Rebuttal of Nouriel Roubini's article "Blockchain's Broken Promises"

in #blockchain6 years ago

Written on the 17th of April 2018 by by Velvet Campbell, Jonathan Gross, Edwina Oliveira

Project Overview

In January 2018, Nouriel Roubini, an American economist and professor at the Stern School of Business at New York University, published his opinions about and comparisons between blockchain technology and its use cases, and what he considers to be the "real and ongoing fintech revolution" using other types of technology, such as artificial intelligence, big data, and the Internet of Things. This paper, the product of a group effort, reviews each of Roubini's points. Nouriel Roubini's article: Blockchain’s Broken Promises.

The participants in this group, in alphabetical order, are: Velvet Campbell, Jonathan Gross, and Edwina Oliveira. Roubini's article was dissected, and each of Roubini's points was assigned to a team member for analysis and comment. The primary contributor is identified for each discussion.

Introduction

(by Edwina Oliveira)

Roubini (2018) opined that blockchain technology is overhyped, and has only one application in the form of Bitcoin, although it has been in existence for nearly a decade. He also claims that cryptocurrencies do not fulfill their stated purpose.

The blockchain and bitcoin, the token, are both needed for the Bitcoin network to work as intended. However, there is a difference between blockchain technology and bitcoin as money. There are various definitions of "blockchain." As noted by Borosa (2018), blockchain is defined as a "tamper-proof, shared digital ledger that records transactions in a decentralized peer-to-peer network." One important feature of a blockchain is the permanent record it maintains of all asset transfers that have occurred between participants in the network. Bitcoin, the token, is the representation of value that can be transferred between participants and serves as electronic cash in the network. These are very different functions, yet Roubini changed his focus over the course of his piece from critiquing blockchain technology to critiquing bitcoin as money.

Bitcoin's Stated Purpose

(Rebuttal by Velvet Campbell)

Roubini starts out with the claim that Bitcoin "does not even fulfill its stated purpose."
Nakamoto (2008) published the whitepaper on Bitcoin with the stated purpose of "A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution." Since the inception of Bitcoin in January 2009, over 309,833,089 transactions have occurred through mid-April 2018 as reported by Blockchain Info (2018) in their "Total Number of Transactions Chart". These transactions have been transferring bitcoin 24 X 7 X 365 days for over 9 years without the utilization of a financial institution or third-party intermediary. These data points clearly refute the claim of not fulfilling the purpose, but even more significant is his lack of acknowledgement of the elimination of a financial institution as part of the transaction. This key component of transferring value without the use of a third party is what drives the innovative opportunities for blockchain.

It is always interesting to hear the comparison to the early days of the internet. Roubini states the internet quickly gave rise to the WWW. A quick research on the internet's history starting in 1965 demonstrates it took almost 30 years to see the real use of applications and adoption (Internet History Timeline: ARPANET to the World Wide Web, 2017). It is unclear why he has arbitrarily declared 10 years to be the deadline for success or failure of cryptocurrencies. It would only be fair to reserve the comparison to the internet after another 40 years to give cryptocurrencies a chance to realize their potential. We are just now starting to get academia and students to understand the technology, so it is only the beginning of development for new innovative projects. The first step is education and then innovation will come about transforming the world.

Great advancements are being made in technology with Internet of Things (IOT), Big Data and Artificial Intelligence (AI) driving the way for many transformative changes. These technological advancements are not mutually exclusive but instead will be complementary with the integration of blockchain. Currently, machines can't have credit cards, bank accounts or money, but cryptocurrencies will open opportunities for these technologies to advance. The future of integrating blockchain will allow the machines to pay for services from each other. The driverless car will need to pay for tolls, power, and accept payment from passengers. Hollis (2018) gives further examples including the IOT sensors monitoring our household consumption with AI ordering supplies which is all tracked on the blockchain. These functions will all be enabled through blockchain and cryptocurrencies, which Roubini does not acknowledge.

It is interesting that Roubini has an Economics educational background and makes the statement that boom and bust cycles could be eliminated with the data-driven improvements in credit. Boom-bust cycles are based on central banks managing the money supply through the adoption of Keynesian economic theory by developed nations (Investopedia - Boom and Bust Cycle, 2018). It is not clear how he can make the claim that advances in current financial services technology improvements in credit allocation would eliminate boom and bust cycles. Interestingly, Bitcoin may be the solution to ending boom and bust cycles and recognizing it supports an Austrian economic theory of market-based rates. The question remains to be seen when the next bust cycle hits if it could turn out to be a compelling event to move people into adopting Bitcoin as a better store of value.

Innovation in financial services to improve existing solutions and offerings is great. Bitcoin's sole purpose was never intended to be competing with every money/commodity/credit option available. Everyone has multiple options and they can choose an option that fits the purpose. Bitcoin and blockchain offer a new alternative but it doesn't mean it has better features than any competing or existing option. For instance, many credit options are available, and a consumer can select from those different options to meet their need. A car loan is different than a home equity line of credit which is different than a credit card. These are all credit services, and each has its own advantages and disadvantages. Bitcoin collateralized loans offer one more option but in no way replaces all existing options.

Bitcoin Does Not Fulfill the Functions of Money

(Rebuttal by Jonathan Gross)

Roubini oversimplifies when he says that as a currency, Bitcoin should be a unit of account, a means of payment, and a stable store of value. Then he wrongly dismisses current (and future) use cases of Bitcoin by saying that Bitcoin is none of those things. First, no currency fulfills efficiently the three above functions of money. Most fiat money are typically good units of account, but they are not good stores of value (inflation and fluctuating exchange rates) and they are less and less used directly as media of exchange, but rather through credit and debit cards. Bitcoin, however, is an efficient medium of exchange. It can be used with low fees and high speed for small and large transactions, whether locally or internationally (fees and speed are facing scalability issues and being questioned but technological solutions, like the lightning network, are emerging rapidly). After only nine years of existence, there are already hundreds of thousands of Bitcoin transactions per day for a total of hundreds of millions of dollars exchanged. Not yet near the levels of exchange of the dollar or the euro, but it means people trust it and use it. A currency works as long as people in a small or large community are willing to accept that currency for transferring value or for exchanging for products or services.

Bitcoin as a good store of value is a more nuanced subject. Roubini argues that it is a poor store of value as its price fluctuates a lot. Although Bitcoin's current short-term volatility cannot be denied, its scarcity (from its fixed supply curve) convinced many people to buy some in the hope of long term price increase. Those that did that a few years ago have not been disappointed. Humans have a tendency to like acquiring scarce things. Bitcoin is the first provably scarce digital thing. Boyapati (2018) compares fiat money, Bitcoin and gold in term of the qualities of money, and especially as stores of value. We encourage the reader to read that comparison. The main negative outlook on Bitcoin as a store of value, mainly when compared to gold, is its youth thus lack of years and established history for proving its durability. So, it is a matter of vision and perspective that will give you the confidence or lack thereof in the long-term value of Bitcoin as a store of value. Where the argument of Roubini falls short, however, is when he compares Bitcoin to fiat currencies, and we know that fiat currencies are terrible stores of value by design, with their unilaterally decided unlimited inflated supply.

Bitcoin is indeed not a good unit of account, mainly due to its high volatility. One day, in many years, with increased liquidity and market cap, its volatility might become low enough for it to serve as a unit of account. On the other hand, like we will see below in more details, Bitcoin's deflationary characteristic is another obstacle for it to become a unit of account. But again, Roubini's choice of argument is unconvincing. He states that no one prices anything in Bitcoin while a whole asset class' prices, the Cryptoassets (Burniske and Tatar, 2018), are denominated in Bitcoin on cryptocurrency exchanges.

