My brother-in-law loves the Calgary Flames. Why? Because he’s from Calgary and that’s how hometowns work. Sure, the Flames have done nothing but disappoint him – year after year, rebuild after rebuild – but they are his team. He’s not a fanatic about them, but when my niece was born there was a mini jersey waiting for her at home. Never once has he busted my balls for being an avowed Tampa Bay Lightning fan, despite the fact that they were the team who boomed the Flames from the 2004 Stanley Cup Finals – and are about to do the same to the Habs. He is the ideal fan; loyal but reasonable. If only the crypto crowd was as temperate.
Recently, everyone’s favorite asshole on Twitter, Nassim Taleb, published a paper entitled “Bitcoin, Currencies, and Bubbles” in which he argues that “BTC is worth exactly 0.”1 For Taleb, the lack of value associated with the cryptocurrency stems from the following:
“A central result (even principle) in the rational expectations and securities pricing literature is that, thanks to the law of iterated expectations, if we expect now that we will expect the price to vary at some point in the future, then by backward induction such a variation must be incorporated in the price now. When there are no dividends, as with growth companies, there is still an expectation of future earnings, and a future expected reward to stockholders — directly via dividends, or indirectly via reverse dilutions and buybacks. It remains that a stock is a claim on accumulated assets and their residual value.
Earnings-free assets with no residual value are problematic.
The implication is that, owing to the absence of any explicit yield benefitting the holder of bitcoin, if we expect that at any point in the future the value will be zero when miners are extinct, the technology becomes obsolete, or future generations get into other such "assets" and bitcoin loses its appeal for them, then the value must be zero now.”2
In short, if there is no reasonable expectation of future cash flows or claims to assets that would generate such, then the financial instrument ought to be considered worthless in terms of cash units. The inability of the instrument to inherently generate a given currency – say USD – means that any attempt to exchange the currency for the instrument is nonsensical. Now, someone might expectedly claim that existing currencies, in and of themselves, do not beget future cashflows. This is as simple as it is tautological. But that’s not why we carry around Benjamins. The reason why we use recognized national – and supranational in the case of the EU – currencies is because they are legal tender. That is, we derive legally recognized abilities when we use them within their respective jurisdictions. Try paying the Canada Revenue Agency with Australian Dollars and see how far that’ll get you.
Under normal currency regimes, the average user receives the benefits of a regulated and recognized means of exchange while forfeiting the ability to claim that such liquid wealth is beyond the reach of the powers that be within the confines of the regulatory framework. This situation is apparent whether we look back at previous monetary systems or their present-day successor.
Historically, one could take hard currencies – in the form of gold and silver bullion – and engage in what the French call thésaurisation whereby one would melt down the coins and bars, convert them to jewelry, cutlery, or whatnot, and tuck away the wealth for a rainy day. But doing so did not ‘demonetize’ the asset. That is, if someone broke into your house and stole the literal silverware and then you called the police, your claim against the thief is not in terms of the cutlery per se but rather the currency units equivalent to the cutlery. Put differently, you suffered a loss of X livres, pounds, or dollars, not the stolen items themselves. This truth is evident in the fact that if the items are gone for good but the thief is condemned, they will be liable for damages in terms of the jurisdictional currency. Thus, even in a definitionally ‘hard’ currency regime, one cannot escape the system without forfeiting the rights inherent within the system.
You can imagine that Person A steals a single Bitcoin from Person B. Person A lives in Halifax, Nova Scotia so he calls the whackadoodles down at the local police department. If we assume that the specific Bitcoin is basically gone the second Person B acquires it then Person B will be liable to Person A for the value – in Canadian Dollars – of the Bitcoin.3 Thus, insofar as a Canadian jurisdiction is concerned, Bitcoin is not a currency but rather an asset whose value is priced in terms of the actual currency of the realm.
Stepping back for a moment, the discussion so far has assumed that Bitcoin is a currency. But is it? This seems dubious on the face of it given that in terms of product/service/currency exchange the tail appears to be wagging the dog. For example, imagine you see a sign in a shop window saying that product X costs Y amount of Bitcoin. How did the purveyor come up with that figure? More likely than not, the shopkeeper started with the value of Bitcoin in terms of the local currency and then extrapolated backwards from there. Even if the shopkeeper is adamant that the price is in Bitcoin regardless of the present exchange rate – thus the price does not shift in terms of the coin from day to day – there is likely a latent assumption that the coin will cover the cost of the product/service in terms of the local currency, or that it might appreciate (in local currency terms) in the near future and thus render a pretty speculative profit. At the end of the day though, the need for the shopkeeper to report economic activity to the state will require that at some point the crypto must be converted into the local currency. It is this consideration that will drive all meaningful relations between the coin and its user. Thus, Bitcoin is nothing but an unnecessary functional proxy for the relevant currency at hand.
