Bub­ble, bub­ble, fraud and trou­ble

Hawaii Tribune Herald - - COMMENTARY - Paul Krug­man is a syn­di­cated colum­nist who writes for the New York Times News Ser­vice.

The other day my bar­ber asked me whether he should put all his money in bit­coin. And the truth is that if he’d bought bit­coin, say, a year ago he’d be feel­ing pretty good right now. On the other hand, Dutch spec­u­la­tors who bought tulip bulbs in 1635 also felt pretty good for a while, un­til tulip prices col­lapsed in early 1637.

So, is bit­coin a gi­ant bub­ble that will end in grief? Yes. But it’s a bub­ble wrapped in techno-mys­ti­cism in­side a co­coon of lib­er­tar­ian ide­ol­ogy. And there’s some­thing to be learned about the times we live in by peel­ing away that wrap­ping.

If you’ve been liv­ing in a cave and haven’t heard of bit­coin, it’s the big­gest, best-known ex­am­ple of a “cryp­tocur­rency”: an as­set that has no phys­i­cal ex­is­tence, con­sist­ing of noth­ing but a dig­i­tal record stored on com­put­ers. What makes cryp­tocur­ren­cies dif­fer­ent from or­di­nary bank ac­counts, which are also noth­ing but dig­i­tal records, is they don’t re­side in the servers of any par­tic­u­lar fi­nan­cial in­sti­tu­tion. In­stead, a bit­coin’s ex­is­tence is doc­u­mented by records dis­trib­uted in many places.

And your own­er­ship isn’t ver­i­fied by prov­ing (and hence re­veal­ing) your iden­tity. In­stead, own­er­ship of a bit­coin is ver­i­fied by pos­ses­sion of a se­cret pass­word, which — us­ing tech­niques de­rived from cryp­tog­ra­phy, the art of writ­ing or solv­ing codes — lets you ac­cess that vir­tual coin with­out re­veal­ing any in­for­ma­tion you don’t choose to.

It’s a nifty trick. But what is it good for?

In prin­ci­ple, you can use bit­coin to pay for things elec­tron­i­cally. But you can use debit cards, PayPal, Venmo, etc. to do that, too — and bit­coin turns out to be a clunky, slow, costly means of pay­ment. In fact, even bit­coin con­fer­ences some­times refuse to ac­cept bit­coins from at­ten­dees. There’s re­ally no rea­son to use bit­coin in trans­ac­tions — un­less you don’t want any­one to see ei­ther what you’re buy­ing or what you’re sell­ing, which is why much ac­tual bit­coin use seems to in­volve drugs, sex and other black-mar­ket goods.

So bit­coins aren’t re­ally dig­i­tal cash. What they are, sort of, is the dig­i­tal equiv­a­lent of $100 bills.

Like bit­coins, $100 bills aren’t much use for or­di­nary trans­ac­tions: Most shops won’t ac­cept them. But “Ben­jamins” are pop­u­lar with thieves, drug deal­ers and tax evaders. And while most of us can go years with­out see­ing a $100 bill, there are a lot of those bills out there — more than a tril­lion dol­lars’ worth, ac­count­ing for 78 per­cent of the value of U.S. cur­rency in cir­cu­la­tion.

So, are bit­coins a su­pe­rior al­ter­na­tive to $100 bills, al­low­ing you to make se­cret trans­ac­tions with­out lug­ging around suit­cases full of cash? Not re­ally, be­cause they lack one cru­cial fea­ture: a tether to re­al­ity.

Although the mod­ern dol­lar is a “fiat” cur­rency, not backed by any other as­set, like gold, its value is ul­ti­mately backed by the fact the U.S. govern­ment will ac­cept it, in fact de­mands it, in pay­ment for taxes. Its pur­chas­ing power also is sta­bi­lized by the Fed­eral Re­serve, which will re­duce the out­stand­ing sup­ply of dol­lars if in­fla­tion runs too high, in­crease that sup­ply to pre­vent de­fla­tion. And a $100 bill is, of course, worth 100 of these broadly sta­ble dol­lars.

Bit­coin, by con­trast, has no in­trin­sic value at all. Com­bine that lack of a tether to re­al­ity with the very lim­ited ex­tent to which bit­coin is used for any­thing, and you have an as­set whose price is al­most purely spec­u­la­tive, and hence in­cred­i­bly volatile. Bit­coins lost about 40 per­cent of their value in the past six weeks; if bit­coin were an ac­tual cur­rency, that would be the equiv­a­lent of a roughly 8,000 per­cent an­nual in­fla­tion rate.

Oh, and bit­coin’s un­teth­ered na­ture also makes it highly sus­cep­ti­ble to mar­ket ma­nip­u­la­tion. In 2013, fraud­u­lent ac­tiv­i­ties by a sin­gle trader ap­pear to have caused a sev­en­fold in­crease in bit­coin’s price. Who’s driv­ing the price now? No­body knows. Some ob­servers think North Korea might be in­volved.

But what about the fact those who did buy bit­coin early have made huge amounts of money? Well, peo­ple who in­vested with Bernie Mad­off also made lots of money, or at least seemed to, for a long time.

As Robert Shiller, the world’s lead­ing bub­ble ex­pert, points out, as­set bub­bles are like “nat­u­rally oc­cur­ring Ponzi schemes.” Early in­vestors in a bub­ble make a lot of money as new in­vestors are drawn in, and those prof­its pull in even more peo­ple. The process can go on for years be­fore some­thing — a re­al­ity check, or sim­ply ex­haus­tion of the pool of po­ten­tial marks — brings the party to a sud­den, painful end.

When it comes to cryp­tocur­ren­cies, there’s an ad­di­tional fac­tor: It’s a bub­ble, but it’s also some­thing of a cult, whose ini­ti­ates are given to para­noid fan­tasies about evil gov­ern­ments steal­ing all their money (as op­posed to pri­vate hack­ers, who have stolen a re­mark­ably high pro­por­tion of ex­tant cryp­tocur­rency to­kens).

So, no, my bar­ber shouldn’t buy bit­coin. This will end badly, and the sooner it does, the bet­ter.

Newspapers in English

Newspapers from USA

© PressReader. All rights reserved.