May 9, 2022
Why Economists Don’t Like Bitcoin
Do their reasons stack up?
As an economist, I’m not a Bitcoin fan. Something seems off about it all. That is a feeling shared by many of my colleagues. But at the same time, because I am one of the economists who has actually studied Bitcoin and blockchains, I hold a fascination with it. As a system/protocol, there is a beauty to it. I really appreciate that … as an economist. It is economically beautiful and elegant and … it does what it was designed for. So how can I reconcile these two feelings?
Here, and in a series of follow-up posts, I am going to focus on why economists don’t like Bitcoin. I’ll start with the evidence for that claim. And then I will posit some reasons given. As I will argue, most of the reasons are not consistent with economic thinking. But once you apply economics properly, I think the issues with Bitcoin can be articulated more sensibly.
The Evidence
Paul Krugman summarised the modal view of economists on Bitcoin as follows:
The story so far: Bitcoin, the first and biggest cryptocurrency, was introduced in 2009. It uses an encryption key, similar to those used in hard-to-break codes — hence the “crypto” — to establish chains of ownership in tokens that entitle their current holders to … well, ownership of those tokens. And nowadays we use Bitcoin to buy houses and cars, pay our bills, make business investments, and more.
Oh, wait. We don’t do any of those things. Twelve years on, cryptocurrencies play almost no role in normal economic activity. Almost the only time we hear about them being used as a means of payment — as opposed to speculative trading — is in association with illegal activity, like money laundering or the Bitcoin ransom Colonial Pipeline paid to hackers who shut it down.
He goes on to say that it looks like a Ponzi scheme but all that is fine because Bitcoin is a side-show. He’s been consistent in these views. Here he is in 2018:
Will that happen? I think it’s more likely than not, partly because of the gap between the messianic rhetoric of crypto and the much more mundane real possibilities. That is, there might be a potential equilibrium in which Bitcoin (although probably not other cryptocurrencies) remain in use mainly for black market transactions and tax evasion, but that equilibrium, if it exists, would be hard to get to from here: once the dream of a blockchained future dies, the disappointment will probably collapse the whole thing.
Most economists nod their heads in agreement with all of this. And you can see that in the surveys of economists done regularly. Here are some examples.
This last one was a survey I was part of. I went against the flow with ‘disagree.’
This one from 2017 is instructive though:
If you recall, at that time, was at a (for then) all-time high of over $19,000 so what they were saying is that it was going to go down. It did.
But the lowest it got to was $4,200 not $1,000. That makes it look like the economists were right. But the survey is ambiguous. I think they thought it would be less than $1,000. Case in point:
Although perhaps this answer from a Nobel prize winner captures the modal view:
And other Nobel prize winner:
The fair view is that most economists are perplexed by Bitcoin and nothing that has happened over the past 13 years has helped them much. But at the same time, I think they feel they should be able to have an informed view on Bitcoin and so express confident opinions.
I’m not judging here. I understand these feelings and share them. But economists, of all people, shouldn’t rely on feelings. Bitcoin is a thing and based on our usual measures of wealth (valued ‘at market’ — aka if it is good enough for stock it is good enough for …) puts it at $600 billion today. That’s not nothing.
The Candidate Theories
Let’s run through the candidate theories for why economists don’t like Bitcoin.
It is for Illegal Activity
This was Krugman’s first argument. Why are people using Bitcoin at all? It is because they can pay each other without using the regular payments system which means they can avoid scrutiny.
What this is saying is that Bitcoin allows the rule of law to be subverted. Economists are pretty conservative and tend to like the rule of law. But here this view is odd because economists are also pretty sceptical as to how the rule of law can overcome market forces. Put in a law, and you raise the costs of certain activities and increase incentives to lower those costs. Seen in that light, Bitcoin is innovative — yes, it is criminally innovative — but it is pretty understandable. Not only that, if it does that job, it is remarkably impressive. imagine having to rely on payments without the backing of the law. That’s not easy. And imagine doing it digitally. Really impressive.
At the same time, as it turns out Bitcoin isn’t that great for those payments. For starters, it is volatile and your average criminal doesn’t like that any more than your average person. Yes, it is more convenient than gold but is it more convenient than USD cash. Either way, you have the problem of converting the assets to be used for paying for other stuff.
