There seems to be no end to the Bitcoin bubble in sight. This comes close to the great bladder development we have known in history, including the tulip bulb in the Netherlands in the 16th century, the South Sea bubble in the 18th century, and many others. These bubbles and today's Bitcoin bubble are always driven by exaggerated optimism about the value of an asset and the expectation that the price of that asset will continue to rise in the distant future. But each time these bubbles were over and prices broke.
The expectation that the price of Bitcoins will continue to rise in the distant future has much to do with the belief of many that Bitcoin and other "cryptocurrencies" are the money of the future. Nothing could be further from the truth. In fact, bitcoin is an archaic currency like gold used to be. Archaic currencies are created with scarce production factors. With a lot of work and machinery, gold had to be dug deep into the ground. Keynes called gold a "barbaric relic".
The same can be said of Bitcoin. Bitcoins are produced with a lot of computing power ("mined", as it is called in Bitcoin terminology in analogy to gold). The computers needed to produce bitcoins consume a lot of electricity and therefore large amounts of scarce energy sources (oil, nuclear power, renewable energy sources). According to some estimates, the energy needed to produce bitcoins for one year equals the energy consumption of a country like Denmark. A phenomenal effort, even if we consider the external costs such as the CO2 emissions associated with electricity generation.
Although Bitcoin is perceived as the currency of the future, it is indeed like gold a currency of the past. The contrast to modern money is striking. Modern money is also called "fiat money" because it consists of nothing. Of course, paper money production costs a lot, but we use fewer and fewer of them. Instead, we use more and more electronic money by paying with debit and credit cards. Electronic money is produced with minimal resources. As the cost of communication continues to decline, the use of electronic money in the resources required to manufacture it becomes even cheaper. In this understanding, electronic money is not Bitcoin, it is future money.
Technological innovation may lead to a further reduction in the resource cost of mining bitcoins. But today, the handicap of bitcoins in providing a resource-cheap form of money is very poorly comparable to the existing forms of electronic money that can be made with small fractions of the cost of bitcoins.
However, there are other and potentially more serious reasons why Bitcoins and other cryptocurrencies have no future as a means of payment and units of account, the two essential functions of money. First, since the supply of bitcoins is asymptotic, its general use as a means of payment would lead to permanent deflation (negative inflation). The reason is that the global economy is growing and a growing supply of money is needed to facilitate growing transactions. The only way to handle this in a Bitcoin economy is to lower bitcoin prices for goods and services, ie negative inflation. The quantity theory of money tells us that one could also handle increasing the speed at which bitcoins are used. This possibility is limited. A Bitcoin economy would face permanent deflation.
Capitalism is based on entrepreneurs who take risky initiatives. These entrepreneurs are generally optimistic. They expect rising sales in the future. Optimism drives the dynamics of capitalism. In a Bitcoin economy where prices fall every year, this optimism is negatively impacted. Price declines cause consumers to postpone their purchases and investors to postpone their projects. It is a world of less optimism and probably less growth.
To avoid this problem, cryptocurrencies should provide a protocol that can increase the supply of those currencies in a steady state. A rule à la Friedman, where the delivery of the currency is subject to a constant annual growth rate, would be the decisive factor. This is not the case with Bitcoin, so this cryptocurrency is particularly unsuitable for the functioning of the future money.
There is a second and more serious reason why Bitcoin is actually not suitable as a currency. In fact, it will be a very dangerous currency. When the world turns into a bitcoin, banks will start lending bitcoin to households and businesses that need credit. But banking is a risky business. The problem is, because the supply of bitcoin remains, there will be no lender who offers LoLR support in times of crisis. And that is certain. Even if the supply of bitcoin or other cryptocurrency can be subject to Friedman's constant growth rule, this will not solve this problem.
LoLR support implies that central banks can not make money from anything. In a monetary system in which the money stock is fixed (or constantly growing), such a LoLR is not possible. This leads to a prospect of regular bank crises, which will lead to bank failure and further negative domino effects for the economy. This is exactly what we saw during the heyday of the gold standard, which was marked by frequent bank crises that led to deep recessions and misery. Like the gold standard, the Bitcoin standard is a thing of the past, not the future.
