Weekly Top 5 Papers – April 23, 2018

1. An Equilibrium Valuation of Bitcoin and Decentralized Network Assets by Emiliano Pagnotta (Imperial College Business School) and Andrea Buraschi (University of Chicago – Booth School of Business)

The rapid growth of Bitcoin over the last decade has sparked an intense debate in the investment community and policy circles. Two questions are at the centre of this debate. What type of asset is bitcoin? What is its fundamental value? Opinions diverge greatly on whether bitcoins are a currency, a commodity, a security, for example; but a prominent view is that bitcoin and similar “blockchain tokens” are not a new asset class and that they either have zero fundamental value or that their fundamental value cannot be determined. Reaching a consensus on these issues is challenged by the lack of a formal model where the interaction between demand and supply for bitcoins can be analysed.

Our paper is, to the best of our knowledge, the first to study the general equilibrium of a decentralized network economy and to derive closed-form solutions linking the bitcoin price to market fundamentals, which allows us to directly address the previous questions. We address the valuation problem in the context of a new type of production economy: a decentralized financial network (DN). On the demand side, consumers value (i) the censorship resistance (CR) of transactions and (ii) the ability to engage in trustless exchanges. On the supply side, a set of miners provide computing resources that affect the network’s security or trustworthiness (“trust”) by which we mean value-enhancing properties related to the absence of frauds and resistance to censorship and attacks. Because the network is decentralized, those who provide resources need to be incentivized to do so. An identifying property of these assets is that contributors to the DN trust (miners) receive units of the same asset used by consumers of DN services. Therefore, the overall production (hashrate) and the bitcoin price are jointly determined. We characterize the demand for bitcoins and the supply of hashrate and show that the equilibrium price is obtained by solving a fixed-point problem and study its determinants. We find that two equilibria exist. In the absence of mining subsidies, a price of zero is always an equilibrium. If, more generally, network trust increases “fast enough” near a price of zero, an equilibrium with a strictly positive price exists. In the second equilibrium, the unity property gives rise to specific asset pricing implications that distinguish DNAs from other assets. First, we show that empirical tests on the efficiency of bitcoin prices cannot rely on conventional martingale representations. Second, it can give rise to price spirals that may help to explain the large observed bitcoin price volatility. Finally, there exists an optimal monetary policy linking the incentive reward offered to miners and the value of the network. – Andrea Buraschi Download Summary.


2. Asymmetric Information and Entrepreneurship by Deepak Hegde (New York University (NYU) – Leonard N. Stern School of Business) and Justin Tumlinson (Loughborough University)

We were inspired by an apparent paradox: the academic literature on entrepreneurs largely describes them as “misfits” who can’t find, can’t stand, or can’t stay in, conventional employment.  And yet, history and the popular press portray entrepreneurs as highly productive self-made visionaries, rejected by employers who could not discern their exceptional talents.  But are these anecdotes merely a biased sample of successful entrepreneurs? We wanted to dig deeper into why individuals become entrepreneurs and what makes some successful.

In this paper, we formally derive and empirically confirm that asymmetric information about worker ability can drive anyone, who believes her productive capabilities to be greater than employers can perceive, to become an entrepreneur.  This explanation holds over a spectrum of entrepreneurs: from immigrant food vendors (whose foreign credentials often go unrecognized) to college dropout technology moguls. Identifying this novel driver of entrepreneurial choice also moves us a step toward cracking the entrepreneurial earnings puzzle. Why individuals choose entrepreneurship likely influences their income—those choosing it for non-pecuniary benefits may reasonably earn less than employees, while those strategically responding to asymmetric information in the labor market about their ability, should earn more. – Deepak Hegde and Justin Tumlinson

3. Regulatory Cycles: Revisiting the Political Economy of Financial Crises by Jihad C. Dagher (International Monetary Fund (IMF) – Research Department)

Financial markets can be fickle, but does their regulation have to be too? Three hundred years of financial regulation offer a cautionary tale to today’s push against yesterday’s regulations. This paper revisits the political economy of financial crises and documents a consistent pattern of politically driven pro-cyclical regulations. That is, financial regulation and supervision tend to weaken during booms, and strengthen during busts. This has been happening since the 18thcentury until today, and observed across countries. These inefficient regulatory cycles have a poor track record. They show that politics can be the undoing of prudent financial regulation. There is much to learn from the past to better understand current economic and regulatory developments. – Jihad Dagher

4. Market Risk Premium and Risk-Free Rate used for 59 countries in 2018: a survey by Pablo Fernandez (University of Navarra – IESE Business School) and Vitaly Pershin (University of Navarra – IESE Business School) and Isabel Fernández Acín (University of Navarra – University of Navarra, Students)

5. Splitsylvania: State Secession and What to Do About It by Glenn Harlan Reynolds (University of Tennessee College of Law)

Lately I’ve been thinking about some of the Constitution’s more obscure provisions, like the Guaranty Clause and Art. IV sec. 3’s provision for creating new states out of parts of existing ones.  Most recently, I was thinking about these provisions in the context of the new state-secession movements that are springing up, in which (typically rural and less prosperous) parts of states politically dominated by large urban areas want to break off and go on their own.

My paper looks at these movements, the complaints that animate them, and their likelihood of success, and suggests some fairly modest changes at the federal and state level that would take most of the steam out of movements for intra-state secession.  While states can split from existing states — look at West Virginia, Maine, or even Tennessee — it’s unusual and difficult.  But addressing the causes of rural unhappiness looks to be (comparatively) easy, if Congress is willing to do so.

I’m gratified that this piece, yet unpublished except on SSRN, has already garnered significant media attention, both on print and in several radio interviews I’ve been asked to do.  SSRN is a good platform for getting noticed!

Here’s the link:  http://www.foxnews.com/politics/2018/03/19/are-some-states-headed-for-splitsville-movement-grows-to-allow-sections-states-to-break-away.html – Glenn Harlan Reynolds