Thu, Feb 08, 2018 - Page 9 News List

To buy or not to buy, the answer remains cryptic

Cryptocurrencies are not likely to affect macroeconomic growth, but its underlying blockchain technology offers a greater challenge to human ingenuity to create welfare-boosting innovation

By Adair Turner

Illustration: Mountain People

In December last year, as the price of bitcoin neared US$20,000, a friend asked me whether she should invest. I said that I had not the faintest idea. As the price hovers at about US$10,000 today, my reply remains the same.

Over the next year, the bitcoin price could double, soar 10-fold or collapse by 95 percent or more, and no economic analysis can help predict where in that range it will lie. Its value is arbitrarily determined by the collective psychology of the mass of investors; it goes where, on average, they think it will.

Like other cryptocurrencies, bitcoin serves no useful economic purpose, although in macroeconomic terms, such currencies probably also do little harm.

In a modern economy, money has a well-defined real value, because governments accept it as payment of taxes and issue debts in defined monetary amounts, and because central banks ensure that total monetary creation, by either the state or the private banking system, grows at a pace compatible with relatively low and stable inflation.

In some sense, money is an arbitrary social construct, but its value and ability to serve crucial economic functions are rooted in the authority and institutions of the currency-issuing state.

However, at any time, groups of people can choose to believe that some commodity — a specific type of seashell, or gold, or tulips — will be a far better store of value than money, and that its value in money terms is bound to rise. What matters is simply that the supply of the chosen commodity cannot be rapidly and limitlessly increased.

Provided that is the case, the price can be whatever speculators believe. In early 1636, 1 pound (0.45kg) of “switsers” — a particular category of tulip bulb — traded in Dutch markets for 60 guilders; by mid-February 1637, the price was 1,500 guilders. In the subsequent crash, some bulb prices fell 99 percent.

Unlike gold or tulips, whose supply is fixed in the short term and constrained by nature in the medium term, immaterial bitcoin could in principle be created in infinite quantities.

In fact, the currency’s supply is limited by clever software algorithms, supported by huge quantities of computing power, which have enabled bitcoin’s creators to achieve a previously impossible trinity: decentralized “mining,” collectively limited aggregate supply and anonymity.

In theory, the latter could allow bitcoin or other cryptocurrencies to be not only an arbitrary store of value, but also an anonymous medium of exchange for large-value transactions, just like suitcases full of high-denomination bills, with no mark identifying the owner, but now in digital form.

However, as Kenneth Rogoff has said anonymous large denomination notes play no useful role in legitimate commerce, but are the favored medium of exchange for drug lords, tax avoiders, terrorists and other criminals.

However, if, as Rogoff argues, there is therefore a good case for eliminating them, the last thing the world needs is to recreate the same problem in digital form.

South Korea has thus banned the anonymous trading of cryptocurrencies, and other regulators around the world are considering whether to do the same.

The best case for going further and banning cryptocurrencies entirely is actually environmental. Estimates of how much electricity bitcoin mining requires vary widely — some put it as high as 30 terawatt-hours per year — equivalent to Morocco’s entire electricity demand — while others suggest it is a sixth of that.

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