That’s the title of my latest piece at The National Interest. The blurb sums it up pretty well. Under the efficient-markets hypothesis, a worthless digital currency should have never gotten off the ground.
That’s the title of my latest piece at The National Interest. The blurb sums it up pretty well. Under the efficient-markets hypothesis, a worthless digital currency should have never gotten off the ground.
93 thoughts on “The Bitcoin Bubble and a Bad Hypothesis”
Excellent, clear piece, John.
I could never understand the hype about Bitcoins – they always were clearly just another tradable collectible, like postage stamps from Belize, or Malibu Barbies In Original Packaging. It was purest fantasy to think that they would attain the status of Cartoons by Da Vinci, let alone that of a currency. Are people so easily gulled that just by calling something a ‘coin’, you can make them think of it as money?
I guess we put the whole mess down as another case where the Overton window has shifted so far that some people can no longer see reality through it.
Your criticisms of bitcoin are a poor rehash of the many out there before you
bitcoin is not a fiat currency
it’s a medium of exchange that various people have decided to have varying degrees of faith in
that it might be silly (simply, there can always be a bitcoin2) is beside the point when you look at why people might want to use them
unless you investigate who is using them and how and why then all you have to offer is hot air
if, say, everyone had some for some reason specific to each person then any argument you might make to the contrary they are then a currency
i don’t have any, simly because the effort to be able to own them is too high
but i do know two groups of people who do – one the tin-hat variety and the other trying to move money from within a controlled jurisdiction to outside of it
mostly it’s the later
want to move you money?
ok buy some bitcoins using one currency – sell them elsewhere in another
you think you are pretty smart but you really don’t understand gold or bitcoins
people hold such things simply because there are loopholes in laws that enable them yo use those mediums to escape taxes, observation/visibility, or currency controls
people don’t actually save them – maybe some do – i don’t know
they use them to hide their tracks
as such bitcoin is better than gold
gold you can use to thwart currency controls across most borders – but you are at risk of being robbed and some borders do control the flow of gold (very few)
bitcoins can’t be controlled – at least right now
there’s an infrastructure for bitcoins and it’s that infrastructure that gives them value
let’s hope it lasts – because having the sort of people i work with examining every transaction of your life makes me cringe because they are intrinsically dishonest and selfish beyond words
they are called government
and you are part of them
There is this analysis that is taking more of a mental view of bitcoin hype. It is an addition to JQ and also Austrian view in the comments (first comment) that is similar to the Peak Oil Poet’s.
I’ve been meaning to seek your view on bitcoin. Now I know. I like the article even if I don’t entirely agree. I think it is a good conversation starter and I’ll be circulating it in selected social media circles for that purpose.
Just for completeness can you explain the ten year success of the Iraqi Swiss dinar (before the US bought it all at market rates) which in the Kurdish region of Iraq during the inter war period sustained both it’s value and utility in commerce in the absence of any government backing by command, or demand, or taxation?
My view of bitcoin at the moment is that it only satisfies two of the three requirements of money. And those are the trivial two. And it doesn’t always do them well either.
Medium of exchange – yes
Store of value – yes kind of sometimes
Unit of account – fail
I’m quite optimistic about much of the underlying technology however. And bitcoin may yet prove me wrong. I don’t think it’s value will plunge to zero or even close to it any time in my lifetime. Such a prediction was made of gold in the 1970’s when the gold standard ended. Yet gold continues to attract a strong following just as it has for thousands of years.
Absent a gold standard or a bitcoin standard I don’t think either will be money that often. But it is possible for either to become a standard in the shadow economy at some point if the benefit is sufficient. When Zimbabwe destroyed it’s currency gold itself did for a time become a currency there. See video:-
In terms of the efficient market hypothesis this is what Wikipedia says:-
I’m not sure where bitcoin violates such assertions. I’m not even sure it qualifies as a financial instrument rather than being a commodity. Clearly it’s utility does not relate to some claim to an income stream.
(p.s. earlier comment in moderation)
As Jordan’s link notes, the only legitimate use for bitcoins is for illegitimate transactions. As long as the seller knows he can cash them in for real money, they do allow readily anonymous online cash transfers.
Not that I know anything about that.
