The Bitcoin frenzy, although over its peak, is still raging on. To help potential investors see through the hype, Koen De Leus, Chief Economist at BNP Paribas Fortis, shares his advice.
“Koen, it peaked at 19,000 dollars! And my friends were bragging about their Bitcoins, thinking I still had mine. But I had to confess: I followed my brother in law’s advice and sold mine a long time ago. They had a laugh at my expense.” I hear a big sigh on the phone.
I reply: “If it’s of any comfort to you, Serge, Bitcoin dipped back down to $8,200. And if you asked me today, I’d tell you the same thing: sell them!”
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“So you don’t believe in blockchain?”, Serge asks me.
“Don’t confuse the two. Bitcoin and blockchain are two very different animals. Blockchain is the technology that supports Bitcoin, and I consider it very promising. The fact that every transaction must be approved by an entire network, and is irreversible, inspires confidence. For example, companies from, say, the food industry or the diamond industry, will be able to manage their entire supply chain. In the field of transportation, blockchain will allow an important decrease in useless paperwork. In the banking world as well, blockchain will be a real revolution. No, it’s only Bitcoin that I’m wary of. Apart from the fact it’s a new speculation tool, what’s so revolutionary about it, in what way is it useful for our society?”
Quantity of money
“It could offer an alternative to the current monetary system where only central banks are allowed to produce currencies, no?”, reacts Serge.
“Yes, I hear that a lot. Bitcoin could sanitise, stabilise the currency system. It could mark the end of the prosperity/recession cycle of the last century. Because the amount of emitted currency is limited, isn’t it? Well, if that was the case, it’s important to remember that in the past, it’s exactly that fixed quantity of money that triggered very painful periods of deflation. Ben Bernanke, an influential economist who took over the US Federal Reserve after Alan Greenspan, demonstrated that systems that apply fixed exchange rates, and especially fixed quantities of currency into the economy and the banking system, actually increased volatility instead of reducing it.”
“In fact, when it comes to that ‘limited quantity’, forget it.” I continued. “By 2030, Bitcoin will have reached its maximum of 21 million units. As the network develops, creating new Bitcoin will take longer. But because of the slow pace of transaction validation, blockchain was recently split. The consequence is the creation of a new variant of Bitcoin.”
“But it was a ‘one shot’…”, interjects my brother in law.
“Of course, Serge”, I reply teasingly. “It will never happen again. But don’t forget all the other crypto-currencies that were created since. There are already 1,340 of them (see the complete list here). There is no limit to the number of virtual currencies which can be created. And, as a reminder, I think it’s best to avoid calling them ‘currencies’.”
The function of currency
“Straight out of a wary banker’s mouth!” laughs Serge. “Why do you think they don’t deserve to be qualified as currencies? You can use them to pay for purchases, can’t you?”
“A currency has three functions: it is all at once a medium of exchange, a means of calculation, and a store of value. Bitcoin and other crypto-currencies can indeed be used as payment, it’s true. But because of the enormous fluctuations, they cannot serve as a unit of measurement. When you use them for purchases, you run the risk of paying tomorrow 20% more than you paid yesterday.”
“This volatility is an unsurmountable obstacle to the store of value’, I add. “After the rally of the past few weeks – and years –, I can understand why people are eager to bet on Bitcoin. But since the beginning of 2017, its stock has grown tenfold, and been multiplied by 2000 since early 2012. It’s best to avoid investing hard-earned money in such a tool. I’m afraid that many people don’t measure the enormous risk that they run to lose their money. For the authorities and central banks, there is the added problem that Bitcoin and other crypto-currencies threaten their seigniorage, their monopoly on currency issuance.”
“You still don’t get it, do you…” sighs Serge. “It’s precisely the purpose of these virtual currencies: offering an alternative to the trickeries of governments and central banks.”
“At the risk of repeating myself, Serge: emitting money in limited quantity is not fraudulent. Without issuing additional money, economic growth would be paralysed. In addition, blocking the amount of authorised money would leave no wiggle room in case of an economic crash. Modern economies are too complex to be regulated by fixed rules. An important lesson garnered from the last crisis is that the world desperately needs a ‘last-recourse lender’, an ultimate saviour. As Draghi famously said: ‘We’ll do everything it takes to save the Euro.’ After the real estate bubble burst in 2008, it was the U.S. Federal Reserve and the American Secretary of the Treasury who injected massive amounts of money into the economy. Would the crypto-networks take over?”
“Today, central banks frown upon the development of an underground economy”, I continue. “People who exploit crypto-currencies – call them what you want – create money out of thin air, and that money finds its way into the economy. Central bankers have no control over that money. Isn’t that dangerous? The total value of these crypto-currencies fluctuates around 250 billion dollars, compared to a total of 6,000 billion dollars in issued currencies. The amount is still limited, but it’s fast increasing. What happens if next year we reach a 1,000 billion dollar value? And if that bubble bursts, the economy will be confronted to a serious problem. The authorities cannot let things go too far.”
“We can also ponder what the creation of the crypto-currencies is contributing to society. For starters, the generated revenues only profit a limited number of people who have access to significant computing power. Also, PowerCompare – a British company that compares utility rates – has calculated that, in 2017, the quantity of energy dedicated to the creation of Bitcoin has surpassed the entire electric consumption of Ireland. Should we rejoice? Yes, of course central banks also create money out of thin air. In the past ten years, the right to print money has allowed the U.S. authorities to generate an additional 70 billion dollars per year. But this is at no cost to society, and with an even lesser environmental impact. In addition, this money has – I hope – profited society. If that’s not the case, then we should complain to politicians!”
Serge mumbles something on the other end of the line, but I am on a roll and won’t let him interrupt.
“Which brings us to the main question: what is the main purpose of crypto-currencies? Bitcoin and other virtual currencies look like solutions that are asking for trouble. We can currently transfer money quite easily – and perfectly legally. If the principal advantage of a currency is to skirt the existing laws or control of capital, then the government must intervene. If these currencies open harmful doors to fiscal fraudsters, junkies and hackers, then the governments must put a stop to it. And if the unbridled emission of these crypto-currencies threaten the whole financial system, central banks must either take control of them, or forbid them. If and when that happens, Bitcoin and other crypto-currencies will drop back down to their underlying, fundamental value. But what is that? There is no underlying value, as there is no future underlying yield. The emitters of crypto-currencies cannot levy taxes, unlike the emitters of ‘traditional’ currencies. The value of Bitcoin is nothing more than what people are willing to pay to obtain it. And that may one day prove to be painfully low.”
Koen De Leus
Koen De Leus is Chief Economist at BNP Paribas Fortis since September 2016. In June 2017, he published a new book, The Winner's Economy: challenges and opportunities of the digital revolution.BNP Paribas Fortis