To hold Bitcoin is to keep a secret and to trust the internet.
or how to think about Bitcoin.
In the end, there is no free lunch when we talk about transactions cost.
Consider Bitcoin as a digital equivalent of gold. We don’t know the price of gold a hundred years out because we reckon that price in terms of fiat, and there’s no way we can predict what central banks will do. We could try to measure the value of gold in terms of man-hours, but still that won’t work because we have no idea what technological advances will take place (that’s in the realm of the unknown unknown), or even which fiat currencies will be around to use as a benchmark.
Ergo, we won’t know what the price of Bitcoin will be a century hence. If we don’t know that, then we don’t know what’s the ‘correct’ price of Bitcoin today. This is just a consequence of using a present-value calculation (the uncertainty on the proper discount rate is not even material).
What we do know is that Bitcoin has had a run-up in price because the players behave like a collective Ponzi. Imagine if the Ponzi players got enamored with gold the way they have with Bitcoin. Not so far-fetched, is it?
There is a difference, of course. Gold is a commodity with ‘intrinsic’ value as jewelry. Unless humans suddenly decide gold has no worth at all, the jewelry component will set a floor to the gold price.
Bitcoin, once mined, is just that: a digital bit sitting in a thousand computers. You can’t eat it, wear it, etc. You might argue that it cost a miner $1,000 to get his Bitcoin, but that’s just sunk cost. It doesn’t guarantee a price that the next guy will pay.
But an even greater difference is this. Anyone else can cook up his Bitcoin wannabe. If he succeeds, then you have an ‘alt coin.’ If you cook it up from an existing alt coin, it’s called a fork. Theoretically, you can then have an infinity of forks and alt coins. In practice, you need a society of nuts willing to see a particular alt coin as money. How many in this society? I don’t know, but a good guess is 1 million. With global population at 7.6 billion, we might have 7,600 alt coins. No wonder, every Ponzi-loving geek goes out to try his luck. Lots of suckers out there still.
What this means is a ceiling on the Bitcoin price, analogous with the floor on gold. Where is that ceiling? Only the god of Ponzis knows. Individually, alt coins including Bitcoin will fluctuate according to the vagaries of sentiment. If an alt coin’s underlying ‘consensus’ mechanism, which is human psychology and not a matter of algorithms, gets compromised, that alt coin will crash. Kindleberger wrote the books on manias and crashes, and he would say that all assets are susceptible.
Can Bitcoin have a floor? If you start from zero, and if everybody deserts you, that floor is zero. (How many penny stocks have come to naught?)
Can Bitcoin (or any alt coin) have a stable non-zero equilibrium price? Bitcoin started out billed as an alternative to fiat, and perhaps it may run a very long run equilibrium if, collectively, Bitcoin users are convinced that their Bitcoin is worth a certain (stable) amount of fiat. This would be paradoxical. You end up holding Bitcoin as just another form of fiat. As it is, the transactions cost of using Bitcoin is on par with that of fiat. So, why bother?
Unless, of course, you think you can still play the Ponzi.
The pleasure of company
“I want only the pleasure of your company.” How often have you heard that? And did you believe?
The idea that people socialize to ‘do business’ is accepted, even needed. But there are times when with no particular agenda, time is definitely not money. Time would be more like a ghost of precious moments seeping through the interstices of events we demarcate.
Did prehistoric man with only stones for tools sit around wondering about time and where it went? Did he learn to write because somehow he wanted time to stop? “Carpe diem,” goes the saying, but the thinking day resists. It passes, and gets rated good, bad, or so-so. Most days are writer-block days.
And then came the Internet. We’ve now got mail but then it also got filled with spam that we now have to filter. We Google but then Google tracks us. We Facebook, and without us wanting it, advertisers stalk us. Walt Kelly got it right: We found the enemy, and it is us.
What to do? Can we befriend our collective social selves? Can we carve out human conversations in private digital spaces? There is something to going back to pen and paper, and the mailman; or to meeting up in cafés that feel like Paris. Better yet, we embrace the idea of organizing a bunch of friends who think of dining as more than just filling up a calorie tank; the venue would be, as Hemingway called it, a moveable feast. Don’t forget to bring manners.
Why do we have tombstones and obituaries? Why do we not just talk? Of course, at a funeral, we have eulogies, i. e., we talk.
Still, talk is ephemeral, like time and our memories. The latter, as we age, get scrambled, and writing is a kind of preservative. It’s as though, with some kind of reification, we manage to live beyond the expiration dates on our memories. And certain transitions literally demand a handing over of memories. Institutional memory is ideally a perpetual motion machine.
