Bitcoins have no inherent bitcoin: How is the value determined?, being a record of pointless calculations. If Bitcoins are indeed worthless, then financial markets should price them at zero. But the introduction of futures trading actually boosted the price in the short run. Even after recent declines, there’s no sign that prices will reach zero any time soon.
On the other hand, if Bitcoins are valuable simply because people value them, then asset prices are entirely arbitrary. The same argument can be applied to any financial asset. As the experience of the mid-20th century shows, a market economy can function perfectly well with a financial sector much smaller than the one we have today. As Bitcoin shows, the massive expansion since then is nothing but wasteful speculation. The spectacular increase and recent plunge in the price of Bitcoin and other cryptocurrencies have raised concerns that the bursting of the Bitcoin bubble will cause financial markets to crash.
They probably won’t, but the Bitcoin bubble should finally destroy our faith in the efficiency of markets. Since the 1970s, economic policy has been based on the idea that financial market prices reflect all the information relevant to the value of any asset. If this is true, market prices are the best estimates of the value of any investment and financial markets should be relied on to allocate capital investment. Although rarely stated now with as much confidence as it was during its heyday in the 1990s, the efficient market hypothesis remains a background assumption of much central-bank and economic policy.
The hypothesis survived the absurdities of the dot-com bubble in the late 1990s and early 2000s, as well as the meltdown in derivative markets that led to the global financial crisis in 2007 and 2008. Although the hypothesis should have been refuted by those disasters, it lived on, if only in zombie form. But at least each of those earlier bubbles began with a plausible premise. The rise of the internet has transformed our lives and given rise to some very profitable companies, such as Amazon and Google.
Even though it was obvious that most 1990s dot-coms would fail, it was easy to make a case for any of them individually. The theory was backed by leading economists and central bankers. Asset-backed derivatives were, ultimately, a bet on the great moderation. The contrast with Bitcoin is stark. The Bitcoin bubble rests on no plausible premise.
When Bitcoin was created about a decade ago, the underlying idea was that it would displace existing currencies for transactions of all kinds. But by the time the Bitcoin bubble took off last year, it was obvious that this would not happen. Only a handful of legitimate merchants ever accepted Bitcoin. And as the Bitcoin bubble drove up transactions charges and waiting times, even this handful walked away. For a while, Bitcoin was used for transactions that people wanted to keep secret from government authorities, like drug deals. It soon became apparent, however, that if authorities wanted to track these transactions, they could. For instance, Silk Road, the first major online drug market, which made use of Bitcoin, was shut down by the F.
Hardly anyone now suggests that Bitcoin has value as a currency. By design, no more than 21 million Bitcoins can be created. Most economists, including me, dismiss this claim. And if the claim is false, Bitcoin’s value is obviously another deadly strike against the efficient market hypothesis. But even if the claim is true, the idea that Bitcoin is valuable simply because people value it and because it is scarce should shake any remaining faith in the efficient market hypothesis.
As the proliferation of cryptocurrencies has shown, nothing is easier than creating a scarce asset. The same argument would apply to any existing financial assets. Suppose, more plausibly, that Bitcoin has no underlying value and will eventually become worthless. According to the efficient market hypothesis, financial markets will correctly estimate the true value of Bitcoin and will drive the price to zero immediately. Until recently, it wasn’t even possible because the Bitcoin markets were themselves as opaque as the currency.
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Now it is possible: Futures trading for Bitcoin on the Chicago Mercantile Exchange has been going on since December. But Bitcoin prices rose after the creation of futures trading and began their sharp decline only when governments took measures to limit speculation. Current futures contracts in Bitcoin extend as far as June of this year. According to those contract prices, the market expects Bitcoin to retain its current value well into the future. Whatever happens to Bitcoin, we must not lose sight of a more fundamental — and more worrisome — development: A financial product with a purely arbitrary value has been successfully introduced in the world’s most sophisticated financial markets. Bitcoin probably won’t bring financial markets crashing down.
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But it shows that regulators need to cut those markets down to size. Re the value of Bitcoin, to repeat an earlier observation. That something crashes to zero does not mean that the correct value was zero all along. EMH violation that the shares had value three years ago.
Hmm, OK, but other things have changed too. From Zucman and Saez we can see that there’s been a vast change in the portion of national wealth in pensions. That implies a larger financial sector, no? We do sorta need that given the increase in lifespans. A richer world would have more of that, a larger financial sector. Dean says, perhaps, but in a different manner. Bitcoin’, again, because it was designed by people without any clear understanding of how currency works.