To bring a little bit of grist to the mill, we make the following comparison between Bitcoin and the origins of money. The anthropologist Graeber (2014) claims that before the invention of money, in ancient times, people did not barter, like commonly believed, but used a debt-based system. When making a purchase, they recorded debt based on a certain unit of account (like grain or animals). They then settled those debts at some point in the future. Bitcoin, with the lightning network, allows implementation of this ancient practice (payment via lightning as a record of a debt, settlement on the main chain) in a much more direct, safe and efficient way than the fiat system, and without fractional-reserve banking.

Unlimited Supply of Cryptocurrency

(Rebuttal by Jonathan Gross)

Roubini attacks the fixed supply of Bitcoin and says this claim is fraudulent because other cryptocurrencies have been forked off of Bitcoin. This is a clear misunderstanding of the market dynamics at play. First, let us clarify the two types of forks in consideration here, as Roubini clearly mixes them up as he mentions Litecoin as a branch of Bitcoin like Bitcoin Cash and Bitcoin Gold. There are two types of forks. The first type is a blockchain fork, like Bitcoin Cash and Bitcoin Gold, for which at a specific point in time, a new coin is created, like Bitcoin, and every owner of a bitcoin becomes also owner of a unit of the new coin (usually in a 1-to-1 ratio). The second type is a code fork, like Litecoin, for which the code is copied from Bitcoin code, tweaked a little bit, and then used to create a new coin. Contrary to a blockchain fork, an owner of a bitcoin does not automatically own a litecoin. The main motivation for a team of developers and/or entrepreneurs to create a fork, no matter which type, is usually to make a modification to the Bitcoin protocol or add new features. Because Bitcoin's governance is decentralized, consensus on upgrades to the protocol are difficult, if not sometimes impossible, to reach. So important disagreements can lead to forks. This is a new evolution mechanism imposed by the decentralized nature of cryptocurrencies and public blockchains. Then it is up to the users and the market to decide which version of the chain is preferred, usually resulting in different prices. The limited total supply of bitcoins is not a false promise. There is a big chance that one of the chains will be ultimately chosen by the market. And the other ones will not be able to sustain a high value, unless there are also used, but most probably for a different purpose. A possible scenario could be that Bitcoin serves as a store of value and Bitcoin Cash as a medium of exchange (not likely in our opinion, but that is another debate, and one that will be settled by the market). Moreover, the claim of false promise from Roubini is an argument against the value of Bitcoin as a store of value. But since a blockchain fork gives Bitcoin owners the same amount of the new coin, if the owner holds onto both coins, he cannot lose value, even if one of the coin loses all its value. And to reassure the Roubini further, most forks have low values, and they should have less and less in the future, while Bitcoin continues to establish its network effect and dominance.

ICOs Increase the Money Supply

(Rebuttal by Jonathan Gross)

The next argument of the author is about Initial Coin Offerings (ICOs). For his point that ICOs increase the money supply and debase other cryptocurrencies, we refer the reader to the previous paragraph and emphasize the fact that ICOs almost always propose new features and services very different than Bitcoin and are not trying to replace or compete with Bitcoin as a store of value or medium of exchange. Beside that point, Roubini says that all ICOs are scams and "are mostly designed to skirt securities law". ICOs are a new way to raise money among the general public or any investors without being limited to accredited investors. It is clear that there is a legal loophole around ICOs and some groups of people try to leverage this to create scams and make money illicitly. But there are a lot of legitimate projects making an ICO for the many advantages it has for them over traditional financing, including: access to a broader pool of investors, creating a community of users with economic incentives, distributing a token that will have utility value, raising capital without ceding partial ownership of their company, and liquidity of the token (investors can exit when they want). With governments and competent regulatory bodies in many countries clarifying their stance on ICOs, the method is evolving and will continue to evolve. ICOs will perhaps lose some of the mentioned advantages, and the industry will adapt to the new or clarified rules. But saying that all ICOs are scams is pure bad faith. Past ICOs have already created amazing projects, the most notable being Ethereum, whose token supply is valued at $40B at the time of this article, more than 3 years after their ICO.

