The price of bitcoin underwent another wild gyration, rising from US$41,030 on September 29, 2021 to US$69,000 on November 10, 2021, before falling back to US$35,075 on January 23.

This is its second largest drop in absolute terms, although it has suffered larger declines in percentage terms, such as between December 15, 2017 and December 14, 2018, when it fell 83.8 %.

More broadly, the cryptocurrency market – comprising some 12,278 coins – was estimated at US$3.3 trillion on November 8, 2021, before dropping to US$1.75 trillion as of January 30.

A private digital asset based on a distributed ledger technology known as blockchain, bitcoin is used as a decentralized digital currency – a peer-to-peer electronic payment system. Without intrinsic value, its market valuation, in US dollars, is nothing more than a bubble.

If you got there early and “hold on for life”—bitcoin’s price was US$327 on November 20, 2015—you’re looking at a capital gain of 11,521.5% by January 30. But, while bitcoin could be worth $200,000 by the end of this month, it could also be worth nothing. There is no anchor.

If, through a random convergence of random factors, bitcoin achieves a positive valuation at some point, subsequent valuations are likely to be driven by the arbitrage condition requiring that the risk-adjusted returns of different assets be equal. And because zero is always a possible valuation for bitcoin, we can expect wild swings in its price.

Certainly, the same goes for the valuation of fiat money issued by the central bank. Although its use in paying taxes and its status as legal tender give it an edge over cryptocurrencies, economics falls short when it comes to determining the market value of this bank liability. central. Without intrinsic value, it is only freely convertible into itself. And while one can postulate a well-behaved demand function for real money balances, this is tantamount to assuming that the problem is solved.

Nor is it to assume, instead, that the actual stock of central bank fiat money produces unspecified productive services or mysterious household uses. The best economics there is is the assumption that efficient barter is impossible and therefore fiat currency is needed to perform essential transactions, such as consumer purchases.

But even if we could extract significant demand for real monetary balances from our universe of inherently worthless fiat money, determining the price of money – the inverse of the general price level of goods and services – would still be problematic, because, in a world of flexible prices, there will always be multiple equilibria.

For example, suppose the nominal money supply – the total supply of money in the economy – and all other relevant factors are held constant. Even under these simplified conditions, there is nothing to identify the initial value of the price level.

There is always equilibrium with a zero silver price, implying an infinite general price level. Moreover, for different initial conditions, there can be rational inflationary bubbles or deflationary bubbles, limit cycles or chaotic behaviors. There is also a unique “fundamental” equilibrium in which the price of money is considered to be positive and constant. Finally, random transitions between different equilibria can also be equilibria in themselves. With irrational behavior and inefficient markets, the scope for market turbulence increases.

Neoclassical economics asserts that “fundamental” equilibrium prevails, while Keynesian economics avoids the conundrum of multiple equilibria by insisting that the general price level is not a flexible asset price determined by arbitration. Instead, it is sticky or stiff.

History assigns an initial value to the general price level, which is then updated with a dynamic inflation equation like the Phillips curve, which asserts a stable and inverse relationship between inflation and unemployment. This approach isn’t great, but I can live with it.

When fiat currency issued by the central bank has value, so do private assets that are confidently expected to be convertible into central bank money on demand and at a fixed price, such as deposits. commercial banks. And government deposit insurance builds that confidence even when most of the assets held by banks are illiquid.

By contrast, stablecoins — digital currencies that are supposed to be convertible into dollars on demand at a fixed price — are actually uninsured deposits. When and where they are accepted, they can facilitate digital payments. But they are risky, even if the assets held against them have intrinsic value.

And, if proceeds from a stablecoin issuance are invested in inherently worthless crypto assets, the stability of those stablecoins is bound to be challenged by the markets.

The current popularity of spectacularly risky and inherently worthless cryptocurrencies is difficult to fathom, and buyers’ confidence in a blockchain’s ability to keep an unalterable record of transactions may soon be tested by the arrival of quantum computing, creating even more risk. Moreover, the amount of energy consumed by distributed proof-of-work ledgers – like the Bitcoin blockchain – becomes more massive with each transaction, which argues for appropriate carbon pricing or, failing that, carbon pricing. a tax on cryptocurrency mining.

Anonymity granted to cryptocurrency holders raises serious concerns about illegal uses of funds, including tax evasion, money laundering, concealing proceeds of ransomware attacks and other cyber crimes, and funding of terrorism. The issue has become urgent – ​​and regulation may not be enough.

Willem H. Buiter is Visiting Professor of International and Public Affairs at Columbia University.

© Syndicate Project 2022

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