Stock markets tend to go up at the end of the year. Quite why this happens isn’t all that obvious, but it may be fair to say even stockbrokers feel the holiday spirit once in a while. The fact that stock markets tend to fall slightly in January and February may also be testament to this – I mean who likes January?
As much as it is a novel trait, it is dubious to impose such a trend onto the virtual currency market. Throughout December Bitcoin has been on a generally upwards sloping trend, with the new price heights the currency has reached bringing to the fore, quite prominently, concerns of a bubble. The trouble with virtual currency, unlike say, the dotcom bubble of the late nineties, is that virtual currencies are not simply new investment products within a new technology (almost like tech shares in the new online space), but possibly a catalyst – or at least a necessary tool – for the emergence of a truly digital economy. And, further, as regulators around the planet have been slow to act, the conditions surrounding the growth and innovation of the industry remain unbounded, and thus – apparently – unpredictable.
But the dotcom bubble is vitally important to remember in this discussion, not just because it was a bubble, but because it was a bubble formed within unexplored horizons. It is fair to look to dotcom when pondering the future of virtual currency. However, I aim to argue within this short piece that whilst the parallels between the current virtual currency market and previous bubbles exist, the likes of Bitcoin and others pose a unique challenge that warrants perhaps more concern than it is receiving.
How many sides to a Bitcoin?
To start, we must consider the two conditions of the most popular virtual currency, Bitcoin, that affect its would-be viability as a ‘real,’ currency.
The basic philosophy of a virtual currency is the philosophy of all fiat, namely that something has value because people believe it has value. I, amongst others, would suggest a thing only has value at the point it is used in the exchange of goods, which is to suggest money in the bank, or indeed your pocket, is only worth something when someone is willing to take it in exchange for an item you value (for the purposes of simplicity, I am ignoring the consideration of the value derived from a thing’s potential to be transacted, which I do believe is a form of value also, and I have written about previously). Given this proposition, I would suggest Bitcoin, with few entities accepting it as valid payment, has no value. Yet this argument is plainly void, and not really of concern here.
The immediate concern is of utility, namely a currency must be able to be utilised in order to have value. People may believe Bitcoin is worth several thousand dollars, but my point of contention would be it is worth dollars. Until there is an active trading market for Bitcoin, by which I mean you can buy and sell things in Bitcoin, the value of Bitcoin must always be determined as the value of an alternative, utilisable currency. Bitcoin in itself has no purchasing power. If one wanted to see a sign of a bubble, I would suggest mass investing into an item that in itself cannot be utilised for any valuable purpose is one, for the emperor most certainly has no clothes in this regard.
The second condition, much more unique to Bitcoin than a ‘real,’ currency, is the ability to mint more of it. There is only so much Bitcoin in the world, just as there are only so many dollars or pounds in the world. Yet tomorrow the Federal Reserve or Bank of England could choose to print more of their respective currencies. This would incur inflation, and impact confidence or alter interest rates. All of these things would impact the exchange rate, which is essentially the metric we are using to value currency (a weakness of the point above – Bitcoin must be valued against another currency, for the value of one unit of currency is meaningless without comparison. The point above is more trying to suggest the consequence of purchasing power, namely that Bitcoin has none, and thus its value might only be reflected in the dollar’s purchasing power). Of course, part of the appeal of Bitcoin and other virtual currencies are the absence of central banks and governments, in what some will surely see as a truly democratised currency. Yet without the ability to create more Bitcoin, I suggest Bitcoin is identical in substantive terms to gold.
Gold, just like Bitcoin, holds no intrinsic value in und itself. Nor will a shop keep accept a bar of gold or a transfer of Bitcoin, instead preferring the dollarized value. Finally, and returning to the point, there is a finite amount of gold on the planet, just as there is a finite amount of Bitcoin left to be, fittingly, mined. The consequences of this perspective are interesting – it may bring calm and alarm to the current situation. Calm as the volatility in the price of Bitcoin is similar volatility that has been seen in the price of gold for centuries, and thus we might question whether recent events are really a cause of concern. Alarm, because it means rather than betting on the future, as some Bitcoin speculators surely think, they are essentially betting on the price of gold and hoping – through the sheer act of betting – that the price rises. In short, and irrespective, the nuance is lost.
Not the same story
Of course, the parallels between the dotcom bubble and golden Bitcoin also exist. Ignoring some important considerations such as voting rights and dividend pay-outs, Bitcoin, gold and stocks might be grouped similarly, all owing value, but value found through conversion. Indeed, in a discussion with colleagues regarding the vast increase in the number of ICOs, the dotcom bubble was raised in the following context:
perhaps there is a bubble, and many of these coins are worthless and will be swept aside. But companies such as eBay and Amazon were born in the days of the dotcom boom. Right now, people are simply looking for the Amazon of virtual currency, whilst aware many more will fail.
