Crypto Inferno

An Interview with Nouriel Roubini

Octavian Report: Can you explain the concerns you have around bitcoin and cryptocurrencies more generally?

Nouriel Roubini: I'm an expert on asset and credit bubbles and why they burst. Some of them can have significant economic consequences. I've written a whole book, Crisis Economics, that is not just about the global financial crisis but also previous asset bubbles like the Tulipmania, the Mississippi Bubble, the South Sea Bubble. So when crypto emerged, I started to think about these new sets of assets, bitcoin and others, and I asked myself: "Are they really currencies? Are they assets? What's their intrinsic value? Are they in a bubble?"

The more I thought about it, the more I started to realize that they had the features of a typical asset bubble. They would not have the same systemic impact if the bubble bursts. Bigger bubbles that burst can have a real economic effect; the housing bubble led, for example, to a severe recession and a financial crisis. This new asset class would not have systemic effects, as it is a small asset class. But I thought it would be worth thinking and writing about — initially on Twitter, then for Project Syndicate. Then I was asked to testify at the U.S. Senate Banking Committee hearing in October on cryptocurrencies and the blockchain.

OR: Why do you think it's a bubble?

Roubini: I have several reasons. First of all, proponents talk about cryptocurrencies being an alternative to traditional currencies or fiat money. But for something to meet the definition of what money actually is, it has to have several characteristics.

It has to be a unit of account and a single numeraire for all transactions. If you want to price everything in dollars or euros we can't have 10 numeraires or 2,000 numeraires with no ability to tell the relative price of two goods — it would be chaos. So it has to be a unit of account and it has to be a single numeraire.

Second, it has to be a widely used means of payment that can be scalable for many transactions.

Third, it has to be a stable store of value in terms of being a store of wealth and of purchasing power over goods and services. We don't like high inflation because it changes the purchasing power of monetary balances. So high instability in the price of a currency is not good.

Now, if you look at bitcoin — or the hundreds of other cryptocurrencies — they're not units of account. There are no goods or services that are priced in bitcoin. Secondly, it's not even a stable numeraire. You have this cacophony since you have thousands of cryptocurrencies: there's no way you can use any of them to have a stable numeraire to price all the goods and services in the economy. (Indeed, in the utopian dream of decentralization of many people in the crypto world, they believe that there should be a different cryptocurrency for every good or service out there; that is the equivalent of returning to barter.) So it fails the first criterion.

Secondly, it fails the criterion of being a means of payment. Bitcoin’s own technology does not allow you to do more than five transactions per second. Ethereum allows seven or eight transactions per second. A standard credit or debit card network allows upwards of 25,000 transactions per second. Something cannot be a viable means of payment if it cannot do more than five transactions per second. There are massive technological constraints.

Three, it's not a stable store of value or purchasing power over goods or services. Suppose you're a merchant and you're accepting, say, bitcoin for payment. You receive a payment in bitcoin in the morning and by the afternoon the price has fallen 10 percent or 20 percent. Your entire profit margin may be wiped out before you’ve had time to convert your bitcoins into your own preferred currency (leaving aside the already high transaction costs). Or say you do keep it in bitcoin, which has gone from $20,000 to $10,000 to $5,000 to $3,000: where is the stable store of value? Where is the stable purchasing power?

People talk about these things as being an alternative to fiat money, but they fail on every dimension of what a currency should be. It's a misnomer, in fact, to call them cryptocurrencies in the first place. They are not currencies by any reasonable definition.

When you look at the pricing of these cryptocurrencies, they look like typical bubbles. You have exponential increases of the value of the assets totally unrelated to the underlying fundamental value. Bitcoin’s own inflation in the three years before its peak was much worse than the Tulipmania or the South Sea Bubble or the Mississippi Bubble. Those bubbles, in the three years before their peaks, went up by 5X, 10X, or 30X at the maximum. Bitcoin went up by 60X. The boom was exponential. And the subsequent bust has been as exponential as the bubble.

The peak of this bubble was 2017. At the beginning of that year bitcoin was worth about $1,000. By the peak it was worth almost $20,000. During that year alone it went up by 20X. This had nothing to do with fundamentals. It was not becoming a bigger means of payment. It was not becoming a better unit of account. It was not becoming a more stable store of value. It was simply that suddenly there was a lot of buzz about bitcoin. Typical bubbles in the late stage become exponential because people — usually smaller retail investors — discover the bubble and buy in due to intense FOMO (fear of missing out). When you have insiders selling at inflated prices to outsiders who are clueless, that's the peak of a typical bubble. Isaac Newton lost his shirt by investing late in the South Sea Bubble — just to give you an example showing that even very, very smart people can be taken by the frenzy and the mania of asset prices rising because everybody else is buying. And here we are talking about people not nearly as sophisticated as Newton.