Thursday, November 30, 2017

Bitcoin and Bubbles

Source: Wall Street Journal

So, what's up with Bitcoin? Is it a "bubble?'' A mania of irrational crowds?

It strikes me as a fairly pure instance of a regularly occurring phenomenon in financial markets, one that encompasses some "excess valuations" in stock markets, gold and commodities, and money itself.

Let's put the pieces together. The first equation of asset pricing is that price = expected present value of dividends. Bitcoin has no cash dividends, and never will. So right off the bat we have a problem -- and a case that suggests how other assets might have value above and beyond their cash dividends.

Well, if the price is greater than zero, either people see some "dividend," some value in holding the asset, beyond its cash payments; equivalently they are willing to hold the asset despite a lower expected return going forward, or they think the price will keep going up forever, so that price appreciation alone provides a competitive return. The first two are called "convenience yield," the latter is a "rational bubble."

"Rational bubbles" are intriguing, but I think fundamentally flawed. If a price goes up forever, eventually the value of bitcoin must exceed all of US wealth, then all of world wealth, then all of interplanetary wealth, then all of the atoms in the universe. The "greater fool" or Ponzi scheme theory must break down at some point, or rely on an irrational belief in the next fool. The rational bubbles theory also does not account for the association of price surges with high volatility and high trading volume.

So, let's think about "convenience yield." Why might someone be willing to hold bitcoins even though their price is above "fundamental value" -- equivalently even though their expected return over a decently long horizon is lower than that of stocks and bonds? Even though we know pretty much for sure that within our lifetimes bitcoin will become worthless? (If you're not sure on that, more later)

Well, dollar bills have the same feature. They don't pay interest, and they don't pay dividends. By holding dollar bills, you are holding an asset whose fundamental value is zero, and whose expected return is demonstrably lower than that of, say, one-year treasuries. One year Treasuries are completely risk free, and over a year will give you about 1.5% more than holding dollar bills. This is a pure arbitrage opportunity, which isn't supposed to happen in financial markets!

It's pretty clear why you still hold some dollar bills, or their equivalent in non-interest-bearing accounts. They are more convenient when you want to buy things. Dollar bills have an obvious "convenience yield" that makes up for the 1.5% loss in financial rate of return.

Also, nobody holds dollar bills for a whole year. You minimize the use of dollar bills by going to fill up at the ATM occasionally. And the higher interest rates are, the less cash you hold and the more frequently you go to the ATM. So, already we have an "overpricing" -- dollars are 1.5% higher priced than treasurys -- that is related to "short-term investors" and lots of trading -- high turnover, with more overpricing when there is more trading and higher turnover -- just like bitcoin. And 1999 tech stocks. And tulip bubbles.

Some of the convenience yield of cash is that it facilitates tax evasion, and allows for illegal voluntary transactions such as drugs and bribes. We can debate if that's good or bad. Lots of economists want to ban cash (and bitcoin) to allow the government more leverage. I'm less enthusiastic about suddenly putting out of work 11 million undocumented immigrants and about half of small businesses. The US tends to pass a lot of aspirational laws that if enforced would bring the economy to a halt. To say nothing of the civil liberties implications if the government can track every cent everyone has ever spent.

But US cash is largely stuffed in Russian mattresses. It is even less obvious that it is in our interest to enforce Russian laws on taxation or Russian control over transactions. Or Chinese, Venezuelan, Cuban, etc. control.

And more so bitcoin. This is the obvious "convenience yield" of bitcoin -- the obvious reason some people are willing to hold bitcoin for some amount of time, even though they may know it's a terrible long-term investment. It certainly facilitates ransomware. It's great for laundering money. And it's great for avoiding capital controls -- getting money out of China, say. As with dollars there is a lot of bad in that, and a lot of good as well. (See Tyler Cowen on some parallel benefits of offshore investing.)

But good or bad is beside the point here. The point here is that there is a perfectly rational demand for bitcoin as it is an excellent way to avoid both the beneficial and destructive attempts of governments to control economic activity and to grab wealth -- even if people holding it know that it's a terrible long-term investment.

On top of this "fundamental" demand, we can add a "speculative" demand. Suppose you know or you think you know that bitcoin will go up some more before its inevitable crash. In order to speculate on bitcoin, you have to buy some bitcoin. I don't know if you can short bitcoin, but if you wanted to you would have to borrow some bitcoin and sell it, and in the process you would have to hold some bitcoin. So, as we also see in high-priced stocks, houses and tulips, high prices come with volatile prices (so there is money to be made on speculation), and large trading volumes. Someone speculating on bitcoin over a week cares little about its fundamental value. Even if you told him or her that bitcoin would crash to zero for sure in three years, that would make essentially no dent in their trading profits, as you can make so much money in a volatile market over a week, if you get on the right side of volatility.

