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.