On December 19, 2017, the Monetary Authority of Singapore (MAS) advised caution over cryptocurrencies. A fewdays later, a similar warning was issued by the Autoriti Monetari Brunei Darussalam (AMBD), the central bank of Brunei. Over the past year, many other central banks, regulators, financial experts, and media outlets warned the public about cryptocurrencies, too.
For a professional economist like me, cryptocurrencies are an excellent teaching tool, offer that important teachable moment that draws the public’s attention. In addition, they offer plenty of entertainment. They are certainly not money. I see no reason to invest in them, I am not a gambler. Let me explain.
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Cryptocurrencies do not satisfy the basic requirements of money. They are not currencies. Their prices in real money are too volatile to make them useful for measuring value or storing wealth. They are useless in risk management. I encourage anyone interested in the subject to read at least the seven and a half line-long abstract of an academic article by David Yermack (NBER WP19747). It is available online. No Bitcoin, or any coin needed to access it.
If cryptocurrencies are not currencies, I would advise Governments to insist that whoever sells them must call them something else than currencies. Let’s stop misleading the public. I will call them here crypto cyber units (CCUs) to preserve the excitement and minimize the confusion.
Today’s paper money, unlike gold or silver coins, can be supplied only by a public issuer, such as a central bank. Think the MAS, the AMBD, Bank Negara Malaysia, the U.S. Federal Reserve. Governments and their central banks have the monopoly on money production for a good reason.
A profit-maximizing private producer of paper money would keep printing notes as long as the revenue from selling an additional note remained above its production cost. The problem is that the production cost of paper money notes, unlike gold or silver coins, is very low.
For example, if I were an entrepreneur and could produce one S$1,000 note for 10 U.S. dollars, I would eagerly maximize my profits by printing a lot of S$1,000 notes. However, eventually,I would need to stop because people would refuse to pay more than US$10 for each additional S$1,000 note. Only the MAS can ensure that an S$1,000 note is worth US$760 (at the April 8th, 2018 exchange rate). MAS limits the volume of notes it prints and puts into circulation by selling them for U.S. dollars and other currencies.
Remember, reputable central banks are in the business of protecting the value of the money they issue, not maximizing profits from money printing. Smart governments help them in this task by pursuing sound fiscal policy. This is why Singapore and Brunei Darussalam have been blessed with such enviably low inflation, for decades, not for a year or two.
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I suspect, most private producers of CCUs will try maximizing profits and behave like private paper currency makers. They will produce CCUs as long their market price exceeds their private production cost. I am not sure what the production cost is today. I worry it could be low, possibly declining over time. Read an article by Cataliniand Gans, “Initial Coin Offerings and the Value of Crypto Tokens, NBER WP24418, for a more in-depth discussion of what it will take to keep ICOs credible and CCUs valuable.
To make it more educational and entertaining, and more worrisome for me, the entrepreneurs call their production process ‘mining,’ possibly to impress on the buyers the idea that they mine them, maybe at a tremendous cost, possibly from some deep, inaccessible areas of the world. This must make buyers feel their electronic ‘coins’ are like gold, if not better.
I read in newspapers that some entrepreneurs issue their own exclusive CCUs through Initial Coin Offerings (ICOs). This sounds really cool. Selling electronic units for real, cold cash! Maybe I would love to sell. But I am not a buyer. Investors in ICOs put real dollars to buy CCUs in the hope they can sell their ‘investments’ for even more real dollars at some time in the future. This is, by the way, what all Ponzi (Pyramid) scheme investors believe when they are allowed to join a scheme by its sponsors.
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Renaming cryptocurrencies to something else than coins or currencies, and renaming the production process to something less honorable than mining or ICO would make them less attractive. In finance, good product names matter. They bring the right feel of affection, comfort, or even courage when the courage is needed most. Appropriately timed marketing messages and names of financial products help investors part with their money faster and easier. Reviews of financial product names show that names evolve over time. In times of financial crisis, financial companies market themselves as masters of financial security protection, conservative behavior, may use a name such as “Asset Preservation Fund.” In happy, go-go times, the same financial companies push out growth, sent out messages that evoke courage and risk-taking attitudes, like “The Soaring Eagle Fund” (See Mullainathan and Shleifer, “Persuasion in Finance,” NBER WP11838).
Of course, one or two CCUs, maybe even the Bitcoin, which seems to be increasingly expensive to “mine,” and thus could be rare enough to preserve its value — but no guarantees — could be an exception if (1) it can provide a valuable service and (2) people using the service are willing to pay for it in real money.
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Personally, I prefer investing in globally diversified financial assets. Historically, when done right over a couple of decades, investing in a mix of equities and bonds was more likely to turn poor students into millionaires than gambling. Well diversified portfolios of equities of superbly managed companies (see research on how to identify best CEOs), issued and traded in reputable markets and managed by transparent asset management companies that keep administrative and management fees at a rock-bottomlevel (say 0.05-0.25 percent of the total value of assets under management per year) have outperformed most investment products when held continuously. (For some real entertainment, see pages 7-8 in Shojai, Feiger, and Kumar, “Economists’ Hubris – The Case of Equity Asset Management,” Journal of Financial Transformation, Volume 29.)
Thank you for your attention and good luck with “mining” and “crypto cyber investing.”
Roman Zytek is currently the Economic Policy and Macroeconomic Statistics Expert at the International Monetary Fund (IMF). He was previously Chief Economist at the Brunei Darussalam Monetary Authority (AMBD).
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Disclaimer: All opinions expressed in this article are the author’s own.