Don't be so Quick to Write Off Crypto: An Open Letter to Paul Krugman

By Marianne White


Famed Nobel economist Paul Krugman wrote an op-ed piece in the New York Times titled “Transaction Costs and Tethers: Why I’m a Crypto Skeptic” laying out in detail his issues with cryptocurrencies. Krugman’s arguments present two challenges with cryptocurrencies - transaction costs and the lack of tethering. He went on to say that despite cryptocurrencies’ innovative technologies, it has “set the monetary system back by 300 years.” Krugman has been a vocal critic of this digital currency from the beginning. While Krugman’s opinion is highly respected and deservedly so, his recent articles surrounding crypto only seem to cudgel bitcoin and neither closely evaluate nor contest any of its details. This article proved no different. Because of his notoriety, his arguments deserve thorough consideration to gain a better understanding of the potential problems with cryptocurrencies, but with the caveat that perhaps he is simply wrong.

The first issue that Krugman describes is transactional costs and the value this brings to any monetary system. Krugman lays out a brief and generalized overview of money’s history. First, there were gold and silver coins which were heavy and required a lot of resources both in actual material resources and the people to go mine them. Banknotes alleviated most of these resource costs and were followed by checks which reduced those costs even further. Credit cards came after that, and so on. These strides taken within the financial system have created “near-frictionless transactions.” He then goes on to say that he cannot understand the hype over cryptocurrencies as “transferring a Bitcoin or other cryptocurrency unit requires providing a complete history of past transactions.” This argument however reads a bit clumsy to anyone familiar with anything in the crypto-world. The ability and access to view the entire blockchain’s transaction history is a means to keep the coin’s decentralized nature, and has nothing to do with the utility of cryptocurrencies nor the cost of sending one. Further, Krugman’s assumption of the “ideal monetary system” of fiat currencies is interesting, considering people are seeing quite the opposite with the 2008 housing bubble and more recently the collapse of Lehman Brother bank to name just a few examples. Banks cannot always be trusted to which the entire concept of the first cryptocurrency - Bitcoin - was founded.

The question of legitimacy of cryptocurrency is another argument that Krugman uses. He writes “you’re supposed to be sure that Bitcoin is real without knowing who issued, it, so you need the digital equivalent of biting a gold coin to be sure it’s the real deal, and the costs of producing something that satisfies that test have to be enough to discourage fraud.” The part about costs needing to be high enough to discourage fraud, after Krugman established one of the failures of cryptocurrency is it’s high cost, will be ignored. The first piece of figuring out if Bitcoin is real is an argument for the legitimacy of everything on the internet. FaceBook, YouTube, and Twitter may seem as though they have a tangible life of their own; however, these digital platforms have no tangible product to sell. Furthermore, the location or person of which the Bitcoin was received is about as relevant to Bitcoin’s utility as knowing the person who printed the dollar bills sitting in people’s wallets or where the diamond for an engagement ring came from.

He continues to write, “Conventional money generally does its job quite well…. Indeed, eight years after Bitcoin was launched, cryptocurrencies have made very few inroads into actual commerce.” Perhaps after being a Nobel economist after so long, Krugman might need a refresher on the history of paper money in the U.S. 1690 was the first year paper money was introduced to the United States from the Massachusetts Bay Colony. After nearly one hundred years, and a civil war, the U.S. government introduced the concept of paper notes based on their holdings of government bonds. Bitcoin has been around for eight years and it was the first of its kind. Denouncing one currency because it isn’t as mature as another which has been in place since 1863, seems like a banal argument especially in congruence with his statement that while cryptocurrency is not being used for utilities, it is being used for “...drugs, subvert elections, and so on.”

The second major issue that Krugman delivers is that of the tether that ties a currency to the real economy. He goes into detail about the ability for both gold and the dollar bill to have these tethers because there is a force, namely the government, that provides them and the enforcement to keep that value. He summarizes it elegantly: “Fiat currencies have underlying value because men with guns say they do. And this means that their value isn’t a bubble that can collapse if people lose faith.” Is that completely true? Going back to the 2008 housing bubble and collapse, the value of the dollar was significantly impacted. Consumer confidence in banks was at an all time low due to record losses in the US stock market. The unemployment rate doubled which caused consumer spending to go way down and the national debt increased from 63% to over 103% in just under four years.

Krugman continues, “cryptocurrencies, by contrast, have no backstop, no tether to reality. Their value depends entirely on self-fulfilling expectations...If spectors were too have a collective moment of doubt, suddenly fearing that Bitcoins were worthless, well, Bitcoins would become worthless.” If the country runs with a capitalist economy, that is always going to be the case. The market dictates the price it's willing to pay for an asset. Take Facebook for example - Facebook has over 750 million users worldwide. Recently though, with the introduction of Twitter, Instagram, SnapChat, etc, people have many more options to stay connected with family and friends. Facebook lost 2.5 million users under the age of 20 last year, and it has been predicted they will lose more in the future. Either the currency will be able to come back, or it won’t, but the same can be said for anything including the current monetary system we have now.

Cryptocurrency is likely to be worthless in the future; Krugman predicts, and continues with “once the dream of a blockchain future dies, the disappointment will probably collapse the whole thing.” Could Krugman be right about the inevitable collapse of Bitcoin? In 1998, Krugman famously predicted: “By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s.” When asked about the huge rise of communication networks in the early 2010’s, Krugman, again, predicted they would fail because, “most people have nothing to say to each other.” Only time will tell if this prediction of cryptocurrencies will come true, until that time, perhaps don’t empty out all of the Bitcoin wallets just yet.