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Memo to Krugman: 7 Problems Cryptocurrency Solves

[ Read on Medium ]

Paul Krugman took time out from his European vacation to write why he’s a cryptocurrency skeptic. This is not surprising given who he is and what his positions have been over his career. Most of the orthodox criticisms against cryptocurrency  I covered previously in my “This Time is Different: What Bitcoin Isn’t” and “What Bitcoin Actually Is” series. But it’s worth recounting how one could easily take many of these criticisms against Bitcoin, search and replace “bitcoin” or “cryptocurrency” for “US dollar” and come out with are more applicable criticism of the modern fiat money system.

“Cryptocurrencies, by contrast, have no backstop, no tether to reality. Their value depends entirely on self-fulfilling expectations — which means that total collapse is a real possibility. If speculators were to have a collective moment of doubt, suddenly fearing that Bitcoins were worthless, well, Bitcoins would become worthless.”

This is more or less a truism that can be said about any fiat currency. Krugman seems to not notice, or care, that for most of recorded history, most currencies were either hard currencies (gold, silver, etc) or hard backed. Elastic, fiat currency, worldwide has only been around since the 70’s, and here’s Krugman complaining that it’s Bitcoin that has a tethering problem (or lack thereof). Further,

“In normal life, people don’t worry about where the value of green pieces of paper bearing portraits of dead presidents comes from: we accept dollar notes because other people will accept dollar notes. Yet the value of a dollar doesn’t come entirely from self-fulfilling expectations: ultimately, it’s backstopped by the fact that the U.S. government will accept dollars as payment of tax liabilities — liabilities it’s able to enforce because it’s a government.”

But people do lose faith in both currencies and governments. There have been 21 hyperinflations over the last 25 years.

It’s happening right now in Venezuela, where the inflation rate is on track to hit 1,000,000% by the end of the year, and Turkey may be next up.

Cryptocurrencies, meanwhile, are tethered to math. While in Krugman’s own words, fiat currencies can be created out of nothing:

“Instead of money created by the click of a mouse, we have money that must be mined — created through resource-intensive computations.”

Yes, that is entirely the point. In a recent Peak Prosperity podcast Chris Martenson quoted Charlie Munger’s observation:  “show me the incentives and I’ll show you the outcome”.

Krugman wonders “What problem does [Bitcoin] solve? I have yet to see a clear answer to that question.” Maybe we can clarify things by starting with the outcome: the fact that cryptocurrencies are here and as the data shows, steadily gaining traction, and then work backwards. (By gaining traction I’m not even talking about price action of any given cryptocurrency, I mean usage-based metrics like transaction volume, active addresses, hashing power, etc)

Via https://medium.com/@mccannatron/12-graphs-that-show-just-how-early-the-cryptocurrency-market-is-653a4b8b2720

When we work backwards we can arrive at what the incentives were that gave rise to this phenomenon. When we do so we’ll understand that they didn’t spontaneously arise out of whim, they came about for a reason, and those reasons are the problems that crypto solves.