The Economist Asia Edition - April 14, 2018

The EconomistApril 14th 2018 Finance and economics 63

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INCE the heady days of late 2017 and

January of this year, crypto-currencies

have gone into retreat. Bitcoin, the best-

known example, is now worth just a third

of its value at its peak (see chart).

But there remain plenty of true believ-

ers in digital currencies. They point out

that prices are still well above where they

were in 2016. And interest from institu-

tional investors is still strong enough for

analysts to want to make sense of the

crypto-phenomenon.

The latest bank to take a shot is Bar-

clays, which devotes a lot more of its

“Equity Gilt Study 2018” to the impact of

technological change on finance and the

economy than it does to either equities or

gilts. Its report describes crypto-technol-

ogy as “a solution still seeking a problem”.

It identifies four challenges in particu-

lar. The first is trust. In most countries,

consumers and businesses have faith in

the currencies issued by the government.

The second is sovereignty: the potential

for tax avoidance and loss of financial

control means that neither governments

nor central banks will be keen to see priv-

ate crypto-currencies take off.

A third challenge is privacy. Although

they can be used pseudonymously,

crypto-currencies are less reliably anony-

mous than cash since the blockchain that

lies behind them records all transactions.

If a pseudonym is cracked, the user’s pur-

chase history is revealed. A fourth relates

to the ability to undo a transaction in

cases of error or fraud—blockchain tran-

sactions are hard to reverse.

On top of all these problems is the fact

that existing alternatives seem to work

perfectly well. It is easy to make payments

and transfer money in an instant.

So what is the appeal of digital new-

comers? Private crypto-currencies can be

attractive in societies where trust is low,

or where governments are unwilling or un-

able to provide reliable means of ex-

change—in wartime or during periods of

sovereign default, for example. Barclays

also suggests that in countries where op-

portunities to invest are limited, “crypto-

currencies may be one of the few ways to

diversify savings out of domestic assets.”

None of these conditions applies in rich

countries. But they hold in some emerging

markets. There could also be demand in

the developed world from criminals (al-

though they now strongly favour cash). By

making generous assumptions about the

size of these low-trust and criminal mar-

kets, Barclays comes up with a maximum

total value for all crypto-currencies of

$660bn-780bn. That is roughly where they

were priced at the beginning of 2018.

Maximum value is not the same as fair

value. Surveys indicate that most people

who buy bitcoin are doing so as an invest-

ment. Just 8% of Americans who hold bit-

coin do so for purchases or payments. That

suggests the main motive for buying

crypto-currencies is speculation, which

also explains their spectacular recent rise

and fall, as with so many bubbles before

them, from tulips to dotcom stocks.

Speculative bubbles are hard to mod-

el—how to find a rational way to assess ir-

rationality? But Barclays uses the inge-

nious parallel of an infectious disease. A

bubble starts with a small number of as-

set owners (the “infected”). New buyers

are drawn in (or catch the bug) because

they witness price increases and fear they

will miss out. A large share of the popula-

tion is immune and will never succumb.

Buyers use a combination of the cur-

rent price and an extrapolation of the re-

cent increase in price to estimate their ex-

pected target value. The faster the price

rises, the wilder investors’ hopes and the

more the infection spreads. Eventually

the market runs out of potential partici-

pants and the price rise slows. Once it

starts to fall, holders lose hope of big gains

and start to sell. The epidemic dies out.

The Barclays model fits the history of

the bitcoin price pretty well. And it sug-

gests that the long-term outlook for the

value of crypto-currencies is bleak. After

all, plenty of people will have bought in

the past few months, when enthusiasm

was at its height. Some will have taken ex-

tra risk to buy the currency, via spread bet-

ting or other types of gambling. Instead of

the riches they expected, they will be

nursing losses. Some will be keen to sell

their holdings. But new buyers will be

harder to tempt now that crypto-curren-

cies no longer look like a one-way bet.

All of this is good news. Perhaps the

blockchain will turn out to be useful for

other purposes—for example, recording

property transactions. But it has been

hard to think about such potential inno-

vations when all the attention was fo-

cused on an ever-rising price. The crypto-

fever has finally broken.

Catching the bitcoin bug

Crypto through the tulips

Source: Thomson Reuters

Bitcoin price, $’000

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Buttonwood

A new study offers cold comfort for crypto-investors

Economist.com/blogs/buttonwood

bears. But all three threats are somewhat

overblown. Start with China. If it dumped

dollar assets, it would push down the

greenback, boosting American exports.

That would be a strange move in a trade

war. It has been reported that China could

do the opposite—boost its exports by deval-

uing the yuan—though this too is improba-

ble. A big devaluation would damage Chi-

na’s authority around the world, and

might trigger another round of capital out-

flows. The Chinese government has fought

hard to stop these over the past two years.

The Fed, meanwhile, signalled its plans

to shrink its balance-sheet well in advance,

so the effects of reversingQE should most-

ly be priced in. And the loose consensus

among economists is that asset purchases

brought down the ten-year yield by only

about a percentage point. Not all think the

effect on the way out will be as large.

As for fiscal laxity, net new borrowing

of nearly $1trn is relatively small compared

with the gross amount of debt America

regularly rolls over. (In the year to Febru-

ary, the Treasury issued securities worth

over $9trn.) That interest rates remain low

despite plentiful publicborrowing indi-

cates that safe assets are still in demand.

Thank structural shifts in the world econ-

omy, such as rising life expectancy that

causes more saving for retirement.

America faces a big challenge balancing

its books in the long term. If it does not, in-

terest rates must soar eventually. But coun-

tries usually have fiscal wriggle-room as

long as they grow, in nominal terms, at a

rate higher than the interest on their debt.

America remains well within this comfort

zone. Rates may rise a little more, but that

would give the Fed welcome room to loos-

en policy the next time recession strikes.

Pessimists who thought rates would never

rise were wrong. Today’s bond-market

doomsayers probably are, too. 7