If my analysis is somewhat accurate and Bitcoin is not a currency in any meaningful sense, and Taleb’s analysis is correct in that it lacks a rational basis as an asset, then why the hell is Yahoo Finance telling me that a single Bitcoin is worth around 35,000 USD?
The easy answer would be that the Bitcoin crowd is made up of equal parts morons and charlatans. While I am sure that there are plenty of coin HODLers out there who lack either brain cells or morals, to brush the entire community aside as functionally limited seems a bit too far. Instead, we would be wise to reflect upon a rationale for why someone might be a Bitcoin buddy despite all the seemingly logical reasons for the coin being a dud.
To understand how the narrative behind Bitcoin can be attractive to some we need to talk about the concept of absurdity. Absurdity occurs when two self-evident states exist whose natures are such that both cannot exist at the same time – thus, the situation is absurd because the impossible collides with the obviously existent. The classic example of this is that humans innately feel that their lives have meaning while it is not self-evident that such meaning exists. We can’t shake the former, yet the latter haunts us. How this applies to contemporary monetary policy is that the two relevant precepts are:
Money is a scarce resource
There seems to always be more than enough money in the system.
As for the first point, folks work hard for their money. Why? Because money does not grow on the proverbial trees. Therefore effort seems to correspond to the possession of money amongst the working classes. Now, obviously, I’m not going to espouse a labor theory of value, but it’s simply the case that people chase after money because of its apparent scarcity.
Amidst the rat race, we are collectively told that one ought to be prudent with their finances, live within their means, and save for a rainy day. However, once obtained, our money because less and less useful as inflation chips away at its purchasing power. Hence bring us into contact with point number two. On a purely nominal basis, the amount of money and ‘near money’ assets in the system – taking America as an example – has increased substantially in the postwar period. For example, the following is the growth trajectory of M3 – the loosest of the major money supply metrics – for the United States.4
If you run the numbers on the rate of growth you get a Compound Annual Growth Rate of 20% while the population over the same period rose at a CAGR near 1%. So it would seem that while money always feels scarce on a personal basis it is in fact quite abundant at the macro-level. Hence why the Bitcoin folks yammer on about how existing currencies are all unsound and basically useless. And you know what? It sounds like a reasonable explanation on its surface, right? Except that a rise in the money supply does not mean that a central bank is printing money wantonly. While Milton Friedman may have been correct in saying that “inflation is everywhere and always a monetary phenomenon,” the causation seems to run in order one direction in that monetary phenomena need not beget inflation.
Rather than the proverbial printing of money, or debasing of the currency, what’s really happened is that assets have become increasingly monetizable. In short, it is easier today for institutions to convert non-cash assets into cash via central bank mechanisms, than in previous decades. If you look at the M3 figure above you will notice that once the US got off the gold standard in the early 1970s, the line began to climb in earnest. The reason being that if the money supply was constrained by the size of the underlying gold reserve, then there would only be so much cash that could be produced via the purchasing of the precious metal. Once the US kicked gold to the curb though, it became possible for the Federal Reserve to accept assets other than gold in exchange for cash. If we think back to the Great Recession we see this in the way in which the Fed provided liquidity to financial institutions in exchange for certain financial instruments such as mortgage-backed securities. Thus, it is not the case that the Fed printed money out of thin air but that the central bank exchanged liquid assets (cash) for less liquid assets of the same worth. The following shows this absorption of assets in the form of the Fed’s balance sheet:5
As The Financial Times’ Brendan Greeley notes in a recent Op-Ed in response to crypto-promoter Cameron Winklevoss’ claim that “all money is a meme”:
“When we say the Fed is printing money, we imply that there was nothing, and now there is something. Ta da! But again, that’s not at all what happens. The Fed has to buy something. Usually it’s a Treasury bill, but in an emergency it can be a more questionable asset. Then the Fed credits back reserves. To believe those reserves are just a meme, you have to believe the assets are just a meme. But they aren’t. Don’t take my word for it. The Fed’s assets provide a return, every year, lean years and fat years, without fail.”
For Greeley, part of the problem surrounding monetary conversations is the persistence of the term ‘fiat currency.’ The adjective use of fiat implies that money exists simply because an authority says so. In contrast, Greeley suggests that a much better descriptor would be ‘credit currency’ since at the end of the day, currencies the world over are backed by the credit of their central banks or governments. The US Dollar will only be worth nothing if the US cannot be trusted to pay back the Treasury Bills sitting on the Fed’s balance sheet. This state of affairs means that it is not authority that drives the monetary system but credit. Taleb echoes this sentiment in a recent footnote when he writes that:
“The use of the designation ‘fiat’ may be a misleading stretch of language: money is not created by edict but largely via credit, by governments or the private sectors – and both lenders and borrowers need the least volatile currency.”