Financial Bubble and Inability to Use

(Rebuttal by Velvet Campbell)

Roubini makes the statement that people only purchase Bitcoin because they expect it to increase in value and for the most part this is a valid point. Unfortunately, he makes an assertion this is a bad investment because it is currently in a financial bubble. Bitcoin is following standard market conditions with the same emotions that all markets have in the unknown. Time will tell if this is a bad investment or a good investment. Gold is primarily a store of value commodity which many compare to Bitcoin. It is very common for Bitcoin owners to regret ever selling their Bitcoin or making any purchases because once the price goes up they realize it was not a financially good decision. It is unclear why he would say it would be hard to use with over 140k transactions processing daily. The transaction fees and convenience are much better compared to the cost and process of an international wire. The energy from mining bitcoin is the key security component that really gives Bitcoin a huge portion of its value. Bitcoin's energy consumption is easily quantifiable which makes it a target for criticism but in late 2017 Domingo completed a detailed analysis of the current banking system for comparison and determined that Bitcoin used one-third of the energy. Significant energy is wasted on buildings, computing infrastructure, transport vehicles, and employees going to and from work in the traditional finance sector which can all be considered equally toxic to the environment. (The Bitcoin vs Visa Electricity Consumption Fallacy, 2017)

Primary Use: Illegal Activities

(Rebuttal by Edwina Oliveira)

Roubini claims that Bitcoin's only real use has been to facilitate illegal activities. Although there have been reported cases, such as those involving Silk Road and BTC-e, in which bitcoin has been the currency of choice for transactions on the Dark Web, there are legitimate uses for bitcoin. According to Chokun (2018), there are several recognizable companies that accept bitcoin for payment of goods and services, including Microsoft, Overstock, and Bloomberg.com. Molnar (2018) reported that real estate transactions have been and can be conducted with bitcoin; aadyashakti (2017) reported that Tesla vehicles can also be purchased with bitcoin.

Roubini does not acknowledge that, although not used solely for illegal purposes, sovereign currency is also heavily used in illicit activities and money laundering due to its true anonymity (bank note serial numbers are not recorded for every transaction). Money, whether in the form of sovereign currency or cryptocurrencies, will always have a role in illegal activities. The real estate and vehicle transactions noted above could easily be part of the money laundering process, whether the form of payment was cryptocurrency or sovereign currency.

Roubini also claims that G20 members are working together to regulate cryptocurrencies and eliminate anonymity by requiring all income- or capital-gains-generating transactions to be reported. He does not provide a citation for this statement, which appears to be mistaken.
The G20 is a group of representatives from the world's major economies that meets annually to develop global policies to address financial and economic issues. The summit for 2018 was scheduled to take place during March, three months after Roubini's piece was published.

The Finance Ministers of the G20 issued a report after the 2018 summit which identified the issues associated with crypto-assets to include "consumer and investor protection, market integrity, tax evasion, money laundering and terrorist financing." However, the group called on other international agencies, such as the Financial Action Task Force, to monitor crypto-assets and associated risks, and assess the types of responses that might be needed to address those risks. There were no directives issued that are consistent with Roubini's comment. The report from the 2017 summit also did not include such directives. In both summits, the position taken by the organization was to gather more information so that appropriate policies can be developed.

Price Decline: Manipulation

(Rebuttal by Edwina Oliveira)

Roubini noted that the price of bitcoin declined by 50% after reaching heights at or near $20,000 per bitcoin in December 2017. He claims that the price would (not `could') have fallen even more had it not been for price manipulation, citing articles about Tether and the way Bitfinex handles Tether on its platform. The market activity related to Tether could possibly have influenced the price. However, CryptoCoinMastery reported concerns and speculation about Tether and Bitfinex in November 2017, before the price decline. Solid information about Tether and Bitfinex has been scarce and the allegations have not been proven. Also of consideration is the fact that a single event cannot be identified as the reason for the price change, which Roubini does not consider in his comments. At the time of the price decrease, there were a number of other events that may have influenced the price decline, including rumors about China and South Korea considering drastic restrictions on bitcoin mining and trading. There is also the possibility that some speculators were selling their holdings to capitalize on any gains they may have achieved or to minimize losses from the price change.

