Frozen coins


Its cost of ‘production’ or mining can only go up because of the nature of the 21 million cap.

When the cost of mining exceeds bitcoin’s price, miners will shut down. What happens then? You can’t transact bitcoin if miners won’t validate the deal. You can’t even have your Minsky Moment.

Ok, it becomes a Disney asset: Frozen. It will be a winter of discontent.

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.

Capitalism, Blood, and Gore

Is there such a thing as “sustainable” capitalism?

Long ago, Keynes warned that laissez faire capitalism was doomed, not in the sense set out by Karl Marx, but because of Marx: Supposedly labor unions got to be strong enough to ‘fix’ wages, and then was born the basic Keynesian ‘inadequate’ aggregate demand explanation of recession, which meant that capitalism was inherently unstable. Keynes response was for governments to fill the gap, and so here we are, still wondering what hit us in 2008. 

Continue reading “Capitalism, Blood, and Gore”

How to invest – the George C Rule

This blog post has an alternative title: Are you smart or dumb? Are you doomed?

Suppose we take as given that dumb money loses to the smart money. After all, price discovery is a zero-sum game in the capital markets.

Here’s an article by James Heaton and Nicholas Polson that can give you a formula for successful investing. The formula is to know when the price is dominated by smart or dumb money, and whether you’re one or the other.

However, it seems that about half of this article is pretty much circular reasoning. The amount of money bet by the smarts is usually equal to that bet by the dummies; otherwise, the market doesn’t come into equilibrium (for every buy, there’s a sell, or simply Say’s Law). So, practically all of the time, when the market is behaving normally, it is very difficult to tell from the price data alone whether it is dominated by smart or dumb money. Of course, when the market is obviously dominated by one of the twin evils of financial crises – Fear or Greed – we have an idea that the price is dominated by dumb money (and we even know in which way it’s wrong!).

Still, in the later part of their article, the authors point to a useful approach called the Costanza Rule. It works if we have extrinsic evidence that we’re either dumb or smart. This part isn’t so hard. If in the past you’ve been losing relative to the market, you must be dumb. Then you follow the Costanza Rule. That rule requires you to do the opposite of what you would want to do. Voila, you’ve turned yourself from dumb to smart.

Or have you? The new real question is then: Do you have the guts to bet against yourself?

The Holy Grail of investments – Part 3

The problem of survival

In two earlier posts, I outlined the problems of the little guy trying to survive in the stock and bond markets. The problem is that markets are notoriously variable, even turbulent at times, and difficult to predict. This must be so because if the markets were predictable, the efficient markets theory would be reality, and there would be no practical point in investing/dis-investing. Stock and bond prices would reflect the best information then available, and on average investment returns ex ante and ex post across all asset classes would be equalized. The historical experiences of individual investors would differ, but this can be attributed to plain luck or lack of it.

Despite the markets’ inherent unpredictability, still, some rules of thumb have worked historically.

Continue reading “The Holy Grail of investments – Part 3”

Efficiency and rationality of stock markets

Can an efficient market exhibit irrational pricing?

The answer is Yes. The answer given here is based on a re-reading of Robert Shiller’s 2005 book, Irrational Exuberance

Let us first define terms.  An efficient market is one where all profitable trades have been exploited; in the textbook sense, it is one where the price observed is the market-clearing price, or where the demand and supply curves intersect.  Irrationality is a defect in the perceptions of market participants; they may be subject to excesses of optimism or pessimism, which may cause them to buy more or less than they would if they had been rational.

Continue reading “Efficiency and rationality of stock markets”

The Quest for Alpha – a book review

Larry E. Swedroe (The Quest for Alpha,  John Wiley, 2011) sounds like a cynic but he does the saving/investing public invaluable service by pointing out how Wall Street works.  The bankers and brokers have yachts; their customers lose their shirts.  It is a caricature that hurts because there is a tough grain of truth in it.

In effect, the story is that financial markets are “efficient” because many players, big and small, devote enormous resources to gauging the “correct” valuation of various investments (stocks, bonds, commodities, etc.) that their collective wisdom is, for practical purposes, impossible to beat.  Even if one were to think that the market has become “irrational,” such a judgment cannot be made ex ante as a means of getting above-par returns. Continue reading “The Quest for Alpha – a book review”