Economist William Luther on the popularity of cryptocurrencies, attitudes toward the blockchain, and the future of the Bitcoin market
How did bitcoin being initially a piece of code become an internationally accepted currency?
In the Sun Also Rises, the character Mike Campbell is asked how he went bankrupt. “Two ways,” – Mike said – “Gradually and then suddenly.” Much the same could be said about the successful launch of bitcoin. For the first year, it was barely known outset a small group of coders. It was essentially worthless for the first nine months. There wasn’t even an exchange until March 2010, more than a year after its launch. So it was slow going at first. However, in July 2010 a Slashdot article introduced bitcoin to a much bigger community. The Silk Road, which launched in February 2011, provided an important early use case. Many people experimented with the new technology and saw its value. In doing so, they expanded the network of users and made it easier for others to experiment. As a monetary economist, it has been incredible to watch this happen in real time.
What macroeconomic factors prevent cryptocurrencies from spreading worldwide?
Bitcoin’s market capitalization is much larger than currencies from small countries like Costa Rica. However, as a global currency, it does not yet have the demand that early proponents hoped for. It has not replaced the dollar in international trade, for example, and there are several potential explanations here.
First, all monies are subject to what economists call network effects. You want to use the money that your trading partners are using and vice versa. That means that, unless your currency is terrible, you are reluctant to switch to some new alternative.
Second, there are costs to switching. You need to learn some new way of doing things. You might need to replace your existing technology—perhaps, from a card reader to a QR code scanner. By piggybacking on existing technologies, those in the bitcoin space have lowered these costs. But they are still not zero. So it will take some time for folks to switch if they decide to switch at all.
Finally, it is worth noting the huge role that governments play. Large governments like the US can create a lot of demand for their currencies by committing to make and receive payments in those currencies and not others. There is some ambiguity in some jurisdictions about whether private contracts denominated in bitcoin will be enforced. There is perhaps even more uncertainty regarding the regulations that those providing bitcoin exchanges and other financial services will be subject to in the future. All of these factors discourage users from giving up their national currencies for bitcoin.
How do factors like the devaluation of Chinese Yuan, the UK’s decision to leave the EU, and unpredictable Trump’s presidency influence the market of cryptocurrencies and the value of Bitcoin?
The worse that existing currencies perform, the more likely individuals are to switch to some alternative like bitcoin. With that said, it is difficult to say whether and to what extent any of those shocks contributed to the long run demand of bitcoin. The world is complex, with a lot of things happening at once, and we don’t observe the counterfactual where, for example, the UK decides not to leave the EU. In my own research, I have looked at bitcoin app downloads immediately before and after the Cyprus bailout announcement and find that they increased a bit in Spain. How much does this affect the long run demand for bitcoin? It is difficult to say.
What would happen if cryptocurrencies were banned in some countries and legally integrated into the economy in others?
Fortunately, few countries have taken steps to ban bitcoin to date and few seem interested in banning it in the future. The problem with predicting the effects of a ban on bitcoin is that those countries that are most likely to ban it tend also to be those with large structural problems. They spend beyond their means and fail to encourage productivity more broadly by securing private property rights, enforcing contracts, etc. Moreover, these same countries would probably have a harder time actually banning bitcoin, both because their governments tend to be less effective and because their state-sponsored currencies tend to be less attractive, meaning individuals are willing to incur more costs (read: prison, confiscation of wealth) to use a superior alternative.
I think banning bitcoin is a terrible idea. To the extent that it lowers transaction costs, individuals should be free to enjoy those productivity gains over the antiquated payment systems that dominate today. Even if they don’t lower transaction costs, banning bitcoin would send a strong negative signal to those working on the next iteration of blockchain technologies. I think we want those technologies to be developed. Economic growth is all about doing more with less. And these technologies offer some hope along those lines.
What are the most popular means of preventing the spread of the cryptocurrencies?
