Will Bitcoin crash and resurrect?

NOT BITCOIN but better.

One use of Bitcoin is for anonymous transactions, i.e., as a substitute for ordinary cash or bank notes.

The problem is that the currently available bitcoins fluctuate in value. The ideal is a bitcoin that is stable for at least a certain determinate or even indefinite time against a major currency, such as the US dollar. In short, we want or need an alternative bitcoin that is like a dollar banknote. We imagine this alternative works better than keeping banknotes under the mattress or in a safe deposit box, because it avoids thievery and the transaction costs of going to the safe deposit box.

It can be done. The easiest is for the US Fed to do it. It would allow anyone to buy something we might call the official bitcoin dollar in exchange for a guarantee that bitcoin dollars are exchangeable into US banknotes. If this works, it will be because it would reduce the costs now paid by the central bank for printing currency and going after counterfeits. In this scenario, the blockchain ensures that counterfeit official bitcoins cannot exist.

Another way is for a major private bank to ‘create’ its bitcoin dollar. Imagine that Chase does it, and calls it the Chase bitcoin dollar. All it is is a special debit card account where Chase guarantees to make the Chase bitcoin dollar exchangeable for cash. The guarantee is in effect a promise that Chase will honor Chase bitcoin dollar liabilities ahead of its any other liabilities. To ensure such a guarantee, Chase would enter into a ‘currency board’ arrangement with the US Fed by maintaining Fed fund balances in a separate special account solely for the purpose of redeeming Chase bitcoin dollars. In short, the fractional nature of the private banking system will not apply to bitcoin dollars.  

The blockchain also allows Chase to ensure that no other entity can create Chase bitcoin dollars. The ‘supply’ of Chase bitcoin dollars will always be the same as the demand for such dollars.

Any other private bank would be allowed to participate in a ‘branded’ bitcoin currency. I can imagine HSBC issuing special debit cards for HSBC bitcoin dollars, HSBC bitcoin euros, or HSBC bitcoin yen. They may be allowed to compete through enhancements on convenience of use, allowing for fee-free global transfers, or even the payment of interest.  

One important enhancement would be US consumer protections against fraud now being given to users of credit cards. Any merchant declining to honor a bitcoin debit card would be presumed to be up to no good.

The similarity with bank notes will have to be carried to an extreme that meets certain anonymity and privacy standards. The issuer of a bitcoin dollar will have to honor the bearer of the account provided that said bearer satisfies identity requirements. 

At the same time, the use of such accounts will have to be protected by bank secrecy rules, but subject to money-laundering limits. For example, bitcoin dollar transactions in a particular account cannot exceed $10,000 per day, and a bank cannot allow a depositor more than one bitcoin dollar account. A maximum-balance limit of, say, $100,000 per account, could be imposed, in parallel with limits now applied under existing deposit insurance schemes.
Central banks could also impose limits on how many bitcoin dollar accounts an individual can have. To protect banks from money-laundering, bitcoin dollar accounts would not be available to corporations.

Will the advent of such official or private bitcoin dollars kill the existing bitcoins? It could, especially if bitcoins continue to be more attractive as speculation vehicles than as means of payment.

But bitcoin exchanges could create ‘hybrid’ bitcoins whose ‘mining’ or supply-side arrangements are fully transparent, and whose value could be stabilized in some fashion desired by the bitcoin holder. In short, there could be different bitcoins for different purposes. Caveat emptor and ‘know your customer’ rules would still be needed. However, such bitcoins would remain without guarantees similar to deposit insurance, and they may still be vehicles for speculation.

My best guess: Bitcoins will evolve, i.e., the fittest will survive. The Dutch tulip variety will become extinct. As of now, they’re pretty much as primitive as Dutch tulips.

Pigou vs Coase, as refereed by Demsetz

This is a good summary of the Pigou vs. Coase debate on externalities. I have one comment: That the author should have brought Hayek into the picture. After all, the piece was published in 1996. What follows is a kind of executive summary.

Demsetz sees the debate on externality as one between two ideals: An ideal state (with perfect information) and an ideal market (also with perfect information and zero transaction cost). Taken to the limit, both models do not generally produce identical solutions. It is well known that the initial distribution of wealth and income affects market outcomes. Change that distribution and the economy rests somewhere else. With Pigovian state intervention, one also needs to factor in the initial distribution of wealth and income as a determinant of political process. Still, it is reasonable to imagine that both models arrive at the same end-point if they started with the same initial conditions.

Demsetz then concludes, based only on theoretical considerations, that the choice between the two models is one determined by preferences for freedom and the final (and/or initial) distribution of incomes and wealth.

Once we depart from the ideal to actual governments and markets, the choice between the two solutions would then have to take into account how much information there is (available) in the competing models, and how well they would reduce transaction cost. Here, Hayek would pronounce in favor of Coase, if only because Hayek believes that the market is more capable of ‘discovering’ such phenomena as efficient technologies and consumer preferences. Transaction cost can be seen as another form of externality, so we start to run the risk of arriving at a proverbial slippery slope.

Nonetheless, Demsetz is essentially right. Transaction cost is not at the kernel of Coase; and neither did Pigou ignore transaction cost. What was being debated was who should have the property rights to the externality, a question that economists usually avoid but one that Coase faced head on.

EC 11 HW – Market Structure (wrap-up)

There is no need to submit your answers.  We will discuss them in class.

