Bitcoin

Bitcoin is not a currency.

Very few people, from Nobel Prize Winning economists to the "man on the street" understand money and value. The phenomenon of cryptocurrency is a case in point.

I highly recommend the little horror story of Gerald Cotton and Quadriga as background to my comments here. Not wanting to trust their money with any "central authority", Quadriga's customers handed over their life savings to a trusted criminal and they vanished with him when he died.

Marketplaces in of any scale require an underlying currency to function. At the very least, such currency must have a more or less stable value on the day the market takes place. In practice, such currencies become stable in larger territories over longer time periods, usually backed by the agreed-to value of some particular good, such as gold or silver or the promise to pay gold or silver.  Unlike in the imagination of crypto believers, the "government" is just another player in the marketplace.

Bottom line: The marketplace is the birthplace of currency. Trust is based on the experience that currency can be exchanged for things of value.

Modern currency is not quite like this. It's based on debt. Currency is created by banks of various kinds along with an equal but opposite debt (loan). The "trust" factor is now based on the ability of the creditor to pay. There is no theory of "value" underlying modern currency - a fact that is widely misunderstood when people talk about "fiat" money. They imagine that the value of money is based solely on the unsupported faith of the naive population that accepts folding bits of paper for real things. In modern economics, the value of things is determined by what people pay for them with no attempt to determine the usefulness of the thing purchased. It is quite true that "money" has been separated from any sensible concept of useful goods or services, but it is not true that there is nothing but naive faith behind "money".

The 2008 crash should have educated people about this money-to-debt relationship. 4 trillion dollars vanished from the world economy because (a) millions of people could not repay their debts and (b) people lost faith in the ability of people to repay their debts and (c) the market for money (debt and repayment risk) followed its own rules into collapse.

Bottom line: Modern money depends on debt and a marketplace for debt-related instruments. The "value" of money in terms of things that are actually of use has vanished from the scene, both in theory and in practice. Money itself has become a thing of value, backed by a chain of debt that is virtually impossible to follow back to the debtor. Debt itself is a "real thing", handed from one creditor to another like a hot potato with everyone hoping to minimize the risk of default. There is a little bit of "hope" in every dollar.

Perhaps the lesson from 2008 is that money itself has no value if not backed by debt in some plausible and transparent way.  Crypto fans drew a different lesson. Maybe we need "money" that's not backed by anything at all.

While Crypto investors imagined that they were placing "trust" in an impersonal algorithm* and not an institution of any kind, what was actually happening was that they retained the need for a marketplace which allowed people to buy and sell "Crypto" for real currency. These marketplaces were needed for fundamental reasons, just as they are needed to trade stocks. Crypto architecture doesn't seem to allow for the "market maker" but this role is absolutely key, especially as the built in inefficiency of blockchain (a feature not a bug) grinds settlement transactions (buy/sell) to a halt. I can hand you a dollar in a second but it is not a practical possibility to hand you a bitcoin in a single lifetime. To do this, I need the services of a market. Bitcoin markets are completely unregulated (another "feature"), allowing virtually anyone to open a cryptocurrency "bank" in their basement. Such as Quadriga, funded by an individual with previous convictions for supporting criminal activities online.

As the scandal around Quadriga illustrates, many Crypto fans placed (or misplaced) their trust in specific human beings with criminal records rather than trusting banks and governments. The disappearance of hundreds of millions of real dollars down the Quadriga black hole is neither unique or unexpected. If you are a cybercriminal, this is perhaps the most attractive "feature" of cyber currency.

Bottom line: "Trust" is necessary, but not sufficient to justify anything to be called a "currency". Owners of such things implicitly trust identifiable human beings or (worst case) human beings who are not identifiable but whose participation in the market is essential.

The Crypto exchange enjoys all the advantages of a real bank but without anyone watching the owner. For example, Quadriga handled billions in real dollars without a whiff of oversight. Its customers, who famously mistrusted governments and banks, trusted Quadriga. Perhaps what befell these customers was some kind of scam or terrible misfortune, but you must at least admit that their trust was misplaced. At the risk of beating a dead horse: people are supposed to trust bitcoin because they don't trust anyone. The miracle of blockchain is that it precisely eliminates the need to trust anyone. To put it another way, if a disaster happens, nobody is accountable. Again, a feature, not a bug.

At any one time, a cryptocurrency exchange owes real money to people who have handed over their crypto but, this debt has no existence in law. The same goes for people who have handed over real money to buy crypto. Especially due to the famously inefficient means that have been designed into crypto, payments from the exchange to the customer can be delayed indefinitely or forever in the case of Quadriga. Unlike in the case of the bank, whose debts are ultimately backed by the government (something viewed as a scandal by the crypto believers), there is nothing standing behind the debts of a "crypto bank". Just like a bank, the crypto exchange only needs to come up with "real" cryptocurrency if the customer actually wants it. Since such currency is almost impossible to "spend", it can sit on the books (possibly fictitiously) until the customer demands to "withdraw" it, at which time he can legitimately expect very long delays that "blockchain" builds into the system.

Crypto economists (are there any?) ignore that "algorithms" don't run themselves. Specifically, by design, the blockchain algorithms behind bitcoin are expensive to run in terms of hardware, energy, and pollution. These are things of real value that are extracted from the real economy as bitcoins created (mined) and exchanged. At best, at its theoretical maximum efficiency, the bitcoin exchange can do no more than transfer "wealth" from one hand to another. It cannot "create" wealth. Any gains achieved by buying low and selling high are exactly canceled by those on the other side of the transaction (buying high and selling low).

Strangely, current (insane) rules of economic theory dictate that the bitcoins have a "real" value, namely the real money cost of creating them, which shows up as revenue for somebody and eventually adds to the GDP. Go figure. In the same way, life-threatening pollution is good for the economy because people get paid to clean it up or treat the victims.

Bottom line: Crypto is an unregulated and sometimes criminal way to extract value (rent) from the real economy. Just as with organized crime, the "value" it creates in the hands of its owners is substantially less than the value it extracts from the real economy and proportionally much more than the value extracted by the legal banking system by means such as credit cards.