Now to support a high price, you need restricted supply as well as demand. There are only so many bitcoins, as there are only so many gold bars, at least for now.  But that will change. The Achilles' heel of bitcoin's long term value is that there is nothing to stop people from creating bitcoin substitutes -- there are already hundreds of other similar competitors. And there is nothing to stop people from creating private claims to bitcoin -- bitcoin futures -- to satisfy speculative demand. But all that takes time. And none of my demands were from people who want to hold bitcoin for very long.  Ice cream is also a fast-depreciating asset, but people hold it for a while. In this view, however, Bitcoin remains a terrible buy-and-hold asset, especially for an investor who plans to pay taxes.

In sum, what's going on with Bitcoin seems to me like a perfectly "normal" phenomenon. Intersect a convenience yield and speculative demand with a temporarily limited supply, plus temporarily limited supply of substitutes, and limits on short-selling, and you get a price surge. It helps if there is a lot of asymmetric information or opinion to spur trading, and given the shady source of bitcoin demand -- no annual reports on how much the Russian mafia wants to move offshore next week -- that's plausible too.

This view says that price surges only happen with restricted supply, and accompany price volatility, large trading volume, and short holding periods. That's a nice testable link, which seems to hold for bitcoin. And other theories, such as madness of crowds, no not explain that correlation.

Bitcoin is not a very good money. It is a pure fiat money (no backing), whose value comes from limited supply plus these demands. As such it has the huge price fluctuations we see. It's an electronic version of gold, and the price variation should be a warning to economists who long for a return to  gold. My bet is that stable-value cryptocurrencies, offering one dollar per currency unit and low transactions costs, will prosper in the role of money. At least until there is a big inflation or sovereign debt crisis and a stable-value cryptocurrency not linked to government debt emerges.

(This view is set out in more detain in a paper I wrote about the tech stock era,  Stocks as Money in William C. Hunter, George G. Kaufman and Michael Pomerleano, Eds., Asset Price Bubbles Cambridge: MIT Press 2003. Alas not available online, but the link to my last manuscript works.)

Update: Marginal Revolution also on bitcoin today.


  1. You seem to forget the basic assumption of rational bubble theory: rg is not even close to serious.

    1. (Strange. The above is not what I wrote. So let me restate more fully.) Rational bubbles require r smaller than g. You describe irrational bubbles that occur when r greater than g. Bitcoin can certainly survive as a rational bubble that constitutes a declining fraction of wealth as long as there are other forms of wealth (such as gold) that yield r smaller than g.

      PS: Serious scientists never consciously misrepresent the theories that they criticize, and they admit errors.

    2. Well said, though maybe the PS is too critical. Prof. Cochrane, you do dismiss the rational bubble theory without really addressing it. Also, what about what me might call the "semi-rational bubble" theory, that it is possible for 99% of the investors to make positive expected returns at the expense of an irrational (i.e., foolish) 1% who don't understand bubbles?

    3. Vacuously, in the case of bitcoins -- the subject of the article -- r > g.

  2. " By holding dollar bills, you are holding an asset whose fundamental value is zero, and whose expected return is demonstrably lower than that of, say, one-year treasuries."

    Except that the Fed holds assets against those dollars, stands ready to redeem those dollars for bonds and loan repayments, and might someday use its gold to buy back those dollars.

    1. The feds assets are largely Federal Government bonds. Those in turn are backed by the taxing power of the Federal Government. The weakness in the dollar system is that neither the Fed nor the Government are limited in the amount of dollars or bonds they can issue. They can create hyperinflation. Also, it is possible for the Government to collapse and lose the ability to collect taxes. There are non US historic precedents for both problems.

    2. Correct, but the same is true of any money-issuing institution. If it loses its assets, or if it issues lots of money without getting assets of adequate value, then its money will lose value. On the other hand, well-behaved institutions can issue money that holds its value.

    3. Good point. It isn't even necessary that the Fed continue to exist. The US government has agreed to accept those dollar bill pieces of paper when you pay your taxes, so they're good for that, if nothing else--- and that's enough.