Because as human history clearly shows adhering to the amassing of random bits of metals as the basis of wealth and power has always lead to peace and prosperity for all! Strange women lying in ponds distributing swords is no basis for a system of government hackers creating imaginary encrypted gold is no basis for a global economy. Bitcoin, like poker or horse races, is not valueless if people want to do it. As long as and to the extent that money is fetishized, the financial sector will grow. It’s efficient in the sense that it is directly producing objects of desire.
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It doesn’t have to do or enable anything material because value is not material. That’s premature, especially since cryptocurrencies in general are a new phenomena. If the value collapses completely and the currency becomes moribund without ever finding a use, then we could say that its value was completely irrational. An option having value doesn’t mean that the underlying good has any value. I can sell options to buy Phlogiston, but that doesn’t mean Phlogiston itself is worth anything.
I can sell options to buy stock in defunct corporations, but that doesn’t mean the corporation has any value. Ideally the two should be linked in some way, but they don’t have to be. Isn’t that the whole point of Ponzi schemes? You can sell options to whatever the scheme is, but that doesn’t mean there’s any value in the scheme itself. If there was, it wouldn’t be a Ponzi scheme. Query: If the Bitcoin apparent bubble collapses, does that disprove the EMH in a way that the collapses of previous undoubted bubbles, from Dutch tulips onwards, did not? If so, what’s special about the Bitcoin bubble?
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If not, how did belief in the EMH survive knowledge of previous collapsed bubbles? Cryptocurrencies in general, and Bitcoin in particular, have clear value in aiding money laundering, and in moving wealth across national borders in countries with capital export controls. Indeed, this latter use may have been the primary purpose for Bitcoin’s invention if it was a national intelligence agency that created it as a means of paying their foreign agents. That’s just arguing post-facto: if it could have had a value but the chances don’t pan out that way, then assigning it a value isn’t necessarily irrational and it doesn’t falsify the EMH. To falsify the EMH, we need to know a-priori that bitcoin has no potential for value. Which is actually pretty unusual — even the most gratuitous bubbles are usually about things that are real businesses that might potentially make some sort of money — but for bitcoin it’s a pretty solid claim. 6 Excuses have been made for previous bubbles that can’t be made for Bitcoin.
I mention excuses for the dotcom and derivatives bubbles in the article. Unless your statement is that it could not possibly, ever, have worked in any manner then the existence of a positive price at some point isn’t a disproof of the EMH. A slight change in tense is needed. The actual human beings who run banks have a powerful incentive to run up the volume as high as possible. It’s clearly a problem of scale if profits can be made by shaving milliseconds off trades. A beast as large as the world economy has become is bound to be infested by commensurate parasites. The Bitcoin bubble is a real bubble with money changing hands.
But it’s paralleled by a virtual bubble in generic blockchain hype, with startups all over the place. JQ has a point that finance is too big, and many financial markets are obese. 5 trn, but what’s a couple of trillion between friends? But they do run efficiently in the narrow engineering sense that the transactions clear quickly and transactions costs are low. 1m interbank foreign currency trade is apparently around 0.
What if anything is wrong with this system? 3 trn is an attractive target, but when they put their minds to it, big banks are capable of designing security good enough to prevent hacking. FX trading must be a small share of bank profits, and the reputational costs of cheating to other business lines would be far higher. From a German bank that went bust in the middle of the trading day, causing temporary chaos.
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I suggest that this picture is replicated across other financial markets: central counterparties and settlement avoid duplication and keep transactions costs to professionals low. Trust isn’t much of a problem in practice: you need a public profile to play, and there are enough duplicate records of any transaction to provide an audit trail. SFIK very few frauds are actually committed by falsifying ledger entries, they are too easy to discover. The reasoning that leads you to the conclusion that the price of Bitcoins will eventually decline to nil does not enable you to estimate when this will happen. John you don’t seem to ever answer why you are so sure that the value of cryptocurrencies can’t simply come from facilitating illegal activity. The ability to make anonymous transfers is clearly very useful for criminals. So long as Bitcoin is anonymously convertible into some currency, itself convertible, somewhere then it will have intrinsic value to all those who wish to avoid undue scrutiny of their business by tax or other authorities.
So its velocity of circulation will tend to be very rapid. Noone said it explicitly because, well. Same way nobody explicitly marked out trade in shuttlecock-manufacturing equipment or used welsh tramcars. It seems more useful to focus on the market structure. How costly is it to short bitcoins?