In general, the problem of a bitcoin economy is that in times of financial crisis, which you can be sure will occur again, there will be a general flight to liquidity. Then a central bank is needed to provide the required liquidity. In the absence, people looking for liquidity sell assets, leading to asset deflation and the bankruptcy of many. A Bitcoin economy does not have this flexibility and will not stand up to financial crises. A Bitcoin economy will not exist in a capitalist system that regularly causes financial crises.
Today, the Bitcoin bubble is driven by the belief that this cryptocurrency has an intrinsic value. A value that results from the conviction that it is the money of the future that will also be available in limited quantities. If enough people realize that bitcoins and other cryptocurrencies have no future as a means of payment, it will be obvious that bitcoin has no intrinsic value and the emperor has no clothes. Then the Bitcoin bubble will burst and the speculators who have entered the bubble too late will be driven by hand.
Of course, none of this should be said that the blockchain technology used in cryptocurrency might not have other important applications. For example, storing large data using blockchain technology makes it possible to do it in a decentralized way, which allows many new applications. However, the current design of Bitcoin makes it unsuitable as a currency for the future.
The idea that Bitcoin is the currency of the future is very popular among market fundamentalists. These are excited about Bitcoin because it is completely beyond the control of central banks. The latter are regarded as the source of many evils. The money they create will lead to hyperinflation and other disasters after these fundamentalists.
There is indeed a potential problem with money. Since production is so cheap, there is a risk that too much will be produced. That leads to inflation. However, many central banks have pursued a strict inflation policy since the 1990s. And that has proven very successful. It has ensured that annual inflation has been close to 2 percent in most developed countries over the last 30 years. For example, in the US, average annual inflation was 2.35% between 1990 and 2017.
That will not convince market fundamentalists. They still believe that the moment of hyperinflation has not yet arrived. For many people, Bitcoin has become a symbol of the world in the free market. A world where markets will not be hampered by government control when creating wealth for many people. This is also a world where the market has its own regulating nature which prevents the financial crisis. In a fictional world like that, bitcoin will actually become an anchor of stability. Not in the real world.
The expectation that the price of Bitcoins will continue to rise in the distant future has much to do with the belief of many that Bitcoin and other "cryptocurrencies" are the money of the future. Nothing could be further from the truth. In fact, bitcoin is an archaic currency like gold used to be. Archaic currencies are created with scarce production factors. With a lot of work and machinery, gold had to be dug deep into the ground. Keynes called gold a "barbaric relic".
The same can be said of Bitcoin. Bitcoins are produced with a lot of computing power ("mined", as it is called in Bitcoin terminology in analogy to gold). The computers needed to produce bitcoins consume a lot of electricity and therefore large amounts of scarce energy sources (oil, nuclear power, renewable energy sources). According to some estimates, the energy needed to produce bitcoins for one year equals the energy consumption of a country like Denmark. A phenomenal effort, even if we consider the external costs such as the CO2 emissions associated with electricity generation.
Although Bitcoin is perceived as the currency of the future, it is indeed like gold a currency of the past. The contrast to modern money is striking. Modern money is also called "fiat money" because it consists of nothing. Of course, paper money production costs a lot, but we use fewer and fewer of them. Instead, we use more and more electronic money by paying with debit and credit cards. Electronic money is produced with minimal resources. As the cost of communication continues to decline, the use of electronic money in the resources required to manufacture it becomes even cheaper. In this understanding, electronic money is not Bitcoin, it is future money.
Technological innovation may lead to a further reduction in the resource cost of mining bitcoins. But today, the handicap of bitcoins in providing a resource-cheap form of money is very poorly comparable to the existing forms of electronic money that can be made with small fractions of the cost of bitcoins.
