Jon Danielsson 01 June 2018



Cryptocurrencies promise new and better forms of money, freedom from government oversight and fabulous riches to investors.   Will they live up to the hype?

The form of money used in almost every country is fiat money. Fiat means "let it be done" in Latin. It is money that only holds its value because governments promise that it will. 

Some cryptocurrencies, starting with Bitcoin in 2009, are designed to be direct replacements of fiat money. Others, like Etherum, provide some economic function  underpinned by the integrity of cryptocurrencies. 

My aim here is not to discuss the technical details and merits of cryptocurrencies, there are many good surveys of that. This video is a good description of the technological fundamentals, although the most entertaining take is by John Oliver. Instead, my interest is in their usefulness for society at large and whether they make any sense outside of the confines of computer science.

The terminology is in some flux, with the term “cryptocurrency” usually synonymous with “virtual currency”, while “cryptoasset” is used for a subset of these. I will use cryptocurrency to refer to all of them.

The original cryptocurrency, Bitcoin, was envisioned as a replacement for fiat cash. It retains the first-mover advantage as it is most valuable of all the cryptocurrencies. The total value of Bitcoins, known as the market cap, stands at about $128 billion as of May 2018.

Bitcoin suffers from design limitations, with high transaction costs,  slow speed and privacy particularly problematic. Recent competitors, such as Bitcoin cash and Litecoin, improve efficiency. Transactions with Bitcoin are not fully private because the underlying blockchain is searchable, and other cryptocurrencies use different technologies to ensure privacy, like Monero’s ring signatures.

The visible blockchain with slow updates is what guarantees Bitcoin’s trust. Improving efficiency by speeding transactions or removing visibility reduces that trust.

With cryptocurrencies, there is a direct trust versus efficiency versus privacy trade-off.

The main competitor to Bitcoin is Ethereum, which aims to be a globally distributed computer program to execute smart contracts.

Ripple is number three, designed to be a new type of a fast payment system. To achieve this it gives up on blockchainand its native technological trust, replacing some of it with trusted institutions, typically banks.

The market cap of the top 10 cryptocurrencies on 19 March 2018

The total volume of cryptocurrencies is typically controlled by an algorithm set up so that some computationally-intensive operation is required to create new units of the currency – 'mining'. The computational problem becomes progressively harder until some other hard limited is reached, what is known as controlled supply. In the case of Bitcoin, the theoretical upper limit is almost 21 million coins, expected to be reached around the year 2140. We now have mined almost 17 million Bitcoins, or 81% of the total. Figure 2 shows the supply until now.

Bitcoin supply, 2006–2018

Most other cryptocurrencies follow a similar setup, but often with a faster mining schedule which benefits the founders and early investors. With some there is pre-mining, which erodes trust.

The controlled supply provides the main argument that cryptocurrencies actually are money. It deliberately mimics the gold-as-money debate: a cryptocurrency-based monetary system would be a modern version of the gold standard.

The cryptocurrency debate

Cryptocurrencies are increasingly controversial. While initially passing without much notice, they recently have made mainstream news and financial authorities have increasingly expressed concern.

The main arguments in favour of cryptocurrencies are typically some combination of:

1. technology
2. money
3. freedom
4. trust
5. privacy/anonymity
6. efficiency
7. the unbanked and those living in countries with crap currencies
8. there is money to be made
9. even the central banks are in on the action

1. Technology

The technologies underpinning cryptocurrencies are quite elegant, and many of those who argue against them are often called Luddites, or accused of not understanding technology. I have lost count of the number of people who have told me that the internet was misunderstood in the early 1990s, and see how big it became. It will be the same with cryptocurrencies, I just have to open my eyes. I have frequently been told that I am just too old to understand the cryptos.

An elegant technology, however, does not imply usefulness in the real world. Knowing all the technological detail does not mean you understand its economic or social function. Take, as an example, human beings. I can know all the physics and chemistry and physiology, understand how molecules and organs operate, yet still not know the first thing about an individual.

Therefore, the advocates of cryptocurrencies should show how they solve real-world social problems, and not just resort to arguing that the underlying technologies are elegant. This is just mysticism. There are several use cases for cryptocurrencies, but nothing so far that is substantial enough to justify their valuations, or supposed impact on the economy.

You might retort that cryptocurrencies can be inefficient and insecure today, without large applications, but that will improve in the future. But a marvellous technological solution for which the real benefits are promised, but not yet real, is just a pie in the sky. Otherwise flying cars, and all the similar 20th century technology promises, would be with us today.

At the end of the day, we have strong incumbent technology, fiat money. If cryptocurrencies are to gain traction, they not only have to be better IT technologies than fiat money, they also have to be better at solving real-world economic and social problems. 

2. Money

What do we need money for? The Wikipedia page on money lists:

  • medium of exchange
  • measure of value
  • standard of deferred payment
  • store of value

My list is slightly different. It encompasses the Wikipedia definition, but adds lending of last resort and the economic considerations, 21 century considerations:

  • facilitating transactions
  • storing value
  • lending of last resort
  • controlling the money supply to suit the economy

We have been debating what money is for long time. Most mainstream economists would subscribe to at least one of the lists above, but there are strong opinions to the contrary. There are two related arguments:

  • The money supply should be tied to some real good, typically gold or Bitcoin.
  • Money should not be a government monopoly. It should be created by the free market.

