Bitcoin and Shadow Exchange Rates

TL;DR

This paper investigates Bitcoin's role in currency exchange rate discrepancies by analyzing peer-to-peer market data, revealing how economic factors and capital transfer frictions influence Bitcoin premiums and their predictive power for exchange rate movements.

Contribution

It introduces shadow exchange rates derived from Bitcoin prices and analyzes their determinants, highlighting differences between P2P and centralized markets and the predictive capacity of Bitcoin premiums.

Findings

BTC premiums are higher for currencies with capital controls.

Microstructure of blockchain does not affect BTC premiums in P2P markets.

BTC premiums can predict future exchange rate depreciation.

Abstract

This research expands the existing literature on Bitcoin (BTC) price misalignments by incorporating transaction-level data from a peer-to-peer (P2P) exchange, LocalBitcoins.com (LB). It examines how broader economic and regulatory factors influence cryptocurrency markets and highlights the role of cryptocurrencies in facilitating international capital movements. By constructing shadow exchange rates (SERs) for national currencies against the US dollar based on BTC prices, we calculate discrepancies between these SERs and their official exchange rates (OERs), referred to as BTC premiums. We analyze various factors driving the BTC premiums on LB, including those sourced from the BTC blockchain, mainstream centralized BTC exchanges, and international capital transfer channels. Unlike in centralized markets, our results indicate that the microstructure of the BTC blockchain does not correlate with BTC premiums in the P2P market. Regarding frictions from international capital transfers, we interpret remittance costs as indicators of inefficiencies in traditional capital transfer systems. For constrained currencies subject to severe capital controls and managed exchange rate regimes, increased transaction costs in conventional currency exchange channels almost entirely translate into higher BTC premiums. Additionally, our analysis suggests that BTC premiums can serve as short-term predictors of future exchange rate depreciation for unconstrained currencies.