Deleted – racism, attacks on other commenters, snark, general uselessness; JQ
Your link states quite clearly that the government of Iraqi Kurdistan accepted “Swiss” dinars, presumably in payment of tax obligations.
@the Peak Oil Poet
Your last comment breached multiple rules – take a week off commenting.
Which is a legitimate reason to use it. For example it makes buying drugs online at places like Silk Road a lot safer. About a million dollars worth of bitcoins change hands there each month.
Actually worse than Malibu Barbies, since there are presumably genuine collectors who want them
@the Peak Oil Poet
I kind of expected this from you. You’re permanently banned.
Good point. The article has been updated since I last reviewed it. Mystery solved.
@John Quiggin That is probably one of if not the most critical test of a currency, whether a sovereign will accept payment of taxes in that currency.
Regarding all this discussion about trading in currencies commodities and derivatives could someone enlighten me on the taxes payable which if high would tend to discourage speculation and wild gambling/fluctuations.
I presume for example that if you bought gold physically here in Australia you would have to pay GST of 10% plus profit to the trader.
But if you trade gold as a futures commodity the cost is far less? Whatever the trade cost from Comsec etc. is?
This suggests that much of the gold currently being traded is perhaps leveraged/illusory just like bit coins? Or are we seeing notionally big chunks of physical heavy metal changing hands only notionally via the Virgin Islands from one Swiss Bank Account to another – or at best possibly involving moving material extracted from one hole which is currently in another hole to yet another hole.
Which all suggests the Bitcoin mania is not that much less insane than the Gold mania.
Just checking. Ta.
There is an alternative interpretation of bitcoins based on money as memory. Money is a record keeping device for imperfect and sometimes dishonest memories of past exchanges.
Stephen Williamson blogged on this using the money parable by Joseph Ostroy:
This money parable explains Keynesian macroeconomics well as Williamson explains:
As I understood it, part of bitcoin’s appeal is a form of scarcity via mathematical problems (?). Don’t know, but this post reminded me of the late Douglas Adam’s brilliance:
The rare information on bitcoin is how it grows to its limit of supply to prescribed 25 Mil BC which acctually plays into the demand for it.
The information on who gets newly issued supply is; those that provide their computer as carrier of a bitcoin algo program is getting 10 BC for the service. This is the major demand for BC. They pick receptors of newly issued BC by lottery of all newly offered computers.
When the BC increased in value, it was almost free to get a chance at 10 BC. When BC was valued at $100, that was $1000 of free value. I tought that once the available BC reached its limit, the demand from new users would dissapear and value of BC would go too. It happened earlier then that.
I can not find the link for that information right now. Once evreyone knew about that and about ability of new alternative bitcoins to apear on the market, the value crashed.
I can’t remember all the details but I remember a story from a few years ago along the following lines.
There was some online fantasy warrior game in which performing certain, relatively mundane and uncomplicated, tasks would earn the player some kind of widget. When a certain amount of widgets had been accumulated the player could turn them into something like a bigger weapon or better armour.
The widgets could be traded with other players and there was even a ‘secondary’ market for widgets in the ‘real’ economy. Apparently gamers were buying widgets for real cash.
Whichever entity owned the game was worried about robot programs playing the game only for the purpose of accumulating the widgets to on-sell for cash profit. Apparently they thought this was against the spirit of the game and viewed it as a gross effrontery.
So they organised a kind of cyber police force to pay a virtual visit to computers who’s activity fit the profile of such behaviour. They would put a notice on the screen saying they suspected this computer wasn’t being played by a real person and if a verification word wasn’t typed in within 60 seconds the computer would be banned and all widgets would be confiscated.
Apparently, somewhere (I think it was Malaysia??), some ‘evil’ gamer terrrsts got around this by having a room full of computers running the widget-gathering trick and one real human person keeping an eye out for the ‘verification’ message to pop up – dutifully typing in the corect word when it did, on each of the bank of computers.
Complex, smart, arguably victimless, enterprising innovation. Apparently the ‘scam’ was worth millions of dollars (real cash, not bitcoins!).
Amazing what people will be willing to pay for, and what other people will do to satisfy that need.
Aha! Apparently it’s called ‘Gold Farming’. They example I was thinking of was about a decade ago, but I saw one on the Grauniad site from 2011. In that version prisoners were being used by guards to crank up widgets.
