Cryptocurrencies: the future of currency or another madcap scheme? – Part 2
Part 1 highlighted the volatility of Bitcoin’s price and, as a consequence, its reputation. Now, let’s take a look at what cryptocurrencies actually are and the role they could play in the future.
Clearly, the price of any asset depends on the perception or maybe even whim of the people who trade it or use it. One big difference between the pricing of fiat currencies such as € or ￡ or $ and cryptocurrencies is that fiat currencies generally have reasonable price discovery – when you want Dollars in your pocket for a shopping trip to New York, your bank can tell you how much (in any other quoted currency) they’ll charge you to provide those (give or take a few hidden charges here and there) and you can check that online and decide whether to use your bank or take your FX custom elsewhere. It’s a reasonably open and competitive process and any discrepancies very quickly get arbitraged out of the system.
With even the most widely available crypto, Bitcoin, this isn’t really the case. Nowadays there are 158 fee-based crypto exchanges.[1] Whilst that’s relatively few compared with fiat currency, you could argue it’s enough comparison to make a choice. These exchanges claim to trade between $0 and $US442m on a daily basis.[2] That kind of movement is certainly not small: it’s less than half the Singapore stock exchange’s average daily volume in 2016 – around US$729m.[3] However, the SGX is regulated, audited and transparent and the volumes are generally believed. It is one of the ironies of BTC that while the blockchain can be open to the public, we have no idea whether all the BTC transactions can be considered ‘real’.[4]
These markets may be doing a lot of daily business but they aren’t generally overseen by financial regulators. Regulators and governments don’t seem to have worked out how to handle the exchanges, whilst hackers, fraudsters and traders in illegal goods are able to go about their business.[5] Consequently, prices are volatile (as mentioned in Part One), despite or maybe because there’s no tangible value attached to these assets and we have no way to know how reliable any of the figures released by these exchanges are. Genuine daily transactional turnover could be wildly exaggerated, to make an exchange seem more popular or mature, but the absence of a regulator allows us no evidence to suggest the numbers are accurate.
Presumably, if enough people read about how cryptos are the future one day, then the price shoots up; and the opposite if there’s a bad press or no press at all. Bad press – such as reports of security issues, on possible government regulation/taxation or reports of the currency being used for drug transactions on the dark web – can check the rate of adoption and thus lower the price. This is the opposite of the general predictability that is required for a currency – a vendor who sells goods will generally prefer Dollars or even Baht because events like the 1997 Tom Yam Gung devaluation happen relatively rarely. When they do, although they might seem dramatic, they’re a drop in the ocean compared to what have become the normal daily moves in Bitcoin.
Unlike fiat currencies, the amount of Bitcoin circulating is limited to a fixed (and arbitrary) amount – 21 million. Some crypto proponents may believe that this means if a country decides to print money to pay for public services or assist exports, Bitcoin will get stronger; yet this would betray a lack of economic understanding. As the Bank of England has explained, and as was evidenced starkly in 2008 when the Federal Reserve’s balance sheet doubled within 2 months but the US Dollar strengthened significantly, issuing additional currency is only inflationary and only weakens the currency stock if it is then deployed in a relatively unproductive manner.[6] This highlights one of the reasons that cryptos aren’t currencies – they don’t have the same economic impact as currency issuance. Also, the 21 million figure is a bit misleading[7] – supplemental units are issued when we have ‘forks’. Whilst many coiners rejoiced that the recent fork had no impact on underlying BTC but created supplemental tokens with additional value, to me this was more evidence that Bitcoin pricing is irrational. Bitcoin should have fallen by an amount substantially similar to the new issuance (a kind of dividend, in effect) but it didn’t.[8] Irrational bubble QED.
Many thanks to Gerry Brady, founder of the BOOM Finance & Economics weekly newsletter (www.boomfinanceandeconomics.com), for allowing me to rack his considerably large and knowledgeable brain on cryptocurrencies.
This article was originally published at https://www2.mbmg-investment.com/in-the-media/inthemedia/154
[1] https://coinmarketcap.com/exchanges/volume/24-hour/ [2] On 11th October 2017, the Bitfinex 30-day index = US$13,274,855,165 www.bitfinex.com [3] https://infopub.sgx.com/FileOpen/20161006_SGX_reports_market_statistics_for_September_2016.ashx?App=Announcement&FileID=423830 [4] https://www.forbes.com/sites/laurashin/2017/04/20/why-bitcoins-greatest-asset-could-also-spell-its-doom/#53031bea6adc [5] https://www.reuters.com/investigates/special-report/bitcoin-exchanges-risks/ [6] https://www.bankofengland.co.uk/monetarypolicy/Documents/pdf/qe-pamphlet.pdf [7] https://www.forbes.com/sites/laurashin/2017/08/02/a-second-version-of-bitcoin-has-launched-could-it-threaten-the-original/#64481b0544a7 [8] https://www.investing.com/currencies/btc-usd