It is worth noting that this perspective does not contradict my earlier claim around the legal nature of currency driving its use. There is just a separation between how we as individuals or corporate bodies engage with the monetary system and the backing thereof. I use Canadian Dollars because it is the legally recognized medium of exchange in my home country – but those dollars are backed by the credit of the Government of Canada and our central bank.
While recent central bank efforts are at least justifiable, there is no denying that such easy liquidity begets moral hazard and distorts market operations in that there is an understanding that you can always break the glass in case of emergency. Additionally, such actions wander into philosophically dubious circumstances whereby the price of an asset is determined by the central bank purchasing it since ‘the market’ outside of the central bank won’t purchase it. The central bank in essence does not pay the market price for its assets but rather sets the market price through its actions. Or rather, the central bank pays the market price – while ignoring an ‘access to liquidity premium’ which market actors would otherwise be willing to pay for. The Fed, and other central banks, effectively provide water to a man dying of thirst while only charging the bottling cost.
As we can probably agree by now, the common Bitcoin rationale of monetary printing narrative fails to hold water. On top of this faulty reasoning, the purveyors and promoters of Bitcoin possess perverse incentives. In a world where the currency is finite – as Bitcoin inherently is – those who ‘get in early’ and acquire the currency units will have significant sway later on if the currency does, in fact, take over the monetary system. The best analogy I can think of is if a cartel purchased a reservoir outside of town and then blew up the public aqueduct carrying water from a different source. What the largest, and most vocal, supporters of Bitcoin aim to do is corner the market and then reap massive returns in the event that we all have to swap over to their system. Which, uh, nope. My oh my, which monetary system ought we to choose? The one run by accountable governments or the one run by anonymous early adopters? Say what you will, but Bitcoin does not ‘democratize’ anything.
The problem with wanting to have a parallel monetary system outside of the mainstream is that it assumes that one can escape society. Call it a burden, life sentence, or injustice, but the fact remains that in order to enjoy the benefits of society, you must take up the obligations thereof. As Oliver Wendell Holmes put it “taxes are what we pay for a civilized society.”6 If you want the upside of modern life, then you need to accept its price which includes putting up with governments who may or may not dabble in questionable policies. Thus, allegiance to the Bitcoin narrative is not simply an economic or financial phenomenon. Rather, it is the outcome of a psychological reality begotten by political choices. These choices are not just random blips and blops but are the conscious result of a living society. By trying to begin the economic world anew, the Bitcoin folks become financial analogs to the political rabble described by Hippolyte Taine in his history of the French Revolution.
“They seem to think, indeed, that human society does not exist, and that they are appointed to create it. Just as well might ambassadors ‘of hostile tribes, and of diverse interests set themselves to arrange their common lot as if nothing had previously existed.’ There is no hesitation. They are satisfied that the thing can be easily done, and that, with two or three axioms of political philosophy, the first man that comes may make himself master of it. Overweening conceit of this kind among men of experience would seem ridiculous; in this assemble of novices it is a power. A flock which has lost its way follows those who go in front; they are the most irrational but they are the most confident, and in the chamber as in the nation it is the breakneck-riders who become the leaders.”7
In the end, Bitcoin is not about cashflows or fundamentals. Taleb is correct in that from an inherent cash flow point of view the coin is worthless. But the Bitcoin folks don’t need such cashflows to make it worth something. All they need are others who are willing to buy into the narrative and provide allegedly nefarious fiat currency along the way via exchange. This is ultimately the irony of Bitcoin – in theory, it is meant to replace existing currencies, but in reality, its worth relies on fresh injections of said currencies into the market to impose expectations of future cash flows. It’s merely the Greater Fool Theory. Nothing more. Nothing less.
https://www.fooledbyrandomness.com/BTC-QF.pdf, p.2.
Ibid.
I’m willing to bet that someone will jump down my throat in terms of case law but hey, I’m a schmuck, not a lawyer.
https://fred.stlouisfed.org/series/MABMM301USM189S
https://fred.stlouisfed.org/series/WALCL
https://www.treasury.gov/resource-center/faqs/taxes/pages/taxes-society.aspx
Hippolyte Taine, The French Revolution: Volume 1, trans. John Durand, (Indianapolis: Liberty Fund, 2002), 146.