What are the costs of holding a speculative position for a long time, long or short? Are transaction costs high or low? Comments 16, 17 and 19 were all addressed in the NYT article. If you disagree with what I said, there, please clarify. It is obvious, every time there is a crash, that the expanded financial sector is harmful. And every time there is a crash, the only sector that gets tender loving care from the gov.
One of the great harms of an oversized financial sector is that it injects such inequality into the political economy that it inevitably shapes the government. Or, in simpler terms, with bubble wealth comes plutocrats, and with plutocrats comes plutocracy. However, the suggestion that the financial sector is too large stops short at saying what should be done to shrink it. Back in the progressive era, there was a word which has fallen out of use: overcapitalization. The worry, in the first decades of the twentieth century, was that the speculative aspect of the stock market was producing a kind of predator wealth, which preyed on the productive forces in the economy. The modern stock market is at the heart of all the rococo extravagances of the financial system. And it is treated as though it were a product of nature, instead of a product of legal malpractice.
I’m sceptical about bitcoin too, but I think the NYT article overstates its case. For example, the arrest of one very prominent drug dealer isn’t by itself sufficient to show that bitcoin doesn’t have a niche application in illegal transactions. Well, sure, if you were considering setting up the next Silk Road then the arrest of the Dread Pirate Roberts might make you reconsider your plan. There are some technical reasons why bitcoin is not ideal as an anonymous payment system. FBI ever managed to catch someone? I think the argument needs to be that the anonymity advantages, such as they are, are insufficient to make up for its other shortcomings.
Bitcoin are certainly not perfect for criminals, but they are arguably better than many other alternative. That arguably gives Bitcoin at least residual value. As an aside, the North Korean regime is apparently holding quite a good deal of Bitcoins. North Korea quite delicious in its irony.
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If that was not wrecking the environment at the same time, I would even smile. What will US produce if US doesn’t produce just money or Bubbles or Fake Values anymore? Americans charging other American an Arm and a few million legs for the financial services to sell each other money. UP in Manhattan or even in South Central LA. SusanC has exactly the right point on the value of crypto for illegal activity.
But this isn’t going to persuade anyone on the EMH question. Some people think blockchain has great potential and with enforced scarcity, this drives Bitcoin pricing. Even though I happen to agree with your view on Bitcoin value, the fact that you think this justifies government intervention in the market is a case example of why I don’t trust people such as yourself to make these kinds of calls as a general rule: hubris and the likelihood that you are wrong. There is at least some efficiency in the pricing of a bitcoin inasmuch as just like in the mining of minerals, there is a fixed and variable infrastructure associated with extraction. What is a lump of coal or a nugget of gold or a chunk of cobalt worth?
For early miners this price was low. To suppose that there is a meaningful question about whether government intervention in the market is justified is a misunderstanding. It is government intervention that creates markets. If you are a major bank stockpiling bitcoin to help you pay off a future cyber-ransom attack you clearly believe it has value to you and you have a specific reason why so. This seems so wrong, have I misunderstood? If the value of bitcoin is down to its designed-in scarcity as a store of wealth, presumably something even more scarce would be even more valuable, and the ideal store of wealth would be something so scarce it didn’t exist. That lass selling the imaginary unicorns is on to something!
You say the NYT article addressed my point, but I am having trouble seeing it. Maybe the issue is that the EMH as you describe it is long dead already in my field of accounting. At a minimum, that assumes that it is enough for all relevant information is available to someone. But I don’t see an argument for why this should be relevant to how no-profit prices get converted into right prices, at least in the terms I am used to. Maybe at bottom the issue is that you are arguing to people who use the EMH to debate the wisdom of public investment, while I am typically arguing to people who use the EMH to debate fine-grained price behavior in equity and debt markets. If JQ’s argument applies equally to baseball cards, doesn’t it prove too much?
And if it doesn’t, why exactly not? I own some 1960s-vintage baseball cards and some 2011-vintage BTC, both easily and somewhat frivolously acquired for literally no money and truly negligible unmonetized opportunity cost. They both make me smile sometimes, like other souvenirs of my life’s journey. Note, too, that collectors can go entirely offline, not bearing a joule of guilt for the ever-rising blockchain cost. In my usage, information has to be discovered by someone before it is information. A super-strong version of the EMH would include the claim that asset markets provide optimal incentives for the discovery of information. My impression of the literature is that this version is fairly strongly rejected on both theoretical and empirical grounds.