Sunday, December 03, 2017
What the bitcoin bubble tells us about the economy
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

When the price of bitcoin makes it on to the BBC news bulletins, along with reassurances from a deputy governor of the Bank of England that when the bubble bursts it will not threaten the world economy, you know it is a breakthrough moment.

That moment was the rise last week in the price of Bitcoin above $10,000 (£7,400) for the first time, which was followed by a rise to $11,000, before a retreat back to around $10,000. The digital currency, or “peer to peer electronic cash system”, created almost a decade ago by the mysterious Satoshi Nakamoto, once worth a few cents, has never before scaled such heights.

Bitcoin and other so-called cryptocurrencies such as ether on the Ethereum platform, are in vogue. At $10,000, the digital currency is ten times its value at the start of the year and, whatever its devotees might tell you, that is unmistakably a bubble. It is a bigger and faster price surge than the Nasdaq before the dot.com bubble burst, the Nikkei before the collapse of Japan’s bubble economy or the gold price in the 2000s. It has something in common `with tulip mania in Holland between 1634 and 1637, but that too was a bubble waiting to burst.

Jamie Dimon, the J P Morgan chief executive, once described bitcoin as “worse than tulip bulbs”, while the economist Joseph Stiglitz has said it should be banned.

Could this time be different and this artificially-created currency be benefiting from a need for a safe haven from a troubled world? After all, the leader of the free world spends his time issuing deranged tweets, and his arch enemy, if that is not too Austin Powers, appears to have developed the capacity to fire missiles – though not yet with nuclear warheads – from North Korea to the whole of America.

The safe haven story does not really fit, however. Though there are risks, the world economy is enjoying its best sustained period of growth, spread across all regions, since the financial crisis. Other traditional safe havens such as gold, have not soared. The dollar is not strong. Stock markets, normally shunned in troubled times, are strong.

So the bitcoin surge appears to be specific to it and other cryptocurrencies, prompting warnings from the authorities to investors. Vitor Constancio, vice president of the European Central Bank, said it was “a speculative asset by definition” and that: “Investors are taking a risk by buying at such high prices.”

Jean Tirole, the Nobel prize-winning economist, wrote that “bitcoin is a pure bubble, an asset without intrinsic value”. And, while saying nobody could predict with certainty that it would crash, added: “I would not bet my savings on it, nor would I want regulated banks to gamble on its value.”

Bitcoin, however, is becoming more of a real currency by the day. A few days ago PricewaterhouseCoopers in Hong Kong said it has accepted payment in bitcoin for the first time for advisory services. Tens of thousands of other businesses accept it. The NME tells me that Bjork, the Icelandic star, encouraged fans to buy her latest album using bitcoin or other cryptocurrencies. A £17m property has gone on sale in London with the condition that the buyer must pay in bitcoin. The proportion of bitcoin transactions is tiny, but it is growing.

For central banks, this creates something of a dilemma. Sir Jon Cunliffe, the Bank deputy governor who offered reassurances on the impact of the bitcoin bubble bursting, said: “This is not a currency in the accepted sense. There’s no central bank that stands behind it. For me it’s much more like a commodity.”

The issue for central banks is whether they stand aside and allow privately-created cryptocurrencies to develop and claim a growing share of holdings and transactions, or whether they should issue digital currencies themselves. In other words, if they cannot beat the rise of bitcoin and its rivals, should the Bank of England and others join them?

Something is stirring on this front. A couple of days ago William Dudley, president and chief executive of the Federal Reserve Bank of New York, said: “I think at this point it’s really very premature to be talking about the Federal Reserve offering digital currencies, but it is something we are starting to think about.”

The Bank for International Settlements (BIS) in Basle, sometimes known as the central bankers’ bank, has also been thinking about it. In a report a few weeks ago it noted that several central banks are exploring cryptocurrencies and the distributed ledger technology that lies behind them. With cash use declining, and particularly sharply in countries such as Sweden, the idea of a central bank cryptocurrency would be as “an electronic version of central bank money that can be exchanged ina decentralised manner known as peer to peer …. without the need for a central intermediary”.

That will be an issue for central banks. One reason for the popularity of cryptocurrencies is their anonymity, which increases their appeal to criminals. But then cash is also anonymous, and central banks have issued that for centuries.

The BIS notes that the only way the public can hold central bank money at the moment is in cash. If they want to hold it in digital form they have to do so via a commercial bank. It sees the issue by central banks of digital currencies would also allow the public to have accounts at the central bank, something it suggests would be of benefit. But if it replaced commercial banks with a monolithic central banks it would not be.

Most central banks are not there yet. At the Bank, it is still a source of great interest and controversy when new physical banknotes are issued. The Bank is also investigating the possibility of issuing its own digital currencu and Victorias Cleland, its chief cashier, wrote an article on the subject in the summer. Cash is in long-term decline and digital currencies are on the rise.

As the BIS put it: “Whether or not a central bank should provide a digital alternative to cash is most pressing in countries, such as Sweden, where cash usage is rapidly declining. But all central banks may eventually have to decide whether issuing retail or wholesale central bank cryptocurrencies makes sense in their own context.”

Where technology is concerned, things move faster than we expect. Twenty years ago, as far as most of us were concerned, the interent and e-mail were curiosities. The first iPhone was only launched 10 years ago. Ten years from now, if not before, there is a very good chance that the Bank and other central banks will be issuing their own versions of bitcoin.