03 Jan CryptoWatch: Bitcoin could have been so much more than a foolish speculation
The U.S. has reached the point where cash could be replaced almost completely with a system of electronic debits and credits. Yet the amount of dollar bills being used continues to grow, particularly bills of large denominations. There are now almost 12 billion $100 bills in circulation, up from 2 billion 20 years ago. Divided by the size of the U.S. population, those 12 billion $100 bills amount to 48 Benjamins for every American man, woman, and child.
I don’t remember the last time I had even one $100 bill in my wallet. Where is all this cash and why do people have it?
It has been estimated that more than half of all U.S. cash is held outside the U.S. Some of this money is held as reserves by central banks; some is used by private citizens and businesses as a second currency or as a hedge against economic instability. Much of the cash, domestically and abroad, is used for illegal or untaxed activities (the underground economy hypothesis).
Cash transactions are anonymous and perfect for hiding clandestine activities from the police and tax authorities. Bitcoin BTCUSD, +0.46% and other cryptocurrencies have the same appeal. Nobody with a credit card and a checking account needs to use a cryptocurrency, but people who want to buy or sell things in secret like them (which is why governments don’t like them).
The speculation taking place in cryptocurrencies is a completely separate issue. There is no compelling reason why a cryptocurrency could not have a fixed exchange rate, like one U.S. dollar per bitcoin, nor is there a compelling reason why the total number of bitcoins could not increase at a fixed rate, say 2% a year. A currency is a stock, a number measured at a point in time, like the number of $100 bills outstanding on December 31, 2017.
Transactions are a flow, like the number of cars sold between January 1, 2017 and December 31, 2017. There is no fixed relationship between the two. The number of cars sold during a year does not determine how much money must be outstanding at any point during the year, or vice versa, because the money can be spent over and over during the year.
Imagine then a new cryptocurrency, nicknamed “Triplecoin,” traded as an anonymous cryptocurrency with a fixed value of three U.S. dollars per Triplecoin — just as if it were a $3 bill. There would be no physical $3 bill, but this fixed exchange rate would be used as the accounting unit. You could buy 1,000 Triplecoins for $3,000 and then buy something for 1,000 Triplecoins. The seller could then use the 1,000 Triplecoins to buy something else or sell them for $3,000 to someone who wants to use Triplecoins for purchases.
Triplecoins would be a shadow currency, a useful medium of exchange for people who don’t want to use checks or credit cards or carry cash, and for those who want to hold U.S. dollars DXY, +0.08% as a hedge against instability in other currencies.
By contrast, the unfortunate decision by their creators to allow the value of bitcoin and other cryptocurrencies to float versus the dollar opened the door for foolish speculation, and many gullible fools have rushed through that door. With no anchor, the price of bitcoin is whatever people are willing to pay — and what they are willing to pay today depends solely on what they think even bigger fools will be willing to pay tomorrow. When the bitcoin bubble pops, some speculators will be battered. So will the credibility of cryptocurrencies.
Gary Smith is the Fletcher Jones Professor of Economics at Pomona College and author of “Money Machine: The Surprisingly Simple Power of Value Investing.” (AMACOM, 2017)