Repeat after me: Bitcoin is not money. Cryptocurrency is not currency, it is a crypto-bet. I am not saying this is the beginning of the end, but the crypto-bubble may be crypto-exploding.
On Wednesday, I woke up to the news that due to a cryptocurrency selloff, Bitcoin’s value was down almost 25 percent over the previous 24 hours, and down 47 percent from its all-time high. Now, why do I care? I don’t. But it sure feels nice to say, “I knew it.” I’ve been saying this over and over and over in the past month: there is a bubble in the market for cryptocurrency.
People, especially young, eager students, keep buying these instruments at exuberant and rising prices, not because the things themselves are more valuable, but because people have become hysterical about them and continue to believe (believe, key word) they are valuable. In the finance jargon: their market value is not warranted by the fundamentals of the asset.
It’s easy to become mixed up in the illusion Bitcoin and other cryptocurrency markets give off, especially if you don’t have sound advisors or experience investing. Articles like, “So you want to become a bitcoin millionaire?” from The College Investor might lead students into the crypto-bubble.
So, finally, I have an excuse to write about how I was right all along, but first, let me hand you my disclosure: I am an economist, not a finance person. What I know about finance is what I know about fitness: the way to get and stay fit is to eat the right number of calories, exercise enough, sleep enough and avoid injuries. Similarly, the way to get and stay wealthy is to start saving early enough, save often enough, save enough each time and keep a “diverse” portfolio, or how it is often said: by putting your eggs in more than one basket.
When people learn that I am doing a Ph.D. in economics, very often they ask me for financial advice. I gently explain to them that as an economist, I do not study money, but instead, I study what people do for money, which I personally think is much more interesting (sometimes it is also disturbing and other times, if I’m lucky, it may be entertaining).
Knowing this about me, you will find unsurprising that I find no interest in dealing with the luring, high-risk and frequently transacted. However, as an economist, I have spent more time than the average person thinking about and learning what money is, and recent news, together with the unavoidably annoying and ubiquitous conversations about cryptocurrency, have nearly triggered me to write about bitcoin and cryptocurrency as a lucrative investment option.
Based on what I have learned and come to believe, I certainly think that bitcoin and other kinds of cryptocurrency are anything but “currency.” The fact that the name is a misleading misnomer is already a sign to worry. The financial system is so unregulated that it has evolved to confuse overconfident investors and trick them into making bets they wouldn’t do otherwise (maybe you’ll want to watch or read the Big Short for context). Being highly skeptical about financial markets, I can only think that if nobody calls the thing I’m putting my money on by what it really is, maybe it means it is not clear what the thing actually is.
And let me repeat: cryptocurrency is not money.
If you took principles of macroeconomics, you learned that money has three properties: (1) money is a store of value, (2) money is a unit of account and (3) money is a medium of exchange. So, let’s break it up for cryptocurrencies. Let’s start with the easy one: Are they a medium of exchange? An inefficient one, but yes, it is a medium of exchange: you can buy and sell things using bitcoins. Second, are they a unit of account? The answer is no. It is not a unit of account; it is a thing that changes value and we measure its value in terms of dollars, the real unit of account.
Finally, is it a store of value? First of all, it is hard to argue that cryptocurrency is a solid store of value because of the volatility in the market for cryptocurrency. The price of cryptocurrency changes very often, fairly dramatically and in an unpredictable fashion.
If I can’t know the price of a bitcoin, I can’t know how many OKCupid accounts I can pay for (yes, OKCupid accepts bitcoins, just like KFC Canada), but to be fair, the value of money is also subject to other forces, like inflation. So, I’d say that cryptocurrency is a very imperfect store of value. However, the more interesting argument when it comes to property is the following: what value is it storing?
You can argue that cryptocurrency is like paper money, which is really just paper and is not backed by gold or salt or big rocks (look at your intro to macro book and you’ll know exactly what I am talking about). Paper money is what we call “fiat money.” Fiat is the Latin word for “trust” and we call it that because the value of the paper money relies on the trust we place not on its value (which is what happens in the bubble market), but on the institution that tells us it has value: in our case, the U.S. government.
Dollars are the safest type of currency: I do not lose sleep over whether the U.S. government is going to disappear overnight, and I know that if something happens to my physical paper money, the U.S. government will replace it for me. Why can the U.S. government do that? Because it is a stable institution, founded on sound principles and it has a lot of weapons to keep people from doing weird things with my paper money.
So, is cryptocurrency like paper money? Perhaps in a failed anarchic state like Somaliland, but not in the U.S. Cryptocurrency is not storing any real value other than the value people believe it has.
The value of cryptocurrency is totally meta, totally imaginary and therefore, totally crazy as a form of money. Now, is it as crazy as a form of investment? Maybe not. I do not know enough about it to say whether it is a high-return investment opportunity. It is certainly high-risk and definitely not cost-free (despite what you read, there are fees that apply to these transactions). I wouldn’t have a problem if investing in cryptocurrency was called “crypto-betting.” I think it’s like going to Las Vegas and playing in the casino. It will be fun and maybe you’ll win. Maybe.