Over time, we have used a number of assets as money, including silver, copper, seashells, and cigarettes. The asset most associated with money is gold, and the longest period of monetary stability the world has ever seen, the gold standard of 1873 to 1914, was based on money being gold. Of course, it isn’t quite that simple as money and monetary stability in Europe, 1300-1914 show. There was plenty of room for manipulation.

So, does it make sense to use a real asset, like gold, or a cryptocurrency as money instead of fiat money?

If we really want to link money to a real asset, gold would still probably be the best choice. Many cryptocurrency advocates propose Bitcoin or something similar in its place, primarily because it supply is fixed. 

There are several reasons why fiat money is still better than either gold or cryptocurrencies.

To begin, transactions using fiat money are much cheaper and faster than any of the cryptocurrencies. Transactions with cash are costless and instantaneous, and so are many electronic transactions. (The latter of course depends on the country. Electronic transactions are much more efficient in places like China and Scandinavia than, for example, in the US or Germany. That is not a failure of fiat money, it is a failure of the financial technology used in these countries.)

Blockchain-based cryptocurrencies like Bitcoin are inherently slow if we want to trust the transaction, at least 10 minutes, or even an hour, and are not costless. Over the past eight months, (to end of May 2018) the transaction costs for Bitcoin have ranged from $0.83 to $55. If we want to speed this up or make it cheaper by switching to a different cryptocurrency, trust has to give. Meanwhile, at least here in the UK, I can transfer any amount out of my bank account to someone else instantaneously at no cost, using my mobile phone.

One example of a transaction involving cryptocurrencies is the sale of a townhouse in Manhattan.  According to its press release "A luxurious Beaux Arts townhouse at 10 East 76 th Street, Upper East Side, New York City has been listed for $29.95M USD, and 1.5 times that amount for digital currency."  The brokerage selling the property explains the crypto premium thus "The reason for the higher sale price in cryptocurrency is due to the volatility in the market, the value of which has fluctuated substantially in recent months."

What is missing is a better way to send money between countries, and for that cryptocurrencies often have the advantage. Within Europe, SEPA is already quite efficient, but outside of that one may have to use SWIFT, which is slow and expensive, and was recently hacked. However, several fintech initiatives based on fiat money aim to solve this, for example TransferWise. Solutions for international transfers are developing rapidly, eroding the advantage of cryptocurrencies.

Fiat money is much more efficient as a store of value, at least in those countries that follow sound principles of monetary policy. Yes, we expect 2% depreciation every year, but can easily get safe investments that mostly offset that. Most of the cryptocurrencies fluctuate wildly, I calculate bitcoin to be about five times as volatile as the SP-500 index. The stable cryptocurrencies, like Tether and Saga, are tied to  fiat currencies, so are no better.

The concept of money is not simple. It has multiple forms: M0 is cash, M1 is instantly available money like cash and checking accounts and M3 is a broader definition, taking in forms of money that are similar but broader (and less liquid) than M1.

While the relationship between M0, M1, M2 and M3, and in turn with their economic functions is clear with fiat money, it is not so with cryptocurrencies. Sofar, none of the cryptocurrencies advocates has really highlighted how cryptocurrencies would function in today's financial system. And to be clear, I mean economic functions and not IT functions.

The volume of money in economies with the largest money supply compared to the four largest cryptocurrencies

The volume of M1 fiat money is more than 100 times that of cryptocurrencies. If cryptocurrencies are to replace fiat money they will need to increase significantly in value. The implications of this for cryptocurrency investors and society is discussed below.

If we want to use money to make the economy work more efficiently, the supply of money needs to adjust to best facilitate economic growth. Things like gold or Bitcoin (or any of the cryptocurrencies) just don’t do that. Well-managed fiat money does.

The central banks are able to control M0, but the broader the definition of money, the less control they have. Furthermore, when we are hit by a financial crisis, people convert higher forms of money into lower forms. For example, we might not trust banks, so we cash in our savings and stuff the money under the mattress.

This leads to a reduction in the supply of money, because of how the higher forms of money are created. Suppose I put $1,000 of cash into my checking account. The bank lends $900 out of that to someone else, who keeps it in their checking account. Now the total amount of M1 is $1,900 while M0 remains at $1,000. If that loan is used to back real economic activity, like a loan to a small or medium-sized enterprise, this deleveraging will reduce economic activity.

A good example of this is of the Great Depression when we saw a rapid reduction of supply of M2, while M1 moderately increased, signalling that people were deleveraging rapidly. This significantly slowed down the economy and was one of the two main causes of the Great Depression.

The supply of money in the US in the Great Depression, 1929–1933

We have as we have seen the same on a smaller scale since 2008. At the height of the European crisis, M1 was growing rapidly while M3 was contracting.

M1 and M3 in the euