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Crypto-fool's gold?

The long history of currency tells us that what the private sector innovates, the state eventually regulates and appropriates

Kenneth Rogoff 

Kenneth Rogoff

Is the the biggest bubble in the world today, or a great bet on the cutting edge of new-age financial My best guess is that in the long run, the will thrive, but that the price of will collapse.

If you haven’t been following the story, its price is up 600 per cent over the past 12 months, and 1,600 per cent in the past 24 months. At over $4,200 (as of October 5), a single unit of the virtual currency is now worth more than three times an ounce of gold. Some evangelists see it going far higher in the next few years.

What happens from here will depend a lot on how governments react. Will they tolerate anonymous payment systems that facilitate and crime? Will they create digital currencies of their own? Another key question is how successfully bitcoin’s numerous “alt-coin” competitors can penetrate the market.

In principle, it is supremely easy to clone or improve on bitcoin’s What is not so easy is to duplicate bitcoin’s established lead in credibility and the large ecosystem of applications that have built up around it.

For now, the regulatory environment remains a free-for-all. China’s government, concerned about the use of in capital flight and tax evasion, has recently banned exchanges. Japan, on the other hand, has enshrined as legal tender, in an apparent bid to become the global centre of fintech.

The United States is taking tentative steps to follow Japan in regulating fintech, though the endgame is far from clear. Importantly, does not need to win every battle to justify a sky-high price. Japan, the world’s third largest economy, has an extraordinarily high currency-to-income ratio (roughly 20 per cent), so bitcoin’s success there is a major triumph.

Illustration by Ajay Mohanty

Illustration by Ajay Mohanty

In Silicon Valley, drooling executives are both investing in and pouring money into competitors. After bitcoin, the most important is ethereum. The sweeping, Amazon-like ambition of ethereum is to allow its users to employ the same general to negotiate and write “smart contracts” for just about anything.

As of early October, ethereum’s market capitalisation stood at $28 billion, versus $72 billion for Ripple, a platform championed by the banking sector to slash transaction costs for interbank and overseas transfers, is a distant third at $9 billion. Behind the top three are dozens of fledgling competitors.

Most experts agree that the ingenious behind virtual currencies may have broad applications for cyber security, which currently poses one of the biggest challenges to the stability of the global financial system. For many developers, the goal of achieving a cheaper, more secure payments mechanism has supplanted bitcoin’s ambition of replacing dollars.

But it is folly to think that will ever be allowed to supplant central-bank-issued money. It is one thing for governments to allow small anonymous transactions with virtual currencies; indeed, this would be desirable. But it is an entirely different matter for governments to allow large-scale anonymous payments, which would make it extremely difficult to collect taxes or counter criminal activity. Of course, as I note in my recent book on past, present, and future currencies, governments that issue large-denomination bills also risk aiding and crime. But cash at least has bulk, unlike virtual currency.

It will be interesting to see how the Japanese experiment evolves. The government has indicated that it will force exchanges to be on the lookout for criminal activity and to collect information on deposit holders. Still, one can be sure that global tax evaders will seek ways to acquire anonymously abroad and then launder their money through Japanese accounts. Carrying paper currency in and out of a country is a major cost for tax evaders and criminals; by embracing virtual currencies, Japan risks becoming a Switzerland-like tax haven — with the bank secrecy laws baked into the

Were stripped of its near-anonymity, it would be hard to justify its current price. Perhaps speculators are betting that there will always be a consortium of rogue states allowing anonymous usage, or even state actors such as North Korea that will exploit it.

Would the price of drop to zero if governments could perfectly observe transactions? Perhaps not. Even though transactions require an exorbitant amount of electricity, with some improvements, might still beat the 2 per cent fees the big banks charge on credit and debit cards.

Finally, it is hard to see what would stop central banks from creating their own digital currencies and using regulation to tilt the playing field until they win. The long history of currency tells us that what the private sector innovates, the state eventually regulates and appropriates. I have no idea where bitcoin’s price will go over the next couple years, but there is no reason to expect virtual currency to avoid a similar fate.



The writer, a former chief economist of the IMF, is professor of economics and Public Policy at Harvard University

Copyright: Project Syndicate, 2017

First Published: Mon, October 23 2017. 22:43 IST