David Andolfatto of the St. Louis Federal Reserve wonders if investors see Bitcoin as a “safe asset”. By this he means the sort of asset that investors run to when economic storm clouds gather and other asset classes start to look dangerous:
Loosely speaking, I'm thinking about an asset that people flock to in bad or uncertain economic times. In normal times, it's an asset that is held despite having a relatively low rate of return, perhaps because of its use as a hedge, or because of its liquidity properties.
Like gold, in fact.
In important respects, Bitcoin is indeed like gold. Digital gold. It is “mined”, with mining becoming more difficult and expensive as undiscovered supplies dwindle. There is an absolute limit (21 million) on the number of bitcoins that can ever be mined: once all have been “discovered”, the supply is fixed, unless the Bitcoin community decides that the hard limit should be changed – which at present seems rather less likely than mining asteroids for gold.
The gold-like nature of Bitcoin protects it from hyperinflationary collapse, believed by many goldbugs and Bitcoin geeks to be the inevitable future of today’s government-issued fiat currencies. And, importantly, it is not under the control of governments or central banks. Neither the political mafia nor the economics establishment have any say over how, when or if it is produced, nor over its market price. For people who believe that “GUBBMINT WILL STEAL YOUR MONEY”, Bitcoin is possibly even more secure than gold. After all, in the 1930s the US government confiscated private sector gold holdings. But it has no means of confiscating Bitcoin holdings, since identifying exactly who holds them is costly and difficult, and they can easily be transferred out of reach anyway. Bitcoin is, after all, an international currency with its own highly efficient money transfer technology.
Like gold, Bitcoin’s market price tends to be volatile. And like gold, its value also tends to be counter-cyclical. When the US economy weakens, or global risks rise, up goes gold…..and Bitcoin. The profiles of both vis-à-vis the US dollar since the end of 2013 look remarkably similar:
We can perhaps say that investors run to gold when trust in government and its instruments fails. In God We Trust becomes In Gold We Trust. But where does Bitcoin fit in?
Bitcoin’s advocates claim that the system is a “trust-free system”, because there are no intermediaries. But for the system to work at all, there must be trust – trust that the technology will work. In Gold We Trust becomes In Technology We Trust. It is perhaps not surprising that Bitcoin use is highest among those with a background in computer science.
But hang on. There’s a problem, isn’t there? After all, governments are human constructs. And so are cryptocurrencies. The coders behind Bitcoin are human. Why should anyone have more trust in a digital currency created by an anonymous group of coders accountable to no-one than in a democratically-elected government accountable to everyone? Why is an essentially feudal governance model “safer” than a democratic one?
Perhaps it is not “gubbmint” that nervous investors fear, but people. People who might make decisions that are not in their best interests. If there is one thing of which we can be certain, the coders who effectively control Bitcoin are not going to make decisions that destroy its value. They have too much skin in the game. That’s what the “proof of work” in the Bitcoin mining protocol ensures. As the supply of “undiscovered” bitcoins falls, so it becomes increasingly difficult and expensive to mine them. Miners thus have an incentive to preserve or even increase the value of Bitcoin. That way they earn seigniorage (the difference between the value of the currency and its cost of production).
But the “proof of work” itself is fundamentally divisive. Bitcoin’s seigniorage model effectively rewards miners for profligate use of energy to (arguably) unproductive ends. Where is the social justice in this? Couldn’t this energy be more productively used to create real goods and services wanted and needed by ordinary people, rather than being directed into the production of a barren asset?
This is, of course, a dangerous argument. Scarce resources – including energy - are often diverted to activities that seem unproductive: space exploration, for example. We are unable to predict in advance what the benefit to humans will be of such activity. Is that a reason not to do it? Similarly, the energy cost of mining Bitcoin is considerable – but we do not know whether there might not be long-term benefits to humankind that we cannot at the moment see. Too narrow a view of efficient and just resource use restricts the natural desire of human to explore the unknown and create useless but beautiful things. Bitcoin itself is a beautiful (though possibly useless) thing, and its underlying technology leads us into the unknown. We do not know where it will take us.
The bigger issue here lies in investors’ desire to invest in safety. Andolfatto observes that the real investment value of a safe asset lies in its behaviour in a crisis:
Safe assets generally earn a low expected return (that is, they are priced dearly). Investors can expect to earn unusually high returns in a crisis event. But if you buy at the top, you can expect to realize unusually high losses when the crisis subsides. In short, it's a great investment -- assuming you can predict when a crisis will occur and when it will end!
This is exactly the problem. Safety is expensive, so investing in it is only justifiable if you believe that a crisis is both likely and costly. The rest of the time, there are assets that give better returns. So the value of Bitcoin, like gold, depends fundamentally on the ability of investors to predict crises accurately. Get it wrong – in either direction – and they can lose a lot of money. No wonder the price is volatile.
But what is the social benefit of providing another type of expensively useless asset for investors who want to game a crisis? It has long been clear that it was the AVOIDANCE of risk that caused the disastrous derivatives spiral underlying the 2008 crisis. The belief that an asset class is safe can be a dangerous illusion – especially if this supposed “safe asset” is created by unaccountable private sector financial engineers, and layers of derived “safe assets” are built on top of it into the bargain. Expensive low-return virtual assets like Bitcoin – and their derivatives - should be treated with considerable caution.
The fact is that it is nonsense to suggest that Bitcoin is “trust-free”. It is no more “trust free” than any other kind of “safe asset”, and probably less so than gold, which at least has the virtue of physically existing, even if only on asteroids. It is telling that we are seeing the growth of gold-backed cryptocurrencies: not everyone trusts in technology. If you want gold, buy gold, not an imitation.
Whether or not Bitcoin is ever useful as money is beside the point. It is a lousy asset.