Some people think that governments cannot ban bitcoin because all of the transactions take place online and there is no central authority that a government can subpoena or shut down. It is true that a government would have a difficult time stopping all transactions. But it wouldn’t need to. Most transactions—and even most bitcoin transactions today—involve some physical presence. You might order that cute new dress online, but it gets delivered to your door. What stops the government from posing as an online merchant or customer? The fact is that, if a sufficiently large government were committed to stamping out bitcoin, it could prevent all large online retailers from accepting bitcoin; it could prevent shopkeepers from posting “bitcoin accepted here” signs in their storefronts; and, in doing so, it would drastically reduce the attractiveness of bitcoin for the rest of us.
How would you describe the future of cryptocurrencies?
I see the blockchain technology as a genuine technological advance. It enables us to do something that we were not able to do before. I would be very surprised if we do not see more and more applications of this technology in the future. However, it is difficult to say precisely what forms this will take. Perhaps bitcoin will become the global currency. Perhaps some other cryptocurrency will replace bitcoin. Perhaps either bitcoin or some other cryptocurrency or both will live on as a niche currency, used in a small set of transactions like international remittances or online micropayments. Perhaps central banks will introduce a blockchain application to replace their legacy interbank payment systems while leaving the retail payment system that most of us interact with largely unchanged.
How would you estimate the future perspectives of the smart contracts?
Smart contracts are very interesting, but I am not yet prepared to say that they will replace traditional firms very soon. Firms are embedded with a lot of sophisticated information that is difficult to articulate and, hence, difficult to specify in a smart contract. Somethings can certainly be programmed, but a lot of production is messy. I am not sure that is avoidable, and I am not sure we want to avoid that messiness. That messiness does some of the work.
I think we are too quick to dismiss intermediaries as useless middlemen. My mortgage originator isn’t just processing the paperwork for my loan. She is also answering questions, providing some perspective, and making me feel more comfortable about the huge decision that I am making. Intermediaries provide value. To the extent that smart contracts significantly lower costs without reducing the value that intermediaries provide, I expect they will be adopted. If they can’t do that, they might still be adopted, but alongside corresponding institutions that serve those other roles. So, in that case, we might see the role of the middleman transformed but not eliminated entirely. But it is probably too early to say much more than that.
What would happen if all private blockchains converged?
There is a fair number of applications that might prefer to limit access to their blockchain to those parties involved in the transactions. If you work for a large company, they don’t have a separate bank account for every line in their budget—or even every department. They take care of all that internally and interact with the bank in a more simplified way. It is not clear that they—or their customers—would want the level of transparency that would come with a global blockchain. We might also think of niche applications. Perhaps you are a baseball card trader. You might start a private blockchain to track ownership of cards for those in your club. If you interact rarely with those outside your club or are concerned about privacy and the costs of managing a niche blockchain are sufficiently small, you might opt for a narrow purpose blockchain. So, full convergence seems unlikely.
How can the problem of identity on a blockchain be solved?
I am not sure that it is a problem. We can use it when anonymity is useful and eschew it when it is not. At the same time, we could create a registration system for a non-anonymous blockchain and make the user list public. I am not convinced that we want or need a one-size-fits-all solution to transacting.
What are general advantages of alternative cryptocurrencies compared to bitcoin?
I think the altcoin space is interesting. On the one hand, it lacks the network size of bitcoin by a lot, and network effects are huge. On the other hand, it has gained some market share. I think that is largely because people find value in some of the features that new coins offer. Bitcoin is really limited in the extent to which it can evolve. It will be interesting to see whether the desirability of evolving is sufficient to prompt mass switching from bitcoin to alternatives.
How do early adopters of bitcoin and official holders of bitcoin (banks, corporations, etc.) interact?
In the early days, there were a lot of folks interested in bitcoin as a replacement for the traditional financial system. It was launched as the financial crisis was underway, so that weighed heavily on everyone’s mind. Today, there is less angst about banks and other corporations in general. New adopters of bitcoin seem less interested in a revolution and more interested in the prospects of a superior payment system. But, at the same time, I hope that the ancillary institutions in the bitcoin ecosystem continue to provide sufficient scope for those preferring to avoid intermediaries. You can think of it like those using cash today. Most of us swipe our cards without much concern that we will be defrauded or monitored. We trust that our banks will do right for us. Others don’t have faith in those institutions and they are free to use cash. I just hope we will be using bitcoin—or something even better—in a generation or so.