With Enchuan Shao.

Tether is a stablecoin that is widely used to trade crypto assets. Using Tether’s price volatility, characterized by two distinct regimes, we identify the structural relationship between Tether and Bitcoin price and the circulating supply of Tether. This study delves into the intricate dynamics of Tether (USDT) and its interactions with Bitcoin (BTC), providing valuable insights into the mechanisms that underpin stability. We propose a new hypothesis based on triangular arbitrage to explain the underlying market structure and the relationship between our variables of interest. We then compare the statistically identified model with the theoretically driven restricted models. Our findings highlight the critical role of the arbitrage mechanism, particularly triangular arbitrage, in maintaining the stability of the Tether price. Consequently, Tether demand shocks can inflate the Bitcoin price in the short run. Contrary to conventional wisdom, our results show that the circulating supply of Tether responds to price differentials in Bitcoin markets rather than its own market conditions.

With Enchuan Shao (Journal of Economic Behavior and Organization, Vol 227 November 2024).

In order to maintain the function of a decentralized financial system like Bitcoin, transaction fees are offered to engage miners in the transaction confirmation process. This paper investigates the effect of miner competition on the equilibrium transaction fees. We develop a game-theoretic model with costly entry into mining activities. We find that miners may strategically assemble fewer transactions into a block to reduce total fees, and as a result, to deter entry. Equilibrium transaction fees also depend on block rewards as a rise in total fees is accompanied by a drop in rewards. Our empirical analysis supports the model's predictions. We provide evidence on the existence of excess capacity in a block, taking into account the random confirmation process. The empirical findings demonstrate that heightened competition tends to increase the block size and total fees. Furthermore, the halving of rewards correlates to a fee hike.

With Enchuan Shao (R&R Macroeconomic Dynamics).

Mining is one of the key features to maintain the value and the security of the Bitcoin system. Like mining of other commodities, Bitcoin mining requires a non-trivial fixed cost to enter the business. We extend a framework that captures some key features of Bitcoin to incorporate entry costs. We use the model to investigate the welfare effect of barriers to entry in Bitcoin mining. We find that barriers to entry can help to improve welfare. Our quantitative results show that this welfare gain is moderate when compared to an economy without entry barriers. The source of welfare gains is coming from the savings in mining costs due to the reduction in competition rather than the benefit from the drop in a delayed settlement.​