How well can a cryptocurrency serve as a means of payment? Since the creation of Bitcoin in 2009, many critics have denounced cryptocurrencies as fraud or outright bubbles. More nuanced opinions have argued that such currencies are only there to support payments for illegal activities or simply waste resources. Advocates point out, however, that - based on cryptographic principles to ensure security - these new currencies can support payments without the need to designate a third-party that controls the currency or payment instrument possibly for its own profit.1 We take up this discussion and develop a general equilibrium model of a cryptocurrency that uses a blockchain as a record-keeping device for payments. Although Bitcoin in its current form has immense welfare costs, an optimally designed cryptocurrency can potentially support payments rather well. First, using Bitcoin transactions data, we show that the welfare cost of a cryptocurrency can be comparable to a cash system with moderate inflation. Second, using summary statistics for US debit card transactions, we find that a cryptocurrency can perform nearly as well as a low-value, retail payment system operating with very low fees.2 Economics research so far has provided little insight into the economic relevance of cryptocurrencies. Most existing models of cryptocurrencies are built by computer scientists who mainly focus on the feasibility and security of these systems. Crucial issues such as the incentives of participants to cheat and the endogenous nature of some key variables such as the real value of a cryptocurrency in exchange have been largely ignored. Such considerations, however, are pivotal for understanding the optimal design and, hence, the economic value of cryptocurrency as a means of payment.