  3. you can't replicate consensus network out of thin air

  4. there is only one Bitcoin, and is limited. There might be other internet coins, but bitcoin is unique. Like Gold is a precious metal and limited, the other metals are named differently too such as Silver, Copper etc.

    1. Except it seems like every few weeks I’m hearing about a “fork” which magically creates new valued coins out of bitcoins. With these spin-offs, does bitcoin itself not lose value? If it doesn’t, then where did all the value of bitcoin cash and bitcoin gold come from?

    2. Just change the hash algorithm used for mining and you have a bitcoin clone with the same properties, though incompatible with the original. There are an infinite number of crypt-currencies with exactly the same guarantees - yet people choose to believe into that one, *only* everyone believes in it. This is highly irrational and worrisome.

    3. LOL...tell when Bitcoin isn't going up $1000 a day...why would anyone stay in it? Or will just go to infinity?

    4. The Forks aren't exactly like bitcoin. There's a subtle difference, which necessitates the fork.

      In an economy, different products, species, or companies can all find their niche and coexist. It's the same for cryptosecurities.

    5. But keep hold of the reality that bitcoin (like any money) has no value other than that it may be exchanged for something genuinely valuable. e.g. a loaf of bread.

  5. Samuelson 1958. The rate of return on the asset in fixed supply (Samuelson calls it "Money") that pays no dividends equals the growth rate of population (or GDP, or wealth, in a richer model). So it's (in principle) a sustainable Ponzi.

    Land beats it, of course, since land pays rents. But land is less liquid. So it's partly stable Ponzi, and partly convenience yield (it's always a matter of degree).

    But yes, the threat of entry is a problem.

    1. Nick,

      Bitcoins are not in fixed supply and there are extraction costs to consider.
      Bitcoins are unlike land in that way. They are "mined" so to speak.

      Like any other mined resource, the rate of return must factor in the cost of extraction.

      BC = Qty of Bitcoins in circulation
      P = Market price of a bit coin ($ / bit coin)
      C = Extraction cost of a bit coin ($ / bit coin)
      RR = Rate of return on a bit coin (% per year)

      RR = [ BC(t+1) * P(t+1) - BC(t) * P(t) - ( BC(t+1) - BC(t) ) * C(t+1) ] / [ BC(t) * P(t) ]

    2. Frank, there is a fixed supply of bitcoin. 21 million...the mining gets harder and harder until 21 million is hit, then there are no more...except for the “forks.”

    3. The Donk,

      There is a fixed future supply of bitcoin, but that future supply is unmined yes? And the cost of extraction (aka "mining") increases as it becomes more difficult to extract those remaining bitcoins - yes?

      The only point that I was making was that the rate of return on bitcoins must include the costs of that mining. It's no different than any other industry.

    4. Who will enforce the 21 million limit? Simple greed will cause the "miners" to blow through it.

    5. God himself will enforce the 21 million limit. Crytocurrencies literally place their trust in God. All kidding aside, the laws of mathematics enforce it. That's the beauty of crypto.

    6. The 21 million coin limit is algorithmically determined. It is not possible to modify this because bitcoin is supported by thousands of people across the globe "agreeing" on the software behind bitcoin and using cryptography to ensure that nobody can cheat.

    7. "bitcoin is supported by thousands of people across the globe "agreeing" on the software behind bitcoin and using cryptography to ensure that nobody can cheat."

      All of whom are are incorruptible and none of whom will yield to threats from gangsters or governments.

      Your faith is touching.

    8. Fat Man it is all faith based.
      Or based on trust, at least. People trust that other people will agree to abide by the rules. Of course gangsters et al abuse that trust. The system only works as long as the abuse of trust is tolerably small in scale. You may cause civilisation to collapse if your writings persuade enough gangsters to do their stuff.
      And, yes, plenty of governments are run by gangsters.

    9. Fat Man. It is a trustless system. To increase the supply, you have to come to a consensus with every one using the bitcoin protocol. It is infeasible to corrupt or force all of them to change.

  6. "The Achilles' heel of bitcoin's long term value is that there is nothing to stop people from creating bitcoin substitutes"

    Aside from branding and network effects, doesn't the proof of work aspect of bitcoin mean that there is in fact a barrier to creating an equivalent substitute?

    1. you are correct. Bitcoins are the greater fool coins...I buy at a dollar and one it reaches $100,000....then I start another scam. The biggest money isn't just going to stay in Bitcoin....for a flat return. These are just poke chips of the casino!