However, there are other and potentially more serious reasons why Bitcoins and other cryptocurrencies have no future as a means of payment and units of account, the two essential functions of money. First, since the supply of bitcoins is asymptotic, its general use as a means of payment would lead to permanent deflation (negative inflation). The reason is that the global economy is growing and a growing supply of money is needed to facilitate growing transactions. The only way to handle this in a Bitcoin economy is to lower bitcoin prices for goods and services, ie negative inflation. The quantity theory of money tells us that one could also handle increasing the speed at which bitcoins are used. This possibility is limited. A Bitcoin economy would face permanent deflation.
Capitalism is based on entrepreneurs who take risky initiatives. These entrepreneurs are generally optimistic. They expect rising sales in the future. Optimism drives the dynamics of capitalism. In a Bitcoin economy where prices fall every year, this optimism is negatively impacted. Price declines cause consumers to postpone their purchases and investors to postpone their projects. It is a world of less optimism and probably less growth.
To avoid this problem, cryptocurrencies should provide a protocol that can increase the supply of those currencies in a steady state. A rule à la Friedman, where the delivery of the currency is subject to a constant annual growth rate, would be the decisive factor. This is not the case with Bitcoin, so this cryptocurrency is particularly unsuitable for the functioning of the future money.
There is a second and more serious reason why Bitcoin is actually not suitable as a currency. In fact, it will be a very dangerous currency. When the world turns into a bitcoin, banks will start lending bitcoin to households and businesses that need credit. But banking is a risky business. The problem is, because the supply of bitcoin remains, there will be no lender who offers LoLR support in times of crisis. And that is certain. Even if the supply of bitcoin or other cryptocurrency can be subject to Friedman's constant growth rule, this will not solve this problem.
LoLR support implies that central banks can not make money from anything. In a monetary system in which the money stock is fixed (or constantly growing), such a LoLR is not possible. This leads to a prospect of regular bank crises, which will lead to bank failure and further negative domino effects for the economy. This is exactly what we saw during the heyday of the gold standard, which was marked by frequent bank crises that led to deep recessions and misery. Like the gold standard, the Bitcoin standard is a thing of the past, not the future.
In general, the problem of a bitcoin economy is that in times of financial crisis, which you can be sure will occur again, there will be a general flight to liquidity. Then a central bank is needed to provide the required liquidity. In the absence, people looking for liquidity sell assets, leading to asset deflation and the bankruptcy of many. A Bitcoin economy does not have this flexibility and will not stand up to financial crises. A Bitcoin economy will not exist in a capitalist system that regularly causes financial crises.
Today, the Bitcoin bubble is driven by the belief that this cryptocurrency has an intrinsic value. A value that results from the conviction that it is the money of the future that will also be available in limited quantities. If enough people realize that bitcoins and other cryptocurrencies have no future as a means of payment, it will be obvious that bitcoin has no intrinsic value and the emperor has no clothes. Then the Bitcoin bubble will burst and the speculators who have entered the bubble too late will be driven by hand.
Of course, none of this should be said that the blockchain technology used in cryptocurrency might not have other important applications. For example, storing large data using blockchain technology makes it possible to do it in a decentralized way, which allows many new applications. However, the current design of Bitcoin makes it unsuitable as a currency for the future.
The idea that Bitcoin is the currency of the future is very popular among market fundamentalists. These are excited about Bitcoin because it is completely beyond the control of central banks. The latter are regarded as the source of many evils. The money they create will lead to hyperinflation and other disasters after these fundamentalists.
There is indeed a potential problem with money. Since production is so cheap, there is a risk that too much will be produced. That leads to inflation. However, many central banks have pursued a strict inflation policy since the 1990s. And that has proven very successful. It has ensured that annual inflation has been close to 2 percent in most developed countries over the last 30 years. For example, in the US, average annual inflation was 2.35% between 1990 and 2017.
That will not convince market fundamentalists. They still believe that the moment of hyperinflation has not yet arrived. For many people, Bitcoin has become a symbol of the world in the free market. A world where markets will not be hampered by government control when creating wealth for many people. This is also a world where the market has its own regulating nature which prevents the financial crisis. In a fictional world like that, bitcoin will actually become an anchor of stability. Not in the real world.
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