Monetary System Doesn't Need Multiple Currencies

(Rebuttal by Velvet Campbell)

Roubini makes the claim that we don't need many cryptocurrencies and would make for very inefficient economy. Many types of cryptocurrencies exist with various functions and they are not all trying to replace money. Bitcoin has one primary use which does act like a form of money. Some are projecting that Bitcoin could be the world's reserve currency. Currently, the US dollar is the main world reserve currency and per the Balance (What is a Reserve Currency?, 2017) the popularity of reserve currencies is a function of their stability and reputation. As Bitcoin becomes more stable it could be possible that governments start acquiring it as a reserve currency. Other tokens have no intention of acting as a currency and have a unique utility value. Ethereum is one cryptocurrency that is acting more as a platform to launch new companies and these tokens seem to act more like a security. Economic theory will evolve, and economies will change so there is no arbitrary limit on the number of currencies that can exist. Market conditions in any situation will drive the demand.

Intrinsic Value

(Rebuttal by Edwina Oliveira)

Roubini claims that cryptocurrency is unlikely to be a substitute for fiat currency because it does not have intrinsic value, whereas fiat currency has intrinsic value because one can pay taxes with fiat currency. We would like to adress a too common confusion of the concepts of intrinsic value and legal tender.

Investopedia defines legal tender as "any official medium of payment recognized by law that can be used to extinguish a public or private debt, or meet a financial obligation." Recognition by law, not the intrinsic value of the medium of payment determines whether a particular currency or other medium of exchange can be used to pay taxes (i.e., be recognized as legal tender). Intrinsic value of any currency is based on what users believe the value of the currency to be. This is true for both cryptocurrency and fiat currency; fiat currency is not backed by and cannot be exchanged for a physical commodity. For example, the US dollar has not been backed by gold since the early 1970s. It is the legal tender of the United States, and its value is backed only by the "full faith and credit" of the United States government, whose national debt is more than $20 trillion (www.usgovernmentdebt.us, 2018).

Roubini also claims that fiat currencies in weak monetary systems experiencing high inflation will be swapped for more stable foreign currencies or real assets. In a hyperinflationary economy, the buying power of the local currency diminishes rapidly so it is spent as quickly as possible. Faure (2013) writes that it is the citizenry that tries to protect their financial interests by using whatever available foreign currency there is. The government or central bank does not systemically replace its weak currency with foreign currency to stem inflation, which is what Roubini implies. Rather, the central bank uses other tools, such as decreasing interest rates, to address its economic issues. Roubini also fails to acknowledge that bitcoin has been used by people in Greece and Zimbabwe in an effort to hedge the consequences of the hyperinflation that both countries recently experienced.

Risk of Deflation: Limited Supply of Cryptocurrencies

(Rebuttal by Jonathan Gross)

As we have seen above, Roubini believes that the fixed supply of Bitcoin is a fraudulent claim as other coins and forks are created. Yet he is now arguing that Bitcoin's fixed supply is a problem and will cause price deflation if Bitcoin were to replace fiat currencies. So let us say that Roubini was convinced by our arguments above even before they were written and we now agree on the fixed supply. The Bitcoin deflation argument is one of the few ideas in this article that has some validity. It does not at all prevent the widespread use of Bitcoin as a store of value nor as a medium of exchange, but it would create difficulties for a unit of account. If debt and wages were denominated in a deflationary currency, the prices of goods and wages would have to decrease over time, leading the debts to be more difficult to reimburse. Many proponents of Bitcoin believe that Bitcoin will remove fractional-reserve banking and therefore debt. But even without fractional-reserve banking, most people need loans, to pay for their houses, cars, etc. Those loans, if denominated in Bitcoin, might become impossible to repay as Bitcoin value rises and wages decrease. Indeed, that undermines the use of Bitcoin as a unit of account. On a positive note, it is interesting to note, though, that Bitcoin's supply, while decreasing, is above zero and will remain so for many more years. Economy under Bitcoin as the main currency might adapt to this new kind of supply. Additionally, alternative cryptocurrencies are experimenting with different, inflationary, supply models.