    2. Seems like a bitcoin clone cannot be a substitute for bitcoin unless it were similarly difficult to reverse a transaction in both currencies. That would require a lot of new processing power or enticing bitcoin miners to start mining the clone instead. Either way, a barrier to entry exists.

      Then there are the network effect and branding aspects. Consider that Wikipedia and Craigslist maintain dominance despite being simple enough for anyone to copy with minimal effort.

      Finally, despite the technical ease of creating clones of existing cryptocurrencies, every cryptocurrency that has achieved some level of success has marketed itself as unique in some non-trivial way.

      By all means, prove me wrong. Perhaps 1,500 cryptocurrencies aren't enough to drive the price of bitcoin down to zero. Perhaps they're mostly too unique. I encourage you to create thousands of substantially identical bitcoin clones. Just give them different names and use them to salt the proof of work hashing. You can call them bitcoin1, bitcoin2, bitcoin3, etc. Unleash them all and see how quickly they manage to pop that bubble!

    3. On top of what anonymous mentioned, you also have the team of highly capable programmers and cryptographers that are actively contributing to Bitcoin's open source software. If you copy bitcoin's code, you will not copy the talent that made the code what it is. So any fork off bitcoin is necessarily less valuable than the original.

      In comparison to other cryptocurrencies, bitcoin's code is the most well tested. No other cryptocurrency comes close to having their code tested as well as bitcoin's

  7. What was the news we missed y’day that explains th price surge today? That foreign criminals use the coins or money laundering purposes? Get real!

  8. John,

    "Now to support a high price, you need restricted supply as well as demand."

    And you need unidirectional trading using market prices. I (as bitcoin miner) will sell you bit coins at the prevailing market price, but I will not buy them back.

    If the bitcoin miner is always willing to buy back the bitcoins at a pre agreed price, then there is no "greater fool" to speak of (and become more like traditional banking).

    With traditional banking, both an asset (money) and a liability (debt) are created.
    A bank that sells money for a debt will always accept the money back at the pre agreed terms of the debt contract.

    1. Yes, but banks always get collateral. Land, machinery, inventory, IP, tradeable securities. what ever. There is no collateral for bitcoins.

    2. Not always.
      Credit card debt, owed to a bank, goes with zero collateral.
      Bitcoin's only value is in the likelihood of being able to pass it on to somebody else who hopes to be able to pass it on also.
      Passing the buck?

    3. "Not always. Credit card debt, owed to a bank, goes with zero collateral."

      It has the personal earnings of the card holder. It ain't much, but it is far more than what stands behind bitcoin.

    4. Agreed.
      Those future personal earnings, of course, may turn out to be zero.
      And a bitcoin, at some point, may have no buyer.
      John brings up some interesting possibilities of who the serious current buyers may be. In addition to amateur speculators.

  9. Thought provoking. Lenders anticipate inflation. My hypothesis. Bitcoin pricing may include an anticipation premium for arbitrary confiscatory gov policy. E.g. Asset forfeiture. Freezing foreign assets. A swap; trade dollars for coins where MRS = MUx/MUy.

  10. Totally unrelated but the argument between Bob Corker and Pat Toomey goes like this.

    Pat Toomey - The jump from 1.9% GDP to 2.3% GDP (dynamic scoring) generates the extra revenue to cover the expected deficit gap of $1.5 Trillion (static scoring).

    I ran the numbers and it doesn't check out.

    Current year real GDP: $17.169 Trillion
    Expected real GDP in year 10 using 1.9% growth rate: $20.72 Trillion
    Expected real GDP in year 10 using 2.3% growth rate: $20.81 Trillion

    Taxes as percentage of real GDP with no tax change: 12.61%
    Taxes as percentage of real GDP with tax change: 11.89%

    Total taxes collected over 10 year time frame with no tax change: $24.04 Trillion

    Total taxes collected over 10 year time frame with tax change and static scoring: $22.55 Trillion

    Total taxes collected over 10 year time frame with tax change and dynamic scoring:
    $22.76 Trillion

    Mr. Toomey needs to learn a little math.

    1. To get to revenue neutrality on a dynamic scoring basis (without interest expense considerations), the proposed tax changes would need to add about 1.09% to real growth (not 0.4% as Mr. Toomey states or 0.8% in other circles).

      And this still doesn't add up when you factor in that budget neutrality is not reached until year 6 with the tax plan. Even with an increase of 1.09% in annual real growth, from years 1 thru 5, the federal government would still be piling on the debt along with the associated interest payments and making payments on previously accumulated debt.

