Dear Paul Krugman,
During a pre-pandemic holiday to Phuket in 2018, I noticed something peculiar. Every district or so was plastered with advertising for cryptocurrency conventions. Poster slogans ranged from “the next ten-bagger” to “the best investment alternative”. Back then, I believed cryptomania was just beginning. Today, its market cap exceeds two trillion dollars and prices for Bitcoin, Dogecoin, and other digital doodads move with wanton abandon. (Although Thailand has since banned the “use of cryptocurrencies as a method of payment”)
Late last year, I read your article Technobabble, Libertarian Derp, and Bitcoin for the New York Times with curiosity and delight. In it, you described how “cryptocurrencies play almost no role in normal economic activity”; how “people [are] willing to pay large sums for assets that don’t seem to do anything”; and how techno babblers are using “arcane terminology to convince themselves and others that they’re offering a revolutionary new technology”.
While I agree with most of your sentiments, I am less skeptical than you are about the future of blockchain technologies. As former Intel CEO Andy Grove reminds in Only the Paranoid Survive, we have to beware the trap of the first version. You might recall, for instance, how battalions of critics mocked Apple’s ugly handheld devices in the 1990s. Technology is iterative and speculative until the winnowing effect kicks in. The same argument may apply to blockchain someday.
I agree with you, however, that the market for cryptocurrencies as it currently stands does not make much economic sense. A mix of reflexivity, positive feedback loops, and the fear-of-missing-out have taken enthusiasm and valuations to new levels. Your parallel to natural Ponzi processes, I think, is most apt. For many, speculation on digital coins is the new national pastime.
But I disagree with your concluding sentiment that “what happens to the [value of cryptocurrencies] is basically irrelevant to those of us not playing the crypto game”.
For one, a speculative bubble is a game of wealth transfer. When given the opportunity, smart unscrupulous ‘money’ will mislead and exploit the uninformed. Inside the facelessness of aggregate statistics are thousands of families who make dangerous investment decisions every day. Driven by the latest fad and their animal spirits, they squander their hard-earned savings on instruments and assets that they do not fully understand. Academics and investment bankers may argue that it is ultimately their own responsibility. But doesn’t the system owe them a duty of care?
Moreover, we cannot neglect the risk of financial contagion, or what Ben Bernanke calls the E.coli effect (where food poisoning in one market leads to panic and fear everywhere). Prudence also tells me, as we saw with the subprime crisis and the failure of Long-Term-Capital-Management, that we should not look at markets reductively. Indeed, if cryptomania follows the trend of past bubbles, peddlers are likely to follow up with more opaque and questionable products. Financial shenanigans tend to fester in uncontrolled runaway markets.
So, if you care about your neighbors and the tail-risks of financial systems, the value, leverage, and interdependencies of speculative markets matter. This is true whether or not you are “playing the crypto game”.
If you agree with my sentiments, what then should governments do? On one extreme, the People’s Bank of China has banned cryptocurrency transactions “to curtail financial crime and prevent economic instability” (supposedly). El Salvador, on the other end, is doubling down. They want “to build a Bitcoin city at the base of [the Conchagua] volcano”.
Is there no reasonable medium?
I, for one, cannot think of any quick wins to protect investors from dumb things while preserving the integrity and openness of the financial system overall. And I know of no price bubbles in financial history that were well managed before its collapse. Unless cryptocurrencies and blockchain technologies justify their economic value, there’s a good chance for history to repeat itself.
Perhaps you’ll have a deeper view on the matter. Either way, thank you for your thought-provoking article!