Scammers and the Fear of Missing Out (FOMO)

(Rebuttal by Velvet Campbell)

Market conditions follow standard emotions that have been tracked for years. Bitcoin and cryptocurrency are no different and will be going through various cycles in anticipation of making money. The market is independent of the functionality and utility of cryptocurrencies. It is the sellers' and buyers' choice to make trading decisions and time will tell which were better or worse. It is unfair to say anyone that bought in December was swindled, as in 20 years this may have been a good purchase. You can't only look at the price and in the end most bitcoin owners will say they will still have a bitcoin that no one can take away from them. This sovereignty over their money is very important for many and something we have never had before. From a financial perspective, Bitcoin makes a good investment as part of a portfolio because it is a non- correlated asset. The VIX is a volatility index of the stock markets and per analysis from Deutsche Bank showed that the price of bitcoin had a negative correlation with this index (Are Bitcoin Price and Equity Market Returns Correlated?, 2018). The key part of diversification is to have assets that don't rise and fall together, and Bitcoin price has shown to not be correlated with stocks, bonds, or gold.

Blockchain Technology Does Not Work

(Rebuttal by Jonathan Gross)

In its last paragraph, Roubini goes as far as saying that decentralized blockchain technology is untested, utopian and does not work. Perhaps he was not directing his attention at the right place for the last few years. For sure, the technology has to mature for enabling its use on a wider scale. But the underlying core components of protocols such as Bitcoin and Ethereum do work and are used. Users trust them for storing large amounts of money and attackers, attracted by those giant honeypots, have thrown at them over the years all their attacks and expertise for trying to break them. No system in the world have given its adversaries more incentive to break it than Bitcoin has.

Roubini also makes a comparison with the establishment of the internet protocols to discredit the universal nature of blockchain protocols. But blockchain protocols are in their early days. Obviously, there is a competition between protocols, each making improvements based on the previous ones or offering another model or set of features. Roubini ignores the fact that TCP/IP, before being universally adopted, also had to compete with other protocols; like IBM's Systems Network Architecture, X.25, OSI (Russel, 2013). Additionally, if we consider the year 1969 for the launch of the Internet (ARPANET), TCP/IP became the dominant and universally accepted protocol only in the late eighties, so around 20 years later; and html was first used in 1991, so as much as 22 years after the launch of the Internet. And it was only around 2005 that the internet and information technology have scaled enough to envision and build video hosting websites such as YouTube.

Conclusion

(by Velvet Campbell)

Roubini is unfortunately missing the key benefits of Bitcoin and the potential for future innovation. The Bitcoin whitepaper conclusion starts with "electronic transactions without relying on trust." The ability to engage in transactions without a third-party intermediary has never been possible. Previously the only solution available for transacting with an unknown party was through a central body (company, government, or system) and now we have a new solution. Roubini neglected to comment on the immutable ledger benefits of Bitcoin. This may provide to be the most valuable component of Bitcoin in securing data globally and documenting history. Roubini is enamored with the other technology trends such as IOT and AI but fails to understand that blockchain will be enabling these new technologies to advance even further. Bitcoin's social good aspect is a huge draw for many people and providing financial services to the undeveloped nations will truly change their lives. Our rebuttal highlights how Roubini failed to present a valid argument on the flaws of Bitcoin as money and he completely missed the crucial benefits of Bitcoin and blockchain. This journey has just started, and we are excited to see the continued expansion of Bitcoin and blockchain capabilities.


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