      Taking the math a step further and assuming no interest rate changes and an average interest rate of 2.5% across the maturity spectrum, real growth would need to increase by 1.11%.

      If interest rates rise commensurately with real growth as John thinks they will, then it gets uglier. The last quarter data indicates that government bond holders are willing to accept 2.5% nominal on bonds even with 3% real growth.

      Using that as a discount factor and considering that the U. S. is already about $20.4 trillion in debt, every 1% move upward in interest rates adds $20.4 billion in interest expense on the current debt.

      Taking that into consideration (previously accumulated debt and interest rate increases commiserate with growth), this tax plan would need to add 1.9% to the Real GDP growth rate over 10 years to be revenue neutral. This would push up nominal interest rates on government debt from 2.5% to 4.4% while real growth would need to be in the 4.9% range.

      And we haven't even talked about other projected expenditures - I didn't see anything in terms of spending restraint in the budget resolution the House of Representatives passed.

      Perhaps Mr. Toomey (and the entire Republican Party) need to learn a whole lot of math.

    2. "Perhaps Mr. Toomey (and the entire Republican Party) need to learn a whole lot of math"
      I doubt they have any such need. They are in a marketing exercise. No need for correct numbers. No need for truth any more. I hope there are lots of people like you to hold their feet to the fire when it does prove to be voodoo.

    3. E5,

      Because the corporate tax rate cut is designed to be permanent, efficient markets would conclude that irrespective of inflation expectations or actual inflation, corporate bond yields would rise and / or corporate bond issuance would slow / contract as higher cash flows become available for debt payments / debt retirement.

      Under the Banking Act of 1933, the federal open market committee (FOMC) is not permitted to purchase corporate bonds because they are not guaranteed in principle and interest payments and are not covered by the full faith and credit clause ascribed to securities issued by the federal government.

      International purchases are a bit harder to gauge because they involve currency swaps and in case of bankruptcy, foreign investors would be seeking judgement in U. S. courts. Though I might conclude that a lack of growth to support the tax cuts (and increased debt issuance) would put downward pressure on the dollar making overseas purchases of U. S. securities (including corporate bonds) less than attractive in the intermediate term.

      Given all this, I would look at shorting the corporate bond market, and I would likely find supporters in the Democratic party as well as fiscal hawks in the Republican Part - Bill Gross / Ed Yardeni / Mohammed El-Erian / Anyone out there?

      I (as a voting Republican) have screamed over and over ad nauseam that tax cuts should be enacted that do not increase the federal debt (Bob Corker is right, Pat Toomey is wrong). But apparently, informed discussion counts for nothing and the only thing politicians understand is money.

    4. Thank you Frank.
      Not being well acquainted with the technicalities you mention I think you are suggesting that corporate bonds will become more valuable as a consequence of the corporate tax rate reduction. (or is it the opposite). I, with a tiddly amount of economics learning, would expect stock prices to rise. If so this would lead the enacters cry "look how clever we are" even if it has done nothing good for ordinary folks.
      I would agree with anybody asserting that politicians are simply selling their services to the highest bidder. Which begins to look like gangsterism.

    5. Anonymous (E5),

      "I think you are suggesting that corporate bonds will become more valuable as a consequence of the corporate tax rate reduction."

      Quite the opposite. I believe the right investment move would be to start shorting corporate bonds after the tax bill is passed for several reasons.

      1. The large difference in top personal (39.6%) vs. top corporate (20%) tax rate is bound to draw a large number of individuals to incorporate themselves and redefine their income as corporate income.

      2. That will also draw in a significant amount of personal debt (credit card, mortgage, etc.) being converted to corporate debt. As a side note, that has some implications for the mortgage loans that the FOMC currently owns. If the individual with the mortgage incorporates himself / herself, that puts the FOMC in direct violation of federal law. Mortgage debt is backed by the GSE's (Fannie Mae, Freddie Mac, etc.) which allows the Fed to wade into that market.

      3. There is enough discord from both the liberal left and enough common sense from the fiscal hawk right to create a marriage of convenience.

      "I, with a tiddly amount of economics learning, would expect stock prices to rise."

      It would depend on the financing makeup of the individual firm. Firms with significant leverage and without direct access to the Fed could see their shares fall.

      Finally, there is the old saying on Wall Street - "Buy the rumor, sell the news".

      I would expect stock prices to fall if and when the Republican tax bill has passed for that reason alone.

