Weekly Economic Update 12-27-24: Some Thoughts on Cryptocurrencies
The views and opinions expressed in this post are solely those of the author and do not necessarily reflect the views of the Georgia Institute of Technology or the Georgia Board of Regents.
The esteemed Dr. Meek needed a respite and invited me to write a guest missive on a topic of my choice. I have chosen Bitcoin specifically, and cryptocurrencies, in general. To be clear, I am not an expert on Bitcoin or cryptocurrencies, nor am I a computer scientist. But I am an observer of historical investment manias and a strong believer in classical money (i.e. precious metals.)
So, let’s start with some definitions:
Key characteristics of money: durability, portability, divisibility, uniformity, limited supply, acceptability.
Block chain: Blockchain is a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a business network.
Cryptocurrency: Cryptocurrencies are digital assets, most often based on blockchain technology.
Now that we have some definitions to work with, let’s jump into the discussion on Bitcoin and why I believe it is the modern day Tulipmania - a period during the 1600’s when tulip bulbs in Holland reached exorbitant prices. Tulips were introduced into Europe and became highly sought after for their unusual colors. Prices were bid up quickly as the ‘greater fool’ theory quickly took hold.
Tulipmania is just one example of mania-led investment bubbles and is widely considered the first recorded one of modern times.
What does this have to do with Bitcoin? It serves as an example of how manias can take hold and feed on themselves, especially when something ‘new and revolutionary’ is suddenly available.
Bitcoin has been hailed as the new currency, unable to be inflated away as the dollar has been over the past 100+ years. Yes, today’s dollar has lost about 97% of its value since 1913 as more and more have been created over the years.
Bitcoin is not supposed to be able to be inflated away. Bitcoin has a ceiling of 21M coins able to be created, or “mined”. But Bitcoin is only one cryptocurrency, there are over 2.4 million cryptocurrencies with a total market cap exceeding $3.4T. Bitcoin just happens to be one of the first to have been created, the most popular, and the one with the highest market cap currently.
I want to be clear, I believe the technology that enables cryptocurrency, blockchain, has tremendous value in logistics and other uses. My concern is the rush of people throwing good money after an apparition that only exists in the cloud of the internet. And, how safe is that cloud, really, among other concerns? Let’s look at some key concerns:
All cryptocurrencies require one have access to a “wallet” that stores their coins. The wallet stores a “key” that can access your coins on the blockchain. So, you never have any physical currency. When I can walk into a restaurant and easily buy a meal with Bitcoin, I might take more notice.
Without a physical coin one is dependent on the network being up and running (i.e., you have a power source, internet connection, and other infrastructure aspects). What happens if power is interrupted, as an example? How will you access your cryptocurrency?
Wallets can be hacked and there is no safety measure I am aware of to replace any stolen cryptocurrency. In fact, because of the difficulty to trace it, it is virtually impossible to see who stole it or to recover it.
Quantum computers: Google just announced a new quantum computer chip that might make the security of the wallets and cryptocurrency algorithms obsolete, or very easily decrypted.
With all the secrecy built into the blockchain aspect of Bitcoins, with no centralized register, how can ANYONE really know how many exist? How can Bitcoin be audited to ensure only 21 million exist? Even BlackRock says there is “there’s “no guarantee” that the 21 million won’t change.”
Leverage. Debt is being used to leverage Bitcoin purchases. This debt depends on the price of Bitcoin moving higher and higher over time. Some of us remember the real estate leverage that led to the Great Recession. If Bitcoin grinds lower, or even stays somewhat static in price, this could cause these leverage schemes to implode. In many cases, it would cause the debt holder to liquidate their Bitcoins to pay off what they could of the debt either by a margin call, to service the debt, or by conditions of the loan. Not only could this tank Bitcoin but could reverberate throughout the broader markets. Some of us remember the phrase “it’s not a solvency problem, it is a liquidity problem” and some of us laughed because we figured it was actually a solvency problem, which it was shown to be, in some studies.
Do you really want to depend on a “currency” that can fluctuate so dramatically in a very short period of time?
Let me conclude by saying that ultimately the market will determine if cryptocurrencies have any real sustainable value and should continue to exist. Sadly though, it will likely depend on what policy makers in the government decide and how they set up the regulatory structure.
I do know this, the government does not like competition in its space and I anticipate if there is a movement to a single cryptocurrency it will be regulated, managed, and controlled by the Federal Reserve Board (technically the Federal Reserve is not part of the Federal Government) in conjunction with the Federal Government. This, or regulated by some other international regulatory body.
In the meantime, I will watch the price of Bitcoin and look to see if it follows the path of those tulip bulbs almost 400 years ago. What could possibly go wrong?