Essays on the economics of cryptocurrencies

Abstract

This thesis aims to contribute to the understanding of the economics of the cryptocurrency market. In the first chapter, I document the literature on cryptocurrency and the financial applications of blockchain infrastructure. Finance and economics literature on the area of cryptocurrency is relatively new and spans only the last seven years, thus this review intends to serve as a foundation to prompt future work and a deeper understanding of this field. In the second chapter, I develop an equilibrium model of proof-of-work cryptocurrencies. Equilibrium behaviour of miners and users are characterised for exogenous blockchain protocol metrics; I demonstrate that equilibrium between miners and users can be achieved in the long run. High fixed mining rewards are the reason for instability in current cryptocurrency designs. The equilibrium model has two key implications: first, decentralisation and technological improvement in mining are drivers of low transaction fees and low mining costs in a proof-of-work cryptocurrency environment; and second, limited block size and mining difficulty create an incentive mechanism that achieves cryptocurrency sustainability in the long run. In the third chapter, I study the return spillover and systemic risk in the cryptocurrency market in the context of connectedness. The data illustrates that system-wide connectedness in the cryptocurrency market, commonly observed as the level of systemic risk in the literature, changes over time with respect to the adoption rate of cryptocurrencies. Cryptocurrency protocol disputes, malicious activities in the cryptocurrency environment, and negative financial regulations on cryptocurrencies are key sources of increased connectedness over different time periods. Instead, pairwise connectedness between cryptocurrency pairs can be explained by cryptocurrency fundamentals.