Bitcoin’s belated bust

It’s been quite a big week in cryptocurrency markets. The price of Bitcoin has fallen close to $4000, down from a peak of nearly $20 000.

As a longstanding sceptic of cryptocurrencies, it might be thought that I would be taking a victory lap. After all, I have previously written that “Bitcoins will attain their true value of zero sooner or later, but it is impossible to say when.” With the Bitcoin price having fallen by 75 per cent, it might seem that my prediction is well on the way to being justified.

Unfortunately, the second part of my statement, about the impossibility of predicting timing has been proved definitively correct.. I wrote this in 2013 when Bitcoins were valued at around $100, and the total market capitalization was a mere billion dollars. A single wealthy individual could have driven the price to zero by short-selling.

Five years later, and despite the price collapse of the past few months, Bitcoins are selling at nearly 50 times the price I criticized as excessive. Moreover, as cryptocurrencies have proliferated, Bitcoin now constitutes only a fraction of the total market. The capitalization of the cryptocurrency market as a whole is fluctuating still close to $100 billion.

Yet this massive valuation is built on nothing. The idea that Bitcoin, or any of its competitors will provide a new and superior means for buying and selling goods and services has been tested to destruction. Nearly a decade after the currency was launched, the use of Bitcoin in purchases is modest, and rapidly declining.

The upsurge in ‘cryptocurrency’ markets in late 2017 was premised on the idea that, rather than being currencies, blockchain tokens like Bitcoin constituted a ‘store of value’. Given the plunge in prices since the December peak, this looks pretty appealing.

More importantly, if a security which does not constitute a claim on anything except a pointless calculation can be turned into a store of value, financial market valuations of all kinds become totally arbitrary.

The idea of cryptocurrencies as stores of value seems now to be dying away. The last refuge of the defenders the claim that, whatever the weaknesses of individual cryptocurrencies like Bitcoin, the underlying idea of the blockchain is an innovation comparable to the creation of the Internet. By analogy, it is argued, the current cryptocurrency bubble should be seen as a rerun of the dotcom bubble of the 1990s.

Even this claim is looking shaky. Many cryptocurrencies advocates point to Bitcoin alternatives such as Ethereum and Ripple as exemplars of useful implementations of blockchain. But these currencies have followed the bubble-and-bust pattern of Bitcoin. Ethereum has fallen 90 per cent December peak of nearly $1400. Ripple has fallen more than 80 percent.

Meanwhile, although a variety of institutions, from stock exchanges to central banks, have announced blockchain projects, few if any have seen the light of day. The obvious problem is that, for most purposes, centralised sharing of data through a trusted intermediary is more reliable than any algorithm based on decentralised anonymous voting.

It’s premature to write off blockchain completely. But a comparison with the World Wide Web is instructive. The first web browser was publicly released in 1991. Ten years later, it was estimated that there were more than 500 billion documents on the Web. The first conceptualization of blockchain was that of the pseudonymous Satoshi Nakamoto in 2008, which was followed by the introduction of Bitcoin in 2009. Ten years later, useful application of blockchain remains a vague promise.

While the Internet was of real social value, the associated stockmarket bubble was not. In inflation-adjusted terms, the NASDAQ composite index is still below its peak level of May 2000, and most of the dotcom darlings have long since disappeared. But at least, unlike the case of cryptocurrency, there was some realism to the story.

What do bubbles such as that in Bitcoin, and the early dotcom bubble tell us about financial markets? Assuming, as seems likely, that the true value of zero is eventually reached, we can say that these markets aren’t totally untethered from reality. On the other hand, as Keynes is apocryphally quoted as saying, markets can stay irrational longer than you can stay solvent. My 2013 claim that Bitcoin has a true value of zero is looking more credible every day, but anyone who bet on it back then would have lost their money.

Financial markets are one of our most important institutions, but they don’t work very well. It follows that massively rewarding the participants in those market is a waste of resources that could be better employed in addressing real social needs. We understood this lesson in the decades of widely shared prosperity that followed World War II. We need to relearn it today.

10 thoughts on “Bitcoin’s belated bust

  1. My hypotheses is thC was created by CIA to fund ISIL or Daesh. It is the perfect payment system for all illegal activities and that includes handling terrorist finances. It is just perfect for ISIL use to sell loot from Iraq and Syria and also a great cover for CIA money to support terrorists in Syria.
    Just as ISIL started growing in strength in 2011 at the time the BC started skyrocketing from $4 and 2017 as ISIL was collapsing so the BC collapsed.
    On the other hand there were many videos showing how ISIL fighters are a very skilled in software and gaming world. Their fighting can be compared to gaming fight experience. They fight as if it is a computer game not a life issue. As i am experienced in gaming world i can see that there is a lot of similarities in their tactics visible on numerous videos.
    Bitcoin is just perfect for hiding CIA finances and also for terrorists and seeing how USA supported ISIL in Syria there is obvious connection.
    ISIL have just lost a major stronghold and BC collapsed too. Is that only a coincidence?