People really pay for this stuff??:
If so, how does that sit with JQ’s criticism of bitcoin?
I dealt with this in a fair bit of detail here
For present purposes, what matters is that people are willing to pay to enter these games at a high level, avoiding the “level grind” of acquiring widgets.
Even if you accept the thesis that people can and will use private by-agreement money [even if the kurdish government accepted swiss dinars, there’s still brixton pounds and so forth], the thing is… bad money drives out the good, no? High-inflation currency circulates more than low-inflation currency, for obvious reasons. And bitcoins are set up to appreciate: given that everyone who deals with bitcoins will also deal with normal currency [since they have to pay their taxes] people will have govcoins to spend and will spend them in preference.
So few transactions will be made in bitcoins: not for lack of acceptance by vendors, but on account of the fact that buyers would rather keep what they have. And this will in turn mean that there’ll be little pressure on or benefit to vendors to accept bitcoins, so they by-and-large won’t, and so bitcoins by-and-large won’t be readily usable to exchange for goods and services.
Or in other words they won’t become socially established. The whole project is doomed, what the users want — “low inflation” “widely-circulating medium of exchange” “not backed by a state or large organisation” — is essentially impossible. Pick any two. The bad money drives out the good, after all.
I am pleased JQ has posted on the bitcoin. I was meditating a post on it myself. My son took some interest (mental not financial) in the bitcoin phenomenon. Here are my diverse obervations (I am addicted to numbered lists);
(1) It does indeed appear to contradict the EMH.
(2) It may have some utility in the sense that drug traders, drug buyers, money launderers and other assorted crooks feel that is has utility in evading justice.
(3) It is most obviously intrinsically worthless and a bubble (that has burst recently).
(4) My 19 y.o. son assessed it was a gamble, wished he had got on it earlier for a $100 he could afford to lose. He had developed some mathematical models (uni maths and engineering student) which he hope would predict the bubble collapse so he could get out in time if he got in.
(5) I took one look at the graph (before the recent collapse) and said “too late”, it’s going to collapse “very soon”. I was right. Lucky guesstimate!
(6) He had trouble using University PCs (running v, slow) and found they were hacked and using 95% of CPU for mining bit coins. He reported this to admin or his faculty.
Collin – there is a bit more to Greshams law than what you have stated. Greshams law says bad money drives out good money when they have equal face value. Bitcoins do not have equal face value with fiat currency. Greshams law is simply supply and demand doing it’s thing in the context of a price fixing arrangement. If you accept gold and silver in payment for tax debt and fix the rate of exchange between the two for that purpose then the cheaper one will be imported in large quantities. This is exactly what happened in the US era of bimetalism.
Botcoin has generally been deflationary since the get go. More so since Cyprus announced it would be confiscating cash from bank accounts. Yet in spite of the deflation circulation has increased. In fact the deflation occurs precisely because of growing demand.
Claims that bitcoin violates EMH seem to be based on the fact that the market price is above zero and an assumption that the correct price is zero. I think it is the later assumption that is flawed.
There is another complication to BitCoin. The exchanges are like roach hotels for your money. You can buy in with as much as you want. But you can only withdraw $1000 per day in non-Bitcoin.
The Winkelvoss twins are sitting on some 40,000 or so bitcoins, that had a market cap of roughly USD10 million at the $266 per bitcoin peak and $3.6 million at today’s $92 price. If they want to cash out, it would take them 10 years at today’s valuation, or 27 years at the peak.
That means that the Winkelvoss twins and the Maltese hedge fund will have to make deals off-exchange.
This feature of Mt. Gox trading limitations, and the way that orders are executed, suggests strongly to me that the guys running Mt. Gox are operating for their own benefit. Trades can take an hour to clear, and price at clearance can be quite different than the price at time of intended sale. That allows Mt. Gox to make extra money both as buyers and sellers.
When price is rising, Mt. Gox can execute a buy on behalf of buyer and then sell it to them at a price higher than they bought it for. When price is declining, Mt. Gox can execute a sale to a buyer, and then buy it later for a lower price.
The truly outstanding feature of Bitcoin is that the largest single stash of them that is known is some 500,000 that a scammer stole from trusting internet denizens who invested in his site.
I have also seen complaints for a while from bitcoin miners that after mining for months or a year, they haven’t gotten credited with a single bitcoin. That suggests to me that somebody is snaffling up bitcoins that get mined by the trusting digerati.
