ANZ Finance blog | The Road to Cryptocurrency part 7 - The Information Business

The Road to Cryptocurrency Instalment # 7: The Information Business

Published 10 September 2021

By Dr Peter J Phillips, Associate Professor (Finance & Banking) University of Southern Queensland

The Road to Cryptocurrency Part 6 -- McGraw Hill ANZ Finance Blog – supermoney

Academics rarely miss an opportunity. If there’s an opening for a research idea, it doesn’t sit untapped for too long. As we mentioned in a previous post, there is a strong flow of ideas from universities, prompting the economist John Maynard Keynes to famously note, “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.” Sometimes, it will be several years before ideas begin to permeate and by that time, their origins slightly obscured, it will seem that the university’s role is follower rather than leader.

This is not to imply that universities invent everything. Far from it. They didn’t invent cryptocurrency. But the ideas about cryptocurrency, its impact on the economy, the efficiency of the cryptocurrency markets, the implications for monetary policy and the monetary system, the minutiae of the information structure, and so forth have been explored in the academic literature. In fact, the earliest papers have now been circulating for five or six years (some for more than ten) and it will still be some time before all these ideas make their way into the popular discourse on crypto. To get ahead of the game, we will review some of these ideas in this instalment.

It should be noted that, at the high end of professionalism (i.e., big Wall Street firms, elite government agencies etc.) there are people whose job it is to review the academic literature, synthesise it, report on it, explain how it can be used, all long before their general competitors get a chance to do so. I call this the information business and it’s a job that students might like to consider. It’s also a job that is rarely on the radar.

When venturing down a new pathway in the information business, one place to start is with published “literature surveys”. These are papers that summarise the main themes of other published papers. Some academic journals specialise in these types of surveys. Examples are Journal of Economic Literature and Journal of Economic Surveys. It takes time for these surveys to be written, usually several years after the research starts to flow, and you might not always find a survey paper on your topic of interest.

"...if you understand finance, you can apply what you know to the crypto markets. And, despite the novelty of the situation, careful study of finance and economics will be rewarded."

This time, we’re in luck. Bariviera and Merediz-Solà (2021) have examined the economic research on crypto and have provided us with an interesting overview and some leads to follow up. They found more than 400 academic research papers, most published from 2015 onwards, covering a selection of themes. The most prominent themes explored by the researchers across these several hundred investigations are informational efficiency, price discovery, volatility, portfolios, bubbles, and the implications for the monetary system (and monetary economics). This review complements Corbet et al.’s (2019) slightly earlier systematic review of the literature.

Bariviera and Merediz-Solà (2021) note that the most highly cited paper (i.e., the one that has been referenced the most in the academic literature) is Böhme, Christin, Edelman, and Moore’s (2015) paper: “Bitcoin: economics, technology, and governance”, published in the Journal of Economic Perspectives. This journal is a widely read quasi-survey outfit that addresses emerging topics in economics in a relatively accessible way. The paper explains many of the basics of Bitcoin, things which many people now know, but they go on to analyse various aspects from an economist’s perspective. While there are many interesting insights (some of which have been resolved by market evolution since 2015), it is worth quoting the opening to their section on monetary policy (p.233):

In a broad sense, the Bitcoin economy implements a variant of Milton Friedman’s [published in 1960] “k-percent rule”—that is, a proposal to fix the annual growth rate of the money supply to a fixed rate of growth. Indeed, Bitcoin’s protocol calls for an end of the minting phase at which point k = 0. In fact, k may even be negative in the future, because bitcoins can be irreversibly destroyed when users forget their private keys. This raises one of the classic questions in monetary policy: What happens when the size of an economy grows at a different rate than the quantity of money in that economy? Or if viewing Bitcoin as a social science laboratory, what happens if the Bitcoin economy grows faster than the supply of bitcoins?

One of the most interesting things to emerge from Bariviera and Merediz-Solà’s (2021) survey is the relative lack of research published in the elite finance journals. The biggest journal of all, The Journal of Finance, has only published one paper on this subject. That was Griffin & Shams’ (2020) study of the relationship between Tether (a digital currency) and Bitcoin. While the study is innovative in terms of its analysis, the subject matter returns to staple themes such as bubbles and regulation. The other ‘big’ journal, The Journal of Financial Economics, has not published a cryptocurrency paper while the Financial Analyst’s Journal has published just a handful of papers.

This leads us to conclude one of two things. Either the ‘big’ journals are too conservative and too slow (something that might characterise most fields of research) or, conversely, they are calm and circumspect and have rightly ascertained that cryptocurrency might be new and exciting, but the underlying finance is not. Whatever the case may be, most of the papers have appeared in ‘smaller’ finance and economics journals. And it is certainly the case that most papers deal with themes that are perennial favourites in finance and economics. This is encouraging in a way. It means that if you understand finance, you can apply what you know to the crypto markets. And, despite the novelty of the situation, careful study of finance and economics will be rewarded.

We could have picked a hundred different examples to illustrate this point but this one caught my eye. In their 2015 paper, Ciaiana , Rajcaniovab and Kancs study Bitcoin price formation using a variation on Barro’s (1979) model of money and prices under a gold standard. Since much of the analysis of prices, risks etc. undertaken by researchers draws on existing theoretical frameworks, it is important not to fall into the trap of thinking that cryptocurrency is completely detached from the accumulated body of knowledge. In fact, Ciaiana, Rajcaniovab and Kancs (2015) conclude that Bitcoin prices move primarily in response to supply and demand (i.e., nothing mysterious) and that, consequently, Bitcoin price formation can be explained by standard economic models like the one developed so long ago by Robert Barro.

Discussion Questions

In Chapter 7, we discuss forecasting price movements on the stock market. How do these concepts apply to cryptocurrency markets? Do they apply?

Robert Barro is a very well-known economist. What are some of his main claims to fame? Also, is there a physics connection (remember we talked about this in a previous instalment)?

Further Reading

Chapter 7 of the textbook introduces the key idea of market efficiency. Financial economists have spent 50 years debating the efficiency of markets and the cryptocurrency market gives them a chance to give their debate a fresh look.