  1. Classify the following markets as competitive (C), oligopolistic (O), monopoly (M), monopolistic competition (MC) or none of the preceding (N). In your answer, include the possibility of illegal producers or consumers. You should answer N, if the demand side of the market is not competitive, but the supply side is. [6 pts.]

_____ (a) law enforcement services

_____ (b) cell phone service

_____ (c) wives or husbands (aka the marriage market)

_____ (d) kangkong, tomatoes, onions

_____ (e) Nokia cell phones

_____ (f) security guard services

  1. The main difference between perfect competitors and monopolistic competitors is: [choose one only – 3 pts.]

____ (a) There are many perfect competitors, while there are usually only a handful of monopolistic competitors.

____ (b) Product innovation is not important for perfect competitors, whereas monopolistic competition would not exist unless sellers can produce “branded” products by using or adapting new technology.

____ (c) In the long run, there is zero profit in perfect competition, while there is a small positive profit for monopolistic competitors.

  1. Match the concept with the appropriate statement: [4 pts.]
Price leadership, or a market dominated by a large firm A. An agreement to collude, allocating market shares and setting prices.
Contestable market B. Ease of entry or exit
One firm is the only seller C. Small firms behave like perfect competitors because they cannot control the price.
Cartel D. Monopoly
  1. In terms of how they deal with consumer demand, the main difference between oligopoly and monopolistic competition is: [choose one only; 3 pts.]

____ (a) Oligopolists set the price by conspiring with each other to form a cartel, whereas monopolistic competitors do not engage in overt conspiracy (i.e. they set the price by secret means).

____ (b) Oligopolists tend to engage in advertising to steal market share, whereas a monopolistic competitor does not bother to differentiate his product from that of his competitor.

____ (c) Oligopolists face a downward sloping demand curve, whereas monopolistic competitors face a slightly downward sloping demand curve. As a result, monopolistic competitors set price without worrying about the prices set by others, whereas oligopolists cannot set the price independently of each other.

  1. Which of the following are valid justifications for monopoly? [Check as many as there are – 4 pts.]

______Where there are economies of scale (there is a natural monopoly), society is better off because production is at the lowest resource cost.

______Monopoly from patents given to investors encourage innovation that benefits mankind.

______Where there are few barriers to entry, and more-or-less constant-average-cost to produce the given product, the result is a contestable monopoly, and here, the monopolist sets prices as though it was producing in a perfectly competitive market in order not to lose his monopolist status.

______Where there is extreme income inequality, and a generally perceived need to provide low-cost access to the given product, a legislated monopoly through licenses (such as for lawyers, doctors, etc.), makes it possible to provide for mandated low prices for a target group of “needy” consumers.



How to let big banks fail

The idea of “too big to fail” comes from the experience of bank runs in the early 20th century.  The answer then and now is deposit insurance. But such insurance has its limits, just like any insurance contract.

Lawrence White suggests that bank runs can be prevented if we redesign the banking system.  He suggests a money substitute that just might work, except that the big banks will have, perhaps, a hard time making money on fees.

It seems that the idea can be integrated with the emerging market for cryptocurrencies.  How?


Living the lousy life of a telecom consumer

Remedies against monopoly

You can almost see  the present system of announced prices, with unannounced promos maintained by the telecoms, as a form of price discrimination, a concept familiar to students of economics.

The two aren’t quite monopolies. But for the sake of discussion only, imagine that they are a two-piece cartel, a bikini in nosebleed-speak.

What can consumers do to foil a price-discriminating monopolist/cartel?

Any interesting answers out there?

Bitcoin as money

BITCOIN Screen Shot 2016-01-29 at 10.04.16 AM

The following is a note found on Facebook.

Random ideas on what makes money money
by Kermit Kefafel,  Friday, January 29, 2016

Is money a public or private good? It is a private good imbued with public interest. The public goods that attach to money are the safety of the banking system and price stability, as conventionally promised by a central bank.

What are cryptocurrencies? They act as substitutes for the use of cash in untraceable transactions, the idea of Bitcoin. You can even buy bitcoins at your local 7-Eleven.

The market for Bitcoin has lately been shaken with the arrest of one of its principals; there is talk that it could collapse. Will other cryptocurrencies have the same problems?

I suspect that for a cryptocurrency to become viable, it must hurdle the trust problem — its users and holders must be assured that its supply and valuation are, in some sense, sacrosanct. That its price could bubble up and down like a financial asset is a negative. Even fiat-currency central banks pay some kind of lip service to exchange stability under the current system of floating exchange rates.

Because of the public-goods aspect of money, a stateless currency requires an enforcement mechanism that is private but viable. Does such an enforcement mechanism exist?

Or, are cryptocurrencies just another Ponzi scheme?


For reference, see Lawrence White’s article in the Cato Journal.

The central bank (Bangko Sentral ng Pilipinas) has issued an advisory regarding the lack of regulation on virtual currencies.

A recent assessment predicts continued growth of Bitcoin in the Philippines.



Rappler is cute, but no cigar, on electricity

As an electricity consumer, I’m grateful for a wrapped-up report on how to understand electricity prices. Rappler.com has come up with such a report. It is an anime that raises more questions than answers.

“Watch this animated illustration to understand how the sins of the past, the capital intensive nature of the power industry, market forces, and moves for cleaner energy sources make their way into the electricy bill.” – Rappler says in its website.

Continue reading “Rappler is cute, but no cigar, on electricity”