The economics of Bitcoin and similar private digital currencies

• Bitcoin and similar digital currencies record transactions in a peer-to-peer network.
• The verification of transactions requires computations by participants in a contest.
• Most bitcoins have been transferred from their original owner.
• The price of Bitcoin has been highly volatile on average.
• Monthly standard deviations of daily returns overlap those of gold and currencies.

Recent innovations have made it feasible to transfer private digital currency without the intervention of an organization such as a bank. Any currency must prevent users from spending their balances more than once, which is easier said than done with purely digital currencies. Current digital currencies such as Bitcoin use peer-to-peer networks and open source software to stop double spending and create finality of transactions. This paper explains how the use of these technologies and limitation of the quantity produced can create an equilibrium in which a digital currency has a positive value. This paper also summarizes the rise of 24/7 trading on computerized markets in Bitcoin in which there are no brokers or other agents. The average monthly volatility of returns on Bitcoin is higher than for gold or a set of foreign currencies in dollars, but the lowest monthly volatilities for Bitcoin are less than the highest monthly volatilities for gold and the foreign currencies.