Lately, this Flexcoin bank appeared. Since it is impossible to run a banking operation using Bitcoins, for the same reason you can’t run a bank on a strict cash-coin basis, it appears to me inevitable that the purpose of Flexcoin is a type of Ponzi scam.
A Freudian slip? 😉
I agree with TerjeP on both, the definition of the Fama et all EMHs and on Grasham’s law.
I still maintain, for reasons given in my 1986 paper and on this blog-site, the Fama et all EMH is not testable (non-refutable). It should simply be ignored. Other notions have been associated with EMH (eg one way to value a physical asset, or bundle of physical assets, by means of discounting future net revenue; eg JQ’s argument). I don’t believe this is helpful.
Otherwise, the bitcoins are but another form of off-balance sheet money. Other historical examples of off-balance sheet money can be found in societies which did not use the financial accounting framework (balance sheet). For example, cowrie shells have served as money, and even a huge stone.
In contrast to the ‘money’ generated by the proverbial Wall Street bankers, bitcoins are harmless with respect to Grasham’s law. This is because bitcoins are denominated
in ‘bitcoin’ and not in USdollars.
I don’t agree with TerjeP that bitcoin is not a unit of account (there are many units of account in reality).
I don’t agree with TerjeP that a bitcoin is a commodity. There are very few words in Economics which are well defined. A ‘commodity’ is one such word. A ‘commodity’ is described by its physical characteristics, time of availability, location of availability (and state of nature) ocnditional upon which it is made available. (Arrow-Debreu and all math econ theoretical models since then, which I am familiar with). IMO, the physical aspect of entering digits in a computer system over-stretches the the crucial aspect of physical characteristics in the definition of a commodity.
I agree with TerjeP @25
The call for ‘regulation’. The regulatory failure, which showed up in the GFC, concerns the failure to appropriately regulate financial securities denominated in national currency units.
I really would object to ‘regulation’ extending to me paying a tax on exchanging my home made apple cake for strawberries grown next door. On the other hand I would object to people using complex company structures, trusts, and tax havens to avoid paying taxes on the proceeds (profits) from transactions denominated in national currency units.
The exchange of an apple cake for strawberries is entirely driven by technological knowhow, natural resources, and preferences. This is what underwrites ‘value’, whether people bother to count it in bitcoins or US dollar is, at the most fundamental level, irrelevant.
As I have said over the past years, we need a concept of monetary objects, their creation, circulation and destruction, which is independent of the balance sheet. The theoretical framework should be so general that any form of ‘money’ is representable. Which form of money appears where an when and under which condition is then an empirical question.
Bitcoins did not appear at the time when the USdollar was non-convertible for a short period of time in or around 1974 – the technology was not available.
To what extent the creation, circulation and destruction of the monetary object ‘bitcoin’ reflects personal preferences for trying out something new or individuals expressing their lack of trust in the management of national currencies are empirical questions.
Interesting analysis, but I use my bitcoin as a v. cheap way of doing small (< $10) international transfers, particularly for donations and payment of online assets.
It's less useful than it could be because of the difficulty of acquiring bitcoins initially, the price volatility, and the security concerns around holding virtual currency on a PC. The first and third are significantly improving, the second not. I'm not sure how you'd start a payment system like this without being subject to speculative exchange bubbles, but perhaps this is a problem which will be resolved in time?
But it's still providing useful value to me. Though I'm not an economist, so perhaps I'm not rational?
What about bitcoin as an emergent phenomenon (as in complexity theory)? It is completely virtual, completely independent of government, decentralised, global, cryptographicaly secure, fast, anonymous and intrinsically valuable because of the “genius of the technology”: http://www.businessspectator.com.au/article/2013/4/9/currency/why-mind-spinning-bitcoin-revolutionary.
Bitcoin is to dollars as the car was to the horse and cart?
I saw some young bloke on the TV the other night who was into Bitcoins. He’d attempted to sell some through a local exchange, which had closed its virtual doors before he actually got paid. The principals are proving difficult to contact …
The really funny thing is, this bloke still believes they have value.
I think one does not have to be an academic (like JQ and EG) but just a moderately intelligent old dog who has walked a hard road to know that;
(1) Bitcoin is a scam; and
(2) Bitcoin is a pyramid scheme or ponzi scheme.