The above is paraphrased, but the point remains clear. However, my issue with that line of thinking is it is too simplistic. Whilst accepting a bubble exists, the search for the Amazon of virtual currency assumes that the currency exists to be found. I would argue we cannot find hope in virtual currency in the same way we found hope in the late nineties because that assumes the likes of Bitcoin does something fundamentally different to, say, Ethereum. After all, Amazon did not survive whilst others failed because of random chance – they survived because they were better than their competitors.
If confidence in the virtual currency market is lost, just as in the days of the dotcom bubble, the loss will affect every currency. Some will argue that, within the coding of various coins, exist tangible features that enable them to rise above the rest. This may well be true, but until the market exists for these coins to be utilised, and thus these features’ benefits demonstrated, the differentiating factors are irrelevant. At least with a company like Amazon (in its early days) one could at least test out their recommendations service, even if they remained sceptical of the viability of the actual company. Currently, there is no logic in thinking the emergence of a bubble in virtual currency is just the same economic natural selection in progress. I suggest this is because our way of thinking about virtual currency is profoundly flawed.
Who are we betting on?
Why does the dollar exist? I’m sure there is a complicated historical reason, but the pragmatic answer is the nation of America required a currency for the purposes of conducting trade between themselves and others, just as the British did with the pound or the French with the franc. The currency existed not for its own sake, but because the country that backed it (with gold, most prominently) and utilised it existed. That concept of country was itself backed by the intangible sense of nationality, and the more tangible threat of firepower. Another question to consider is why did the dotcom bubble occur? One might find emphasis in the bubble part of that question, but fundamentally the dotcom bubble occurred because the internet came into being, which facilitated the creation of online companies.
For the most part, the trading of a currency is not the trading of a country, just as the dotcom boom was not about betting on the internet itself, but about betting on entities being founded in the online space. Colonisation may also be considered – the territory colonialists sort to settle was never in question; they were gambling on their ability to settle.
Really, beyond the question of is there a bubble in Bitcoin, and beyond the technical conditions that distinguish and make interesting virtual currencies, is what is the point of virtual currencies? We already have a largely online banking system, whilst the internet remains without sovereign status and the very real power of nuclear weapons protects the global financial order. To answer this question, I am going to move away from some of the metaphysics discussed above, and explain why I believe the question must not concern whether there is a Bitcoin bubble, but rather whether there is a much more explosive fragility in the virtual currency market itself.
The real problems of virtual currency
The rise of virtual currency is found in its alternative name – cryptocurrency. It is no surprise that the transactional market for the likes of Bitcoin stems from its use in the anonymous purchasing of illicit items. This aspect is, on the one hand, a criticism in itself, and on the other, a point worthy of praise – in the age of big data, with the need to ask questions about who owns our personal data, and the anonymity of cryptocurrencies may be a valuable tool in this area. It is not the purpose of this piece to argue for one hand over the other, though I do confess as an answer to my rhetorical question, “what is the point of virtual currency,” anonymity may serve as a valid reply.
But today, anonymity seems only a point of technical excitement for those in developer circles, and unable to explain the cacophony of speculation that surrounds Bitcoin’s December ascendance. Instead, I want to again consider the paraphrase above, as well as the novel story of the Ice Tea shop that increased its value massively simply by adding ‘Block Chain,’ to its name. A quick Google search will show that 2017 saw a meteoric rise in the number of ICOs (initial coin offerings), ranging from obvious jokes to serious propositions. And, importantly, the money generated in these offerings is real, and for some extremely large. This practice of rapid production for quick public offering does and should raise echoes of the dotcom boom or just a classic bubble, but unlike the dotcom boom there is a much more pressing concern – who is issuing these virtual currencies?
Just like the Ice Tea company (cynically) leveraged the furore surrounding block chain technology for profit, so too will celebrities leverage their fame to make a quite buck. Unlike the sale of shares in a company, or the entering of a loan agreement, or even the good faith transaction that occurs via crowdfunding sites, the launch of virtual currency comes with no obligation on the part of the issuer to honour or maintain the value of the currency. And, though the same could be said with a share issue, there is at least the acceptance of risk on the part of the shareholder that their investment may lose value. When we mentally evaluate virtual currencies, there is a danger we think of the purchasing of Bitcoin simply as a currency transaction, with no evaluation of risk because the cash in our wallet does not (often) become worthless overnight – why would the cash in our virtual wallet do anything different? (I don’t really want to talk about all of this here, but I think a mention of how the industry is branded and marketed is important. Calling virtual currency portfolios wallets as opposed to accounts, for example, associates the ‘investment,’ with something innocuous. Similarly, the presentation of trading websites, with an emphasis on user friendly access – not in itself a bad thing – should raise the alarms of a bubble. When something complex is sold as something simple, mistakes will happen)
But celebrities may simply operate on the periphery. Companies might choose to raise capital via a coin offering in the knowledge that they as the issuer have no obligation for the performance of the currency there after. If these offerings were then used in share buybacks, as has been the habit on Wall Street in recent years, we would see a massive and baseless shift surrounding corporate wealth. This, of course, ignores the fragility that is unearthed when considering the issuing of virtual currency by corporations – what happens to the value of all other virtual currencies when Google, Facebook or Apple engage in their own ICO? For virtual currencies, where value is derived entirely from the confidence people place in them, the above companies will certainly command a great deal of confidence – and belittle others as a result. Further, when these companies issue coins whilst retaining data rights to the coin’s ledger, they cement their monopoly positions, and destroy the benefits of anonymity. For those that praise the anonymous aspect, they must become aware of this. For the technologists that presume virtual currencies to be inevitable, they must re-imagine their paradise with various corporate logos.
