My 5 cents on the Bitcoin mania

Bitkoins. Foto: AFP/LETA
Mortens Hansens
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Everybody has an opinion about the cryptocurrency Bitcoin. Me too.

Bitcoin has seen an astonishing price development in the past year. On 1 January 2017 its price was 964$, which had risen to 19,758$ on 17 December (an increase of 1,950%). At the time of writing (around 6PM – one has to be precise here; the price can fluctuate very much during the day – on 28 January) the price is 11,564$, down some 41% since its peak in December, see Figure 1.

Figure 1: Bitcoin price in US dollars

Source:  https://coinmarketcap.com/currencies/bitcoin/

Even at this lower price the total market capitalization of the almost 17 mill. Bitcoins in circulation is around 200 bill. USD (approximately 160 bill. EUR) – much less than euro coins and banknotes in circulation (some 1,200 bill. EUR) but much more than e.g. kroner from my native Denmark (worth some 10 bill. EUR).

Bu what does this value of 200 bill. USD – some 6 years of Latvian GDP – actually represent? As I see it, nothing much.

Bitcoin is not money

For “something” to be money that “something” has to be unit of account.  Not the case for Bitcoin – prices here in Latvia are in euros and nowhere are they in Bitcoin. Money should be a reasonable store of value – if I trust the ECB on its promise to deliver “close to but below 2% inflation” yearly, then my unspent euros preserve most of their value during the year. Not so with Bitcoins where price fluctuations at times are in double digits during just one day! Furthermore money should be a medium of exchange but a) Bitcoin transactions take time and b) are not generally accepted – I think my local RIMI would be surprised if I asked if I could pay with Bitcoin.

The wild price fluctuations actually create a paradoxical situation by making Bitcoin even less of something that could be classified as money: a) With prices going up, hoarding of Bitcoins takes place and very few are used for transactions – people keep them in anticipation of still higher prices, b) borrowing in Bitcoin is risky – if you had bought a flat on 1 January 2017 for 100 borrowed Bitcoins they would have been equivalent to 96,400$ then but equal to 1,156,400$ today (a very expensive flat and you would most likely default on your loan…) but c) it is also risky to be a lender in Bitcoin – if you had lent, say, 10 Bitcoin on 17 December last year, today the dollar value of your loan would be down by 81,000 USD.

In short, the price volatility makes Bitcoin even more unlikely to act as money than it already was!

Bitcoin is clunky

As already mentioned Bitcoin transactions are time-consuming whereas e.g. VISA can process many thousands of transactions per second. The mining of Bitcoins consumes electricity on a very big scale (the equivalent of whole countries during a year) and it becomes a bit of a joke when a conference about Bitcoin does not accept the conference fee paid in Bitcoin because it is too troublesome….

Bitcoin is bad for monetary policy

Imagine that Bitcoin became the sole currency of the world. The total number of Bitcoin cannot exceed 21 million (it is somehow ensured in the code behind Bitcoin) and this will have a strange impact on the world economy. AS GDP grows there will be the same amount of money to buy more goods and services – but that means that those goods and services will fall in price and we will have persistent deflation in the economy. It also means that the purchasing value of nominal wages will increase even without productivity increases. At times, nominal wage cuts will have to be negotiated, which is much more complicated than negotiating wage increases. And with lower and lower prices we will postpone purchases of e.g. cars and refrigerators, waiting for even lower prices – but this will slow down the economy. A constant money supply for a growing economy is simply bad policy!

Bitcoin is not safe

We can have cash euros stolen from us or have deposits stolen if we lose our bank card – but although Bitcoin is purely electronic it can also be stolen from you, just take the example of the then largest trading exchange Mt. Gox. Another crypto-currency, NEM, saw about 400 mill. $ worth of its coins stolen by hackers just a few days ago.

So why all the hype?

To Bitcoin enthusiasts it is important that the currency is not controlled by a central bank (a typical libertarian point of view, which is important because…., well, perhaps libertarians can explain) and that it will have a maximum supply of 21 million – currency debasement and exploding prices are thus not possible as with printing e.g. endless amounts of Zimbabwe dollars or, the best current example, Venezuelan bolivars. But that argument does not fully hold – Bitcoins may be limited to 21 million but as other crypto-currencies are created (at the time of writing there were 1,494 different such currencies, including for instance the Tattoocoin, Snake Eyes and the Marxcoin), supply nevertheless increases and also in the crypto-world is not limited.

Critics say that crypto mostly has value for criminals who can perform transactions that cannot be traced but the same can be said for cash, of course. Two arguments in favour of crypto are the possibility to circumvent capital controls (though not exactly legal either) and the cases where crypto is preferable to domestic currency; again Venezuela provides an excellent example – but these are still rather limited arguments for explaining all the hype.

Conclusion: Two simple ways to tell it is a bubble

The so-called blockchain technology underpinning crypto is fascinating and may become very useful (I don’t know…) but as can be seen from my arguments I don’t have much faith in the “currency” – its proponents will say that I don’t understand the “new economy” and that a “paradigm shift” has taken place but I think the same was said before the dot.com bubble burst in 2002. Allow me in the end just two back-of-the-envelope type arguments for why this is a bubble – they are not scientific but they work:

1) Everybody talks about Bitcoin (remember 2007 when everybody talked about real estate prices?).

2) 97% of Bitcoin investors are men……

 

Morten Hansen is Head of Economics Department at Stockholm School of Economics in Riga and a member of the Fiscal Discipline Council of Latvia.

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