government selfishly maximizes actual income without regard to citizen welfare. There are two sources of income: taxes and coins. rω0wkrk represents the actual tax revenue, while S(r,π,Inp) represents the actual coinage tax income. Similar to Cagan (1956), we call the exchange equation and assume that the velocity of money flows in an exponential form, so Equation 3 holds. λ(Inp) represents a function of currency volatility versus inflation sensitivity. We assume λ(1) < λ(0) to reflect the relative ease of trading with additional currency.

3, 2 model solving

As mentioned earlier, our model consists of two dates t = 0,1. At t = 0, the government chose a tax rate r and a regulatory policy Inp . Then, according to the given r and Inp , and expecting an inflation rate of π , the citizen chooses a portfolio that solves the problem 1. Uncertainty is resolved at t = 1, and then the government chooses an inflation rate of π and achieves a return. We use the inverse induction method to solve the model.

At t = 1, the government sets an inflation rate to maximize the income from the seigniorage tax. Increasing the rate of inflation will allow the government to obtain more monetary units, but will depreciate every unit of currency. Following Cagan (1956), we find that the internal optimality of the government depends on the sensitivity of the velocity of money to inflation. When Inp = 0 , consumers can use digital currency to promote the frequency of transactions, making the velocity of money more sensitive to inflation. The government internalizes this incremental sensitivity, so loose regulatory policies require a credible commitment to restrictive monetary policy.

At t = 0, the government develops fiscal and regulatory policies. Fiscal policy is equivalent to choosing a tax rate for capital gains. Regulatory policy is the same as choosing whether to allow citizens to hold digital currency.

In terms of fiscal policy, a lower tax rate means lower tax revenues for holding capital investment constants. However, lower tax rates will also increase the return on capital investment, thereby increasing endowment capital investment and increasing taxes. The government will weigh these effects and choose an optimal tax rate.

In terms of regulatory policies, citizens are allowed to hold private digital currencies so that they can invest in non-taxable assets to evade taxes. This loose regulatory policy also limits the government's monetary policy. Nonetheless, private digital currency investments provide diversification of capital investment (see Chan, Le and Wu (2019)), so loose regulatory policies may increase capital investment and increase government tax revenue.

3, 3 results

First, we compare the results produced by the loose regulatory policy (ie, Inp = 0) with those produced by the restrictive regulatory policy (ie, Inp = 1). This contrast allows us to deduce the impact of private digital currencies on citizen welfare. Subsequently, we internally decided whether the government would allow digital currency transactions.


Figure 1: This figure depicts the difference between citizen utility under the loose regulatory policy and citizen utility under restrictive regulatory policies.

Positive differences mean that citizens can achieve greater utility under loose regulatory policies.

Figure 1 confirms our first finding that private digital currencies help improve citizen welfare. This is especially true for economies that have a negative correlation between local investment and private digital currency returns.

This finding is due to the fact that low correlation promotes more diversification, which in turn leads to higher citizen welfare.


Figure 2: This chart depicts the difference between local investment under loose regulatory policies and local investment under restrictive regulatory policies.

Positive differences mean that citizens can achieve higher levels of investment under loose regulatory policies.

Figure 2 establishes our second finding that private digital currencies have increased local investment in emerging market economies. This finding is due to the fact that private digital currencies act as a hedge asset (see Dyrberg (2016), Chan, Le and Wu (2019)) and therefore complement local investments. When the return on local investment is negatively correlated with the return on private digital currency, the increased investment effect is more significant.


image 3

Figure 3 emphasizes that the government can benefit from a loose regulatory policy, which is particularly significant when the return on local investment is negatively correlated with the return on private digital currency and the absolute magnitude is large.

By allowing citizens to use digital money to generate revenue, this allows the government to raise tax rates and thereby increase government revenue.

Our findings emphasize that corrupt emerging market governments generally recognize that allowing private digital currencies to be optimal. This result is particularly important because it means that, despite the selfish motives of corrupt governments, private digital currencies can bring benefits to citizens and governments in emerging market environments. Loose regulatory policies have improved citizen welfare and increased government welfare. As we have seen, the former is generated by diversified returns and a reliable commitment to restrictive monetary policy, which is because the government uses it to collect more taxes.

Fourth, the conclusion

This paper systematically classifies digital currencies. We conclude that private decentralized digital currency is a new invention that has important welfare implications for emerging markets. We have shown that the existence of private digital currencies has a supervisory effect on government policies, resulting in welfare gains. Our work emphasizes that private digital currencies should not be seen as a substitute for traditional currencies, but as an important optional asset.

Whether private decentralized digital currency will continue to surge is beyond the scope of this article. However, the history of money suggests that there is always a demand for a non-state currency that is a suppression of sovereign currency inflation propensity. If this demand continues, some private decentralized digital currencies are likely to continue to exist. Our papers show that alternative currencies such as Bitcoin will be welcomed by individuals and governments because it increases the overall welfare of the country.

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