But what happens when we write and no one reads? Is it the same as if we talk and no one listens?
Whatever did happen to E. F. Hutton? (The one with the slogan: ‘When Hutton talks, people listen.’) My guess is that slogans come and go, sales talk goes only so far, and stock market bubbles don’t last. I would, for sure, be lucky predicting The Stock Market Crash of 2018. Unlucky speech or writing gets forgotten.
Victor Hugo wrote about revolutions at different levels of perception. In Les Miserables, one such revolution came down to asking, ‘Do you hear the people sing?’
Perhaps change is why songs are written, and the good ones last. When things haven’t really changed, the songs of that era become forgettable.
In sum, we have tombstones because we want to be remembered well. Your tombstone ought to say, ‘She had a style and wrote or sang a good song. You too can sing it, softly. People will hear it and sing it too.’
Can the reputation mechanism be made robust? Can there be a Law Merchant on the internet if miscreants can hide behind encryption?
In some ways, Bitcoin has spawned a new wild West.
The questions then are:
Can blockchain identify a fraudulent transaction?
Will the community of users pre-agree to a readily enforceable clawback or restitution mechanism?
This is a story of mania, panic, and crash. It’s not new.
Today’s market cap is roughly $150 billion. Averaged over, say, 3 million holders, that’s $50,000 each. Peanuts, if you belong to the 1%.
The trick is to kite the price to anywhere from 5 to 20 times the current level of $4,000.
The sales are essentially wash sales, as coins just go round and round. That’s why they’re coins, see.
Spectators – the victims – then want in, and the insiders pump and dump swimmingly, until the 3 million can get out with huge profits, at the expense of the latecomers.
The end is a classic Minsky Moment, when the latecomers try to sell. The algorithms in the trading platforms would ask: ‘To whom?’ And the price spirals to nothing.
Question for economists: Can the end trigger a financial or economic crisis? A dire scenario is that the latecomers’ loss results in bankruptcies and loan defaults, a retrenchment in purchases of housing and consumer durables, or in a general malaise in business and consumer confidence. Banks may fail if they finance bitcoin purchases.
With the benefit of foresight, monetary authorities will likely institute safeguards. Trading platforms are like banks, and will need adequate capital in case of an epidemic of ‘fails,’ which can happen if traders engage in short sales, or in margin trading. The Know Your Customer rule will have to be integrated into the block chain data base, and imposed by banks on customers operating trading platforms.
Of course, theoretically, since virtual currencies can function as money, all trading can take place outside the banking system. If that were the case, the ponzi won’t work: How would the victims’ money enter into the bitcoin system? The price would go up and down forever, but that’s all. It’s funny money after all.
Or why Bitcoin and its variants are risky assets.
It’s fair to say that virtual currencies need block chain. Block chain is an essential or necessary innovation behind such currencies. That block chain is not sufficient becomes obvious when we consider the question of how many virtual currencies can exist.
This is pretty much a question in institutional economics. It would be like asking which fiat currency would dominate global transactions.
Ronald Coase’s transaction-cost theory of the firm probably has the answer.
The dominant virtual currency is the one with the least transactions cost. While trust is an unmeasurable element that reduces transactions cost, transaction cost can itself be measured.
There are other factors along with trust that augur well for the dominant virtual currency. Among these factors are:
It should have ‘standing’ with central banks if only because they issue legal tender, whereas virtual currencies are not.
Its value in terms of the dominant fiat currencies must be reasonably stable. For now, the leading virtual currency, Bitcoin, fails.
Also equally important is transparency in its creation and modification. It seems that users of a virtual currency will need at least an unwritten constitution that lays out the fundamental laws of the community of users, even if they wish to be as ‘decentralized’ as possible. Again, here, Bitcoin fails, as can be seen with the ongoing ‘fork’ controversy over Segwit2.
CONCLUSION. It’s too soon right now to say that Bitcoin is here to stay.
1. Can economics say anything about unforeseeable (uninsurable) disasters? I’m thinking about the idea that a butterfly moving its wings can cause a global tsunami.
2. Will robots cause permanent unemployment? Rephrase this question. In ancient history, the nobility didn’t do the work because they had vassals and slaves. Were the nobles unemployed? Was that a bad thing? Is employment/underemployment/unemployment an issue of quality of life?
3. What exactly is poverty? If stray dogs are poor, and pet dogs are rich, is it good policy to control the population of stray dogs? Or is it better policy to have feeding stations for stray dogs? Or is it an even better policy to mandate that those who have pet dogs also feed the poor and hungry humans nearby? After all, we seem to always say that humans have rights that animals don’t.