Finally, we must consider the role of countries in this emerging market. As it stands today, when a country wishes to borrow money they issue gilts on the bond market, and repay those gilts in accordance with the conditions of – what is essentially – the loan. My question would be when will we see countries engaging in the virtual currency game, again, for the same benefits as those of already discussed? The phenomenon would, essentially, be the same – the leveraging of perceived prestige and security to create confidence in the ICO, only for it to be discovered later that neither the prestige nor the security are part of the deal. It is here we find another point of contention.
That same idealistic technologist mentioned above may well retort to much of my criticism that once the digital economy has fully developed, with the transactional capabilities of say Bitcoin proven, the problem of the reliance of confidence will be absolved much like the fiat nature of many ‘real,’ currencies is accommodated already. But, I argue, there are two fundamental problems with this logic when we introduce corporations and countries as players into this market. The first is that, in order to reduce their exposure and protectionist burden towards a virtual currency, a country might actively discourage the integration of that currency as a part of the economy. The second, and I suggest more realistic response, will be extremely tight regulation of virtual currencies such that the benefits are maintained for the issuer and not for the holder. In this new, imagined digital economy we must question whether it remains a free market economy.
Regardless – and I do believe the above rhetoric is weak – it would be a mistake to assume our current currency structures, which have developed over centuries, will immediately make the leap into the virtual world.
The involvement of nation states into the virtual currency market is not fantasy however, and I believe is much more inevitable than many realise. The primary example currently is Venezuela, which finds itself in the mists of economic turmoil. With an economy dependent on oil, and many traditional lines of credit unavailable to the Venezuelan government, the talk of an ICO for the country has been making the rounds. Some will argue this is merely a conflagration of headlines – on the one hand Venezuela’s crisis, on the other hand Bitcoin’s ascendancy – turning into an idea that will never actually come to fruition. I argue otherwise. If we are to believe virtual currency and the fully realised digital economy are inevitable, we must look to the game of empire played centuries ago by the world’s leading super powers to see they will either forge the path, or be left behind. Whilst nuclear missiles and battleships might ultimately maintain the dominance of the dollar, those same resources will, I believe, ensure a similar power for America’s eDollar.
In many ways, for the purposes of advancing the digital economy and maintaining a certain level of financial stability, the involvement of nation states into the virtual currency market may be the best outcome. Yet, assuming my prior cynicism is unfounded, that surely means the benefits of decentralisation and anonymity currently enjoyed by virtual currencies will be lost, in which case I return to a previous question – what is the point?
To conclude, Bitcoin is quite clearly in a bubble at this moment in time. But this bubble is not the serious point of contention when we consider virtual currency. As I have argued, the problem with virtual currencies is that they are masquerading as real currencies, with no sovereign state nor regulation to maintain their value – only confidence. I suggest confidence is a dubious thing, and I believe I make a compelling argument in comparing the investible nature of virtual currency to the investible nature of gold. I also dismiss the claims that the current virtual currency market is simply the re-imaging of the dotcom bubble by pointing out that all virtual currencies suffer from the same flaws, and thus the emergence of an Amazon of virtual currency is a fallacy position.
I believe absolutely that virtual currencies are here to stay. Really, this is why I believe governments will end up embracing virtual currencies, rather than persisting with the current policy of reactionary regulation. And despite my apparent tone in places, I do not dislike them.
However, I believe in the same capacity that we must – as a society – debate the role of big data and social media from a health and liberty perspective, so too must we approach virtual currencies with caution. I remarked above that the bubble of Bitcoin has formed in the unexplored horizon of virtual currency; I am not the first to make the parallels between the American Frontier and the digital economy. But the Frontier eventually met the Pacific Ocean, at which point consolidation, integration and regulation of the territories was vital to ensure prosperity. We must do this now with virtual currency, though the decisions we make will fundamentally influence the shape of the digital economy, and who holds power in the digital economy. It is futile to argue about a bubble in Bitcoin – whether it explodes tomorrow or not is irrelevant, virtual currencies are here to stay. Let’s accept that fact, and have a much more profound discussion about what we want this technology to be.