    6. Anonymous,

      Slightly related to John's post above:

      "I don't know if you can short bitcoin, but if you wanted to you would have to borrow some bitcoin and sell it, and in the process you would have to hold some bitcoin."

      To short anything (in John's instance bitcoin, in my instance corporate bonds) you either need to:

      1. Borrow the asset, sell it into the market, and hope to buy it back later at a cheaper price.

      2. A little more convoluted but you can short assets by first starting a company and selling equity shares for cash. That cash represents a cushion against losses as well as operational expenses. Then your company will swap additional shares with a willing participant (bank, mutual fund, etc.) for corporate bonds. Sell the bonds that you receive into the market and hopefully buy them back later at a cheaper price. Once that transaction has completed, reverse the swap of your equity for corporate bonds.

      You are in essence creating a float of shares outstanding, in addition to the permanent shares that you have sold to investors. This has the advantage of not relying on credit to borrow existing bonds.

      If you borrow corporate bonds, you are going to be borrowing them at a premium from a bank and selling them at a discount to the bank (a banker always get's his spread).

      If instead you swap shares for the corporate bonds (and then swap them back), the bank / mutual fund / etc. you are doing the swap with inherits some of the risk associated with your attempt at short selling.

  11. "It's an electronic version of gold, and the price variation should be a warning to economists who long for a return to gold."

    There are very important differences between bitcoin and gold, and it is important to understand them.

    First, Gold exists as part of physical reality. Its existence is not a function of anyone's opinion.

    Bitcoins exist because there is a community of humans that created them and that must validate them and all transactions. Communities are subject to all kinds of problems, including war, tyranny, plague, famine, natural disaster, and fraud. The opinion you need may or may not be available when you need it and may or may not carry a price you can afford.

    Further, the limited supply of gold derives from the cosmogenic process that produced it and the earth's geology. No one can change that. Bitcoin is a creation of humans. The limits imposed on its issuance are subject to intervention of a limited number of humans. There is no reason to believe that you can depend on their integrity. If it becomes advantageous for them to remove those limits, they will do it.

    Incidentally, the price of gold never varies. One ounce of gold is always worth one ounce of gold. The price of fiat currencies fluctuates all over the place. That is not a flaw of gold, it is a flaw of the fiat currency system and the politicians* who run it.

    *Central Banks are political institutions, created by and subservient to governments. The people who run political institutions are, ipso facto, politicians, regardless of whether they have been trained in economics, have PhDs in economics, or pay dues to the American Economic Association.

    1. "the price of gold never varies" -- false
      "One ounce of gold is always worth one ounce of gold" -- true
      Gold is a physically used material. It has properties that are useful in industrial products.
      Gold is supplied to the market by mining, recycling, and drawing from stores.
      Thus supply and demand pricing applies.
      Also speculation on gold is particularly annoying to people who depend, for their ongoing business, on a regular supply of the stuff.

    2. Gold is the yardstick everything else moves.

    3. Fat Man you have your tongue firmly planted in your cheek I presume. I do not presume you are an idiot.
      All money yardsticks have varying length (even without approaching the speed of light). Same with gold if you treat it as money.
      Gold's value relative to that of other consumable commodities also varies. It is exchanged in a market.
      Using gold as a value standard is optional.
      Everything moves.

    4. Not silver? Why? Silver was a monetary metal before gold. In China.

    5. Yes indeed. Or any substance that is hard to replicate and without other usefulness. Red feathers. Sea shells. Bits of brass. All in the context of people trusting that they can hold said money for a period of time before exchanging it for real useful stuff. And, of course, the exchange rate between said money and real useful stuff is variable.

  12. Whatever the reason, cash holdings in general are en vogue.

  13. This article is missing something important.

    The whole "discounted dividend" valuation refers to cash for reference. But there is no economic model for valuation of currencies. Yeah, that's right. There are models for relative changes in the value of a currency. But there's literally no model out there for figuring out how much a Euro should be worth.

    That's the first problem here. To present a compelling argument, you'd have to present a model, show how other currencies conform to the model, with an error-correction model. Then, you'd just show how bitcoin has a huge error, and you're done.

    However, there is no such model.

    Second, the argument about the ability to expand supply is false. There have been hundreds or even thousands of literal bitcoin clones out there. But they all have failed. All of them. Without some sort of differentiating feature, bitcoin clones fail. And it's easy to see why. Because they are just like bitcoin, with the disadvantage of being less liquid, bitcoin dominates.

    But one thing is totally clear here: The success of bitcoin has provoked thinkers around the world to redefine the concept of money. Let's do that first before presenting an opinion.

    1. Real money stores labor so it can be transported across space and time...that's why money that required no labor to produce is not a reliable store of buying power. In 1964 the minimum wage was $1.25, or five silver quarters. The face value of those five coins would be a lousy minimum wage today, but the silver value (+/- $16.00) would be a reasonable wage. The silver, which required labor to produce, successfully stored the value of labor over that period. The government-decreed (fiat) measure did not. We don't have a "wages" problem, we have a "money" problem. Bitcoin attempts to re-create this labor input with "proof-of-work" but will fail because there is no barrier to substitution. People are not "adopting" (read: using) Bitcoin, they are merely holding it for speculative purposes. After 8 years there are just 300,000 Bitcoin addresses with > 1 BTC; Coinbase's 13M customers are merely customers of the Coinbase Bitcoin bank. And "good" money is neither hyper-inflationary (Zimbabwe) nor hyper-deflationary (Bitcoin), it should be stable against the cost of goods and services. Why would you ever "spend" a Bitcoin? Please look up "Gresham's Law".

    2. Mark in the AUS makes a lot of good points. One thing to consider is wither Bitcoin is actually a currency. I know its original intention was to serve as a currency, however, the "financial asset Bitcoin" seems to have grown more rapidly than has its currency potential. Furthermore, the hyper-deflationary and extremely volatile nature of the currency (at this moment) seems to only slow the potential currency applications and accelerate the pace of Bitcoin becoming a financial asset.

      Something can be named a "Coin" or "Currency" but that does not mean it is such. We do not have to expand the definition of a currency because Bitcoin is misnamed.

  14. Well you print trillions for gamblers of Wall Street to cover their bad bets...what else would the gamblers do....than gamble on a electronic coins. I assume the world's central banks will rescue the richest and bankers...when this explodes. When do the Krugman Coin exchange come online....just create a coin say it is worth A Trillion and walla! Hey if the FED can print itself $4 Trillion why can't every Tom, Dick and Harry print themselves some bit coins(I like to call them Tulip-Coins.

  15. On shorting bitcoin, if anyone is interested:

  16. Hi John,

    I think you have mischaracterised the concept of a rational bubble — at least insofar as the concept is used in the mathematical finance literature. There, a rational bubble simply refers to the situation where the discounted price of an asset is a strict local martingale (and hence a strict supermartingale) under an equivalent risk-neutral probability measure. The asset is a bubble because its current price exceeds its discounted expected future price under the risk-neutral measure; it’s a rational bubble because such a price process is consistent with equilibrium with rational assets. None of this implies that the price will continue to rise (it won’t) or that there must be “greater fools.”

  17. Great piece by Cochrane but he may be wrong.

    Why does everyone use Craigslist?

    Also tax evasion has become deeply embedded into modern life.

    Also US cash circulates domestically, 75% of it. The Fed says US cash, now at nearly $5000 per resident, will double in 10 years.

    Offshore banking exploding too.

    So, perhaps due to consensual delusion and tax evasion, bitcoin will not burst.

    As Leona Helmsly said, "Only the little people pay taxes."

    I feel small quoting her.

  18. Imagine if there were only at most 21 million USD in the world. what do you think the EUR/USD rate might be?

    Only time will tell what the unit of account (1 Bitcoin) will be worth relative to other currencies

  19. Bitcoin is here to stayDecember 1, 2017 at 9:10 PM

    Here is an explanatiom for the price that I found convinving.

    1. That, to me, is a helpful explanation.
      i.e. bitcoin is a rationally useful mechanism for exchanging real stuff. And it gets irrational bubbles. Psychology is applicable.

  20. Interesting blog! The following paper provides a small model for the exchange rate of cryptocurrencies in which speculative demand determines the quantity of bitcoins in circulation:

  21. Good read, point seemed to be: people holding it know that it's a terrible long-term investment, said it over and over lol.
    Couple of facts though,
    1.) you do get dividends in the form of forks, two have happened already, they are already gaining some adoption.
    2.) Bitcoin/digital currencies are looking to replace to older fiat (fake) systems, and (some) make them more transparent.
    3.) Bitcoin adopters do see it as a long-term saving strategy and are adding a little, seeing the potential, and then completely shifting to it.
    4.) Some people will always be exiting and replacing their btc for real world assets like groceries, dollars, cars, houses and boats etc.
    5.) We will not be buying bitcoin very soon, we will be buying 'satoshis' which are fractional parts of a bitcoin. That will make it palatable for a whole new generation of 'consumers'.
    6.) Bitcoin is the gateway to all the other currencies right now and once people enter they diversify into others, they are all still more or less pegged to btc.