The creation and trading of bitcoin is not transparent nor subject to any regulatory oversight. It is clear that creators (with inside knowledge) can do anything they like in certain respects. This is notwhithstanding claims that the code that runs it is open source and open to scrutiny.
Bitcoin is an elaborate and ingenious scam and it faciliates trade in illegal and dangerous goods. It also wastes computer resources. Bitcoin and like schemes should be subject to heavy regulation and a hefty Tobin style tax. You want to trade in spurious currency that facilitates illegal transactions? You pay heavily for the privilege. I have zero tolerance for this sort of financial chicanery which is totally non-productive and which once again works to shift wealth from workers and unsophisticated people (if they get caught up in it) to too-clever-by-half shysters and con merchants. Bitcoin (as a creation) is a quasi-criminal activity and perhaps even a criminal activity in the moral sense.
If one of the key features is to facilitate anonymous transactions, how would the users you seek to regulate and tax be identified?
I’d just like to say that if any one has any Malibu Barbies in their original packaging, or alternatively fabulous new packaging, I am willing to pay for them in bit coins. And I’d like to state that on all my bit coins you can clearly see the tooth marks.
This leaves the problem of distance. Do you have a contract with all postal services world-wide in bitcoins? If not, some if not all trade remains virtual.
Disclosure: I am long bitcoin from early mining. i saw a small window of opportunity and took it. Backups are awesome.
On non-usefulness of bitcoin – a refutation (not very technical one and there are probably better out there)
” This, with some crypto features, allows it to be used for secure time-stamping, proving ownership of tangible property, decentralized DNS and new ways to sign contracts without having to fully trust any one party.”
It is the distrust embedded in the bitcoin blockchain design that makes it valuable.
The default client bitcoin-qt allows you to sign and verify messages against the blockchain. An essentially permanent public verifiable record of the message. Other clients are more elaborate.
I am more in the crowd that thinks the world needs a better micropayment system (fricitonless) and that a market niche exists for a thing like bitcoin. BTC may not be it and there are a number of competing designs already running. Also various venture capital outfits are getting involved. I see the market opportunity for such a system is going to get bigger not smaller.
However one more banking snafu is going to see demand climb for bitcoin if nothing else is available. It won’t return on capital invested it will be return of capital that is the primary driver.
PS: I haven’t bought any drugs but I did some computer ram which saved using my credit card across the internet with essentially unknown people.
If we use registered mail I’m sure I can post my bit coins just about anywhere in the world. Postage costs will be low as most of the coins I have bit are aluminium Japanese coins.
I don’t think it is really up to me as a layperson in matters of jurisprudence, law enforcement and financial compliance to come with the methods of proscribing and/or regulating and/or taxing shadowy activities like bitcoin. It should be enough for me to state my principles, state which approach I would support and give my vote to the political party (if any) which will tighten financial regulation across the board.
It would not be beyond the collective knowledge and experience of the relevant and responsible bodies to come up with ways of tightening regulation and throttling back, if not stamping out (no pun intended) shonky schemes like bitcoin.
The FBI and others went after Kim.Com albeit with debateable success. There is no reason on the face of it why such government organisations and Interpol could not go after the creators of Bitcoin and like schemes if certain aspects of them were proscribed. (Not that I support the notion of US agencies in particular going after people in other jurisdictions.) All it would take internationally, would be an International Agreement on accepted currencies and proscribed currencies for inter-national trade and exchange. The bar could be set relatively low. The official currencies of all nations and like polities recognised by the UN General Assembly (with no Security Council veto) would get a guersney. Trade in any other currency or currency mimicking unit would be illegal under international law. I am fairly sure the distinction between currencies and securities etc. could be clearly defined.
The fact that something bad or damaging is hard to stamp out is no reason to resile from attempting to stamp it out. Slavery still exists today. It is impossible to stamp out. But enormous strides were made in stamping out 99% of it when people, nations and the international community got serious about proscribing it. Artificial financial instruments and schemes which game our national and international monetary and financial systems and play and prey on greed, gullibility and weakness for no genuine net productive return are THEFT. They should be stamped out as far as is humanly possible.
Almost any traded good can satisfy the three characteristics of money (store of value, medium of exchange, unit of account). However if we set the bar too low then everything is money and the concept of money becomes meaningless. When there are many businesses that offer their price book in BitCoins and do their double entry book keeping in BitCoin units then I will concede that it is a unit of account. In the interim I think such a claim entails stretching the language of such things.
Accordingly I don’t generally regard gold as Money outside the context of a gold standard.
Ikon – I don’t think buying or selling drugs or inventing and / or using BitCoin is immoral. Can you justify such assertions.
If i may do it too.
Avoiding taxes is immoral, and bitcoin serves that.
Tax redistribution is essential to prosperity of a whole society. Without tax, health, retirement, education systems ability to redistribute accumulated wealth you would get increasing accumulation of wealth/ money in smaller and smaller hands while there would be less and less money which enables exchange on the bottom. Prety soon (50 years) you would have all money in a system, being placed in single hand, while nobody else would have any. and production would find no buyers since they have no money.
That lack of redistribution can be aleviated by loaning accumulated money to poor so they can buy products that made wealthy wealthy, but at some point in time the debt placement will stop or be reduced just as it did in 2008.
It is the circulation of money that makes an economy prosperous, the process which i call Nominal Surplus Circulation.
94% marginal tax provided the most prosperous times in USA history because redistributed money from top to bottom without increasing debt enabling purchasing power to keep those on the top wealthy and those on the bottom to enjoy real goods.
Avoiding taxes is imoral.
Oh, I didn’t mean to suggest that you personally need to come up with the technical solution as to how that was to be done. Sorry if I gave that impression.
I suppose I was just trying to highlight the fact that the anonymity aspect of BitCoin was designed at least in part to avoid the kind of scrutiny which you think should be applied to it.
Probably not a popular view on this blog, though:
I would be wary of correlation vs causation in this instance.
I would also be skeptical if many, or any, paid an effective marginal rate of 94% due to loopholes, deductions, off-shore havens, etc. I would be really interested in data on that front however and am always happy to be proven wrong.
TerjeP, which of following is not a unit of account at present?
No, it is not a popular view at almost any blog in the world today, not even on the circuitists blogs like MMT. But it was popular at Robert Reich’s blog, but he closed off comments few years back. This is the view that only small precentage of relly progressive population is holding.
Then you should try to disprove that time when 94% marginal tax rate was present correlate with the most prosperous times. No matter the real tax rate. I believe that psychological effect on wealthy and managements is also very important by not allowing for incentives for fraud, or financial abuse, or fighting with workers about share of the productivity rise.
I want to prove that debt replaced tax redistribution effects that lead to prosperity.
Lets try to clear all, absolutely all, of the debt in a system, liquidate all assets to pay of debt. What would you get?
Without firesale prices you would get what net wealth charts at the present show. In USA chart from 2007, 1% of population holds 34.6% of accumulated money in the system while 40% at the bottom holds 0.2% of all money (net worth) in the system while top 10% holds 73% of money.
With firesale prices you would get much worse relation. You would get that only about 5% of population holds any money. Can you have any kind of economy where only 5% of population holds any money?
Of course there would be developement of barter economy and alternative money before all people without money die off.
Just try to imagine clearance off all debt/ liquidation.
Money pulls production and exchange. In other words, as Liza Minelli sings “Money makes the world go around”.
In other words debt, makes the world go around.
In other words, money is debt.
In other words, when tax and social net redistribution of money is replaced with debt as agregate demand enabler, it will hit the ceiling and crash the economy.
94% marginal tax rate prevents debt growth and provides for sustainable agregate demand and supply side interaction. Which is requierd for prosperity growth.
EG – For each example you offer there are many businesses that do their double entry book keeping and issue a price book denominated using that currency. So by my own criteria they all function as a “units of account”.
My long comment is in moderation even tough it has only one link with a response link. weird.
Agregate demand and supply side are interactive components of an economy, i would say that everyone agrees with that.
94% MTR gives support to both sides at the same time in addition to strong safety net. It prevents increasing accumulation of money on one side while giving to those that provide demand for products of supply side. It is a redistribution that keeps the ballance between demand and supply at the highest levels.
You can replace such redistribution with debt which also speeds up the accumulation onto supply side, but only up to some point in time, untill it hits the ceiling like in 2008.
Not in my book.