  2. “Financial markets are one of our most important institutions, but they don’t work very well. It follows that massively rewarding the participants in those market is a waste of resources ..”

    Well yes, but that they don’t work very well makes it inevitable that they massively reward some participants. When you can’t estimate the economic value of an asset accurately – and for many financial assets it is, with the best will in the world, difficult – then it becomes easily possible for people to manipulate the apparent value so as to appropriate some for themselves.

    Keynes did say “when the capital allocation of a country becomes a by-product of the operations of a casino, the job is likely to be ill done”. And Bitcoin is an uber-casino.

  3. The phrase “…widely shared prosperity that followed World War II…” is telling. Nations were united by the shared experience of the recent conflict and recovery from the same. Sharing the prosperity was therefore much easier than it is today. Current populations are less likely to have lived through the same challanges together and have had decades of rugged individualism type capalist propaganda. For this reason I don’t think its a matter of relearning old lessons but of fostering a certain sense of nationhood.

    Back then cynicism in governement existed but hadn’t evolved into the complete disolusionment of today. Crytpo currencies are often a symptom of the current anti-government sentiment. This is conflating the problems of government incompetence and self interest with real and imagined faults in the institutions and systems of democracy.

    This is throwing out the baby with the bath water but anti-government sentiment is driven by a layer of consumerism obscuring the bedrock of public institutions that underly the economy.

  4. “The phrase “…widely shared prosperity that followed World War II…”” triggers thoughts of the back-to-the-future dreamy 1950s idolised by the ilk of Abbott, LNP and Co. Of course, things such as little effective taxation for the top end and little affordable housing for the bottom end as of now would be applied back then, and then carry on here and now and into the great 1950s hereafter – just as a cold war revival and all the nuking-up are… We ought be careful what we wish for.

    And we ought be particularly careful about choosing any open ended “prosperity” revivals over continued human and ecological survival. What’s left to share after “prosperity” doubles each 24 years, say, with notionally necessary 3% pa growth targets? To loosely paraphrase a reasonably famous old question*, what would it profit anyone to have any share in such prosperity only to lose the very Earth forever? World Overshoot Day occurred on August 1 this calendar year. Overshoot Day for Australia occurred 4 months earlier on March 31!

    It seems all economic prescriptions adopted and likely to be adopted by Power are inherently death sentences.

    *Mark 8:36

  5. ” …. centralised sharing of data through a trusted intermediary is more reliable than any algorithm based on decentralised anonymous voting.” Not to mention cheaper. I’ve yet to hear of a blockchain proposal that can come within a mile of the transactions costs of for instance the interbank FX market, where trillions – literally – change hands every day at margins of a handful of dollars per million trade. SFIK it’s never been hacked. I dare say the clearing house in New York that’s responsible can afford to hire the very best Red Team antihackers.

  6. There is a whole raft of (un)-economic creations and processes on which we, as a nation, waste stupendous amounts of resources. Cryptocurrencies are just one. Each one of us tends to have a bee in the bonnet about a few, selected examples. Here are a few of mine in no particular order;

    (a) negative gearing;
    (b) fossil fuel subsidies;
    (c) business subsidies in general (welfare for the rich);
    (d) pointless offensive wars;
    (e) too much personal transport (automobiles);
    (f) pubs, clubs and low-brow entertainment;
    (g) professional sport;
    (h) g a m b l i n g (not sure if that gets auto-censored);
    (i) horse racing;
    (k) pets (expensive, useless, often treated cruelly, spread disease and kill wildlife).

    We are all guilty of indulging in at least some of these wasteful activities. The point is they are far too prevalent overall. They either distort our economy, waste our dwindling resources or both. Every one should be discontinued and/or have any subsidies removed and/or be hit by heavy pigovian taxes, as the case may require. Of course, this won’t happen. We will fail to discipline ourselves, we will continue to indulge ourselves, so nature will perforce apply “discipline” to us as natural limits.

    It won’t be long now, as the monkey said when he got his tail caught in the chaff cutter.

  7. An intriguing piece in The Conversation (***** suggesting that common law jurisdictions may not recognize cryptocurrencies as legally enforceable property. The doubt could be easily cleared up by legislation, but the bubble will have popped before the issue arises. Who’s going to waste legislative time on this?

  8. «More importantly, if a security which does not constitute a claim on anything except a pointless calculation can be turned into a store of value, financial market valuations of all kinds become totally arbitrary»

    The same applies to gold, rare stamps, or even in large part Sydney land; I welcome you to the concept of “collectible”, which includes assets that have a price because someone wants to hoard them, and that someone wants to hoard them because they know somebody else wants to hoard them and thus they are somewhat liquid. Bitcoin and gold and rare stamps have the same nature, and it is one that can last for a long time. They all have after all *some* usefulnuss, but by far the “collectibility” is the major component of price.

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