By Luca Marchiori
This study analyzes the macroeconomic implications of virtual currency issuance. It builds on a standard cash-in-advance model extended with (i) ‘virtual’ goods, sold against virtual currency, and (ii) miners, the agents providing payment services. The main finding is that virtual currency growth may have effects opposite to those predicted by monetary theory when miners are rewarded with newly created coins. Declining currency issuance, as in Bitcoin, raises the price of virtual goods, which counteracts the traditional impact of a reduced inflation tax. The paper also shows how fiat money growth affects the welfare effects of virtual currency creation.
What this paper is saying is that there is a sweet spot for virtual currencies where they have been accepted for transactions but are not yet too close to the supply limit. Once supply is too limited to reasonably reward miners, the later start charging higher transaction fees and the cost of the goods bought with virtual currency increases, leading to a net welfare loss. In other words, virtual currencies are cool for a while but are not there to stay.