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May 29, 2021
FINANCE To its bickering tribes, a bit like the rest of society. One competition that’s gaining a lot of attention right now is the demographic and digital divide between crypto kids and fiat dinosaurs. The children of crypto believe that blockchain-based finance is the future and a haven from the inevitable degradation of fiat currency. In the opposite corner are the titanosaurs of the fiat world, the central bankers. I’m skeptical of crypto assets, frankly, because they’re dangerous, Bank of England boss Andrew Bailey said this week.
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It’s a good time for dinosaurs. The dollar price of bitcoin, the mainstay of crypto assets, has gone from around $ 58,000 in mid-May to around $ 33,000 in the space of a few weeks. Most of the drop came after Tesla chief executive Elon Musk said his company would suspend its policy of accepting bitcoin for the purchase of its cars. A pledge by Chinese regulators to crack down on bitcoin mining has given further momentum to the sale.
The consequences have so far been few. Because there has been no visible collateral damage, crypto has been widely viewed as an accessory in the financial markets. This view is too dismissive, however. Crypto, like gold, is built on a collective belief in its value. But to some extent, so are all asset prices. And crypto is moving beyond the point where it can be seen as its own autonomous world.
To understand the rise of bitcoins, it is useful to go back to the work of Thomas Schelling, economist and game theorist, winner of the Nobel Prize. Schelling argued that people are often able to tacitly act in concert if they know others are trying to do the same. Many situations bring up a clue, a focal point, around which people can coordinate without explicitly consenting to it. For example, if asked to choose a positive number, people will offer a variety of responses one, seven, 100, and so on; but if asked to choose a number that others will also choose, there is one overriding choice: the number one.
This idea applies to certain assets that lack intrinsic value. The gold investment argument, Schelling said, can be best explained as a solution to a coordination game. Gold bars are valuable because enough people tacitly agree that they have them. Their value is enhanced by their rarity and longevity. Willem Buiter, a prominent economist, once aptly called gold the six-thousand-year-old bubble. Bitcoin is newer, but similar. Yes, the technology behind it is ingenious (although Ethereum, the second most valuable crypto asset, arguably has the most compelling user case). And, yes, bitcoin is used in transactions, if not more for Tesla cars. But its selling points are rarity and fame. It is a natural focal point. As with gold, you can theoretically justify that it is paper money inflation proof.
The latest gyrations seem to confirm that crypto is a walled garden unrelated to the rest of finance. But if you take a closer look, a different pattern emerges. There is already a path from crypto prices to gold. According to a recent analysis by Nikolaos Panigirtzoglou of JPMorgan Chase, a bank, flows to exchange-traded funds (ETFs) that invest in gold began to recover just as silver was coming out of bitcoin futures contracts. and ETFs. This suggests that institutional investors are turning to gold again after a surge of interest in crypto because bitcoin prices had risen too quickly. Viewed this way, the fall in bitcoin and the rally in gold is a trade of relative value within the larger set of inflation hedges.
Plus, it’s hard to shake off the feeling that crypto crashes now matter. This is the third bear market in four years, but a lot more money is now at stake. The market cap of cryptocurrencies tracked by a specialist website, coingecko.com, was over 2.5 billion. of dollars in mid-May. Fifteen days later, it had fallen to $ 1.5 billion. It’s a big waste in anyone’s money. Crypto prices are rising again, so these losses are already eroding. But with each new peak, the asset class looms more and more. And a dollar lost in crypto investing is the same as a dollar that has already been earned or borrowed, although at this time it is difficult to know precisely who bears the loss.
There is something else to consider. Cryptocurrencies are highly speculative assets. So it’s hard not to view their prices as a signal of a broader change in risk appetite. Beliefs count for all kinds of asset prices, whether in dollars or bitcoin. You might be able to ignore this crypto-crash. But the next one will be harder to ignore.
This article appeared in the Finance & Economy section of the paper edition under the title “L’anti-fiat punto”
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