Finally, as is well known, Bitcoin is public. If it is private, it is very fragile in that regard. Once enough information about wallet holders is known, you can trace payments in a way that any law enforcement agent could previously only dream of.
So this theory we have to put in the category of economists thinking Bitcoin is unimportant rather than a coherent argument against it per se.
It is a Bubble/Ponzi scheme
Hard to get away from that one. Bitcoins do nothing other than be bitcoins. If they have value it is because people find them valuable and know other people find them valuable.
But then again, isn’t the same true for money? As John Maynard Keynes famously wrote:
By acting as a money of account it facilitates exchanges without its being necessary that it should ever itself come into the picture as a substantive object. In this respect it is a convenience which is devoid of significance or real influence. In the second place, it is a store of wealth.
So we are told, without a smile on the face. But in the world of the classical economy, what an insane use to which to put it! For it is a recognized characteristic of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit.
Why should anyone outside a lunatic asylum wish to use money as a store of wealth? Because, partly on reasonable and partly on instinctive grounds, our desire to hold Money as a store of wealth is a barometer of the degree of our distrust of our own calculations and conventions concerning the future. Even though this feeling about Money is itself conventional or instinctive, it operates, so to speak, at a deeper level of our motivation. It takes charge at the moments when the higher, more precarious conventions have weakened. The possession of actual money lulls our disquietude; and the premium which we require to make us part with money is the measure of the degree of our disquietude. (Keynes, 1937, emphasis added)
Yep. That is what makes Bitcoin most like money. Where Bitcoin differs from money is that government-issued money can be used to settle government-issued tax bills. So long as the government says you can use fiat money to pay taxes, there is a reason to make sure you have some fiat money in your position on April 15 (or whatever). But that use does smell like a tail wagging a very large dog. To be sure, it is a difference we can point to. But does the existence of that difference make money any less of a Ponzi scheme than Bitcoin? That’s a tough question and so I am going to have to return to explore this theory in a future post.
It wastes resources
If there is one thing economists don’t like, it is wasted resources. And if you look at Bitcoin, it is using the electricity generated by a reasonably sized country like Sweden. But you know who else is using the electricity generated by a reasonably sized country like Sweden? Yes, Sweden. And economists don’t particularly seem to mind Sweden. Many of the economists named above really love Sweden.
Economists can’t talk about wasted resources without thinking about what the resources are used for. So when they say the resources are wasted, they mean that Bitcoin generates no value.
This, however, is a very uneconomic conclusion to draw. The electricity used to power Bitcoin is being paid for. And not by governments (which can draw the ire of some economists as potential waste). But by people who appear to be acting of their own free will in a market to pay for this stuff. Whatever it is they are getting from Bitcoin — be it illegal activity facilitation, buying into a Ponzi scheme or something else — they are paying for it and who are we to judge? Everywhere else economists don’t judge, at least as professionals. But for Bitcoin, it is held to be waste despite being as ordinary a market transaction as we can imagine.
How economists declare something to be waste — and there can be waste — is by identifying a market failure? When it comes to Bitcoin, when pushed, economists identify electricity usage as being socially underpriced. Why? Because it is generating pollution and pollution is a quintessential market failure.
But here’s the problem with that. That argument may be true but it is not particularly true of Bitcoin. Basically, Bitcoin involves the same waste as using a fridge. Both are subject to the same market failure. Can we really say one is worse than the other?
Now I happen to think that there is a market failure at the heart of Bitcoin. But it is not one that any economists to my knowledge have talked about. And alas it is, for that same reason, kind of complex to explain. As this post has already stretched reasonable reading requirements, I’m going to devote a full post to that in the near future. Stay tuned.
Summary
In summary, economists don’t like Bitcoin but their arguments are weak. They are certainly not strong enough to suggest a policy intervention. Even after 13 years, I think that most economists hold Bitcoin to be a sideshow. They don’t like it but are not really worried about it either.
I think there is more to the story than the current steady-state view. More on that later. (Click here to read Why Economists Don’t Like Bitcoin, Part II)
