Speech by Olivier Klein, CEO of BRED Banque Populaire at the 18th Recontres Économiques d’Aix-en-Provence on 6, 7 and 8 July 2018. I do not address in this brief analysis cryptocurrencies that central banks could create to replace for all or part of tickets, or ICO (Initial Coin Offering) that can finance business projects, no more that the technique on which the cryptocurrencies rely, the Blockchain. My thinking focuses exclusively on private cryptocurrency, the type of Bitcoin.
Bitcoin and other cryptocurrencies are essentially a product of a utopian world in which money would no longer be national but universal, valid in all countries and for everyone, and able to be transferred completely securely and without cost. This currency would pass through intermediaries, and its value could not be manipulated by governments or central banks. It would be subject to private, decentralised management. It would guarantee the anonymity of transactions, and its guardian would not be a central bank but an algorithm, a supposedly infallible IT programme. And, at a push, it would be possible for everyone to launch their own project to create a private currency, outside of controls and regulation.
It is a libertarian utopia that abrogates the role of the state, institutions, banks… what a dream!
I will try to demonstrate that it is precisely a utopia and that it cannot work in this way.
This analysis is based on monetary theory.
We must first ask ourselves if these cryptocurrencies are appropriately named and if they are really currencies. Going back in history, we find the hypotheses of Friedrich Hayek and the Austrian School, who, in 1976, called for the denationalisation of money, “to take from government the monopoly of issuing money and hand it over to private industry”. In some ways, the development of cryptocurrencies could be fulfilling this wish.
However, bitcoin is not a currency in the classic sense of the term. It is not a unit of account, or a medium accepted everywhere (in fact by very few merchants) to exchange value, and is extremely volatile. But nevertheless, it is a form of private money, without a central bank, as it is exchanged between the members of the “clubs” that hold it. It is created by a private issuer who benefits from it. Because, remember, when someone creates a private currency in the form of a cryptocurrency, as the issuer, they receive a very small percentage of the amounts issued.
We must also question the nature of the counterparty of the currency created. Another look at the history books shows us why cryptocurrencies are intrinsically unstable and why they are not currencies. In the 19th and then at the end of the 20th century, two schools of thought came into conflict, that of the Currency school and that of the Banking school. The Currency school considers that quantities of currency must be based on holdings of precious metals, either gold or silver. These are private currencies, issued by banks. They circulate and are regulated freely by supply and demand, without state or centralised intervention. The convertibility of currencies into gold or silver in fact penalises the banks if they issue too much, and, reciprocally, their results are weighed down if they do not issue enough.
For its part, the Banking school considers that the best counterparty for the currency is not gold or silver, but economic development. Money is created from credit. Today, loans make deposits. In other words, it is still the banks that create money, but they do so depending on demand for credit, thus mainly the needs of the economy. And this system must be regulated by an institutional authority, since it is not self-regulated by the convertibility of each currency into gold or silver. Regulation is therefore the task of an external organisation, the central bank, which has a number of instruments to influence, as much as it can, the quantity of credit distributed by the banks.
In both cases, there is a point of reference, whether it is the needs of the economy and central bank policy, or precious metals. In addition, the Banking school implies that there is a unification of the value of each private bank currency by the necessary conversion to prices fixed in the currency issued by the central bank. The currency area is thus homogenised and the quantity of currency issued regulated by central bank policy.
The debate between these two way of thinking is in practice outdated, because central banks were not created on the bizarre whim of a bureaucrat who wanted to create administrations to control currencies and individuals, but quite simply as a response to a series of extremely serious financial crises that occurred at the end of the 19th and the beginning of the 20th centuries, owing to repeat bankruptcies of banks, while they were issuing currencies convertible against gold and silver. Without a central bank to homogenise a currency area, these currencies could carry different values depending on the degree of confidence accorded to each issuing bank. Until confidence completely disappeared, as did the bank itself, though a series of cumulative processes. . By homogenising the currency area and playing the role of lender of last resort, the central bank has thus created the possibility of stability, thereby preventing the recurrence of financial crises or considerably dampening the effects of such crises on the real economy.
Moving on to our argument, all this explains why cryptocurrencies are not really currencies. They have no basis. They do not have as a counterparty gold or silver, or the needs of the economy, since they are issued by private individuals depending on rules set arbitrarily by these individuals and without any objective reference outside the cryptocurrency system itself.
In addition, newly-created “currencies” have proliferated (more than 1,600 cryptocurrencies!), which we can clearly see is unrealistic, because it is not in any way linked to the development of the real economy. To be a currency, economic players must have confidence in the currency issued and accept it as a discharge payment method, i.e. as a means of definitively releasing the debtor from his debt to a creditor or supplier. We can see that if everyone can create a currency from scratch, without counterparty or external regulation, none of these “currencies” can win the necessary confidence from everyone to acquire the real status of currency. In addition, if everyone could issue its own currency, no monetary constraint would therefore be possible and the system could not work.
I would not therefore say that it was a currency, but at best a financial asset. And, for all the reasons set out above, a cryptocurrency’s value is extremely unstable. A fall in confidence is enough to trigger a drastic slide in the value of this type of currency, or conversely, when its value rises, more and more people buy it, pushing up its price without a visible limit and “in a vacuum”. We are then faced with wild speculation, speculative bubbles that can balloon and burst at any time.
In conclusion, it is therefore at best a financial asset, but an asset that has no basis. We therefore bet on the value of this currency, through supply and demand alone, with no other reference point than the confidence that we have in future supply and demand, and without any objective reference point relating to the value of a company or economic development. In this case, we are in a purely self-referential situation. It is therefore in essence a hyper-speculative asset, as is created from time to time in the financial world, completely detached from the real economy.
Institutions exist precisely because they respond to a need for regulation to avoid this type of chaos and crisis. It is undoubtedly not the time to try and destroy them.
In conclusion, I would like to recall the words of a columnist from the Financial Times, who said that the way economists have paid no attention to cryptocurrencies is only equalled by the way in which cryptocurrency enthusiasts do not care about the economy. Finally, as Jean Tirole highlights, while blockchain is useful, cryptocurrencies do not contribute to the common good.