    Six cool things that came to mind after reading that, sorry if it got long. I feel it's like a lava lamp sucking up from one blob to the next haha.

  22. Bitcoin cannot protect against double spends except by consensus. Bitcoin can never be cash, cash is protected from double spends by the watermark. which is observable at the moment of transaction. But cash suffers a finite possibility of counterfeit.

    First, we have to agree on what cash is. Then we can find direct mappings between digital cash, paper cash and mineral cash. But if we do not know what cash is, then the discussion is pointless.


  24. Hi John,
    What if bicoin is belongs to the asset classes of currencies? The US dollar has no dividends. Bitcoin could be such a thing . And it definitely allow people to purchase stuff just like the US dollar.

    1. My 2 cents worth....... yes, bitcoin has use as a medium of exchange in the manner of other kinds of money. The puzzle being discussed is how to explain its price trajectory.

  25. A few points:

    -Bitcoin and other cryptoassets can be valued with the equation of exchange. Here's a good explanation:

    -Bitcoin's volatility now is much higher than it will be if it succeeds in becoming a store of value. Right now almost all demand is speculation that Bitcoin will be a popular SoV in the future. If it becomes an actual SoV, that would imply people are buying Bitcoin with the expectation that it will roughly hold its value, rather than with the dream that its price will increase 100x. If it achieves that, there will be less room for speculation because Bitcoin will have been de-risked.

    -As others have mentioned, Bitcoin can survive as a SoV despite clones because it had a security advantage and a network effect advantage. Let's say in the year 2025 you want to save $100k for 5 years. You have a choice between Bitcoin (which we'll assume is used by 10% of the population and costs hundreds of millions of dollars to successfully attack) and Foocoin (used by 0.1% of the population and costs $50k to attack). Which do you choose to store your wealth in? This is why you can't make Bitcoin non-scarce by making copies of the network.

  26. On January 23rd, South Korea’s Financial Services Commission confirmed in a statement that all Bitcoin investors and traders would need to do future business dealings though real-name bank accounts in order to “reduce room for cryptocurrency transactions to be exploited for illegal activities, such as crimes, money laundering and tax evasion.”

    Right after the news hit the market, the price of Bitcoin fell below $11,000 and Ethereum fell to $1,174. While many analysts and experts believe that while South Korea may be seemingly attacking Bitcoin, the real-name bank accounts system will give more security to investors and to the market. The country has been trying to tame the heat recently and the South Korean government now believe this is the way to do it.

    More at

  27. Wow, thx a lot for this information John, good job !!!!


  29. Buffett, the CEO of Berkshire Hathaway (BRKB), has been a bitcoin bear for years. He has often compared the cryptocurrency to gold, saying that both assets are strictly speculative and don't produce earnings and dividends like stocks do.

    Before the Berkshire annual meeting on Saturday, Buffett told CNBC that bitcoin was "probably rat poison squared."

    ICO Review

  30. Replies
    1. It's not bubble, this is real technology like, you can see on how popular it is

  31. Great info rich blog Jon. I think it a bubble, but a big bubble but bitcoin has been used majorly as a medium of exchange in the manner of other kinds of money.

  32. I really appreciate this post. Well described. Thanks

  33. What could possibly go wrong?

  34. Money is accordingly a system of mutual trust,

  35. You can look at the future-spot basis at CME or crypto exchanges, such as BitMEX. When BTC/USD rises, the basis rises, i.e. the convenience yield decreases and vice versa when BTC/USD falls. If bitcoin is similar to gold, why do people prefer to hold spot when the price falls, i.e. when bitcoin is "doubted".

  36. Would it be correct to summarize this post as you seeing Bitcoin as a finite digital resource, which can be transacted with anyone around the world and nobody can stop those transactions.

  37. Came across the old post after hearing you mentioned on an investing podcast. Have you changed your mind or done more digging into the technology of BTC and what makes it unique? At the time of writing, BTC was ~10k and now we're north of $40k.

    What will things look like in another 4 years? I suggest your readers educate themselves on what is becoming one of the greatest inventions since the internet itself.

  38. "Bitcoin has no cash dividends"
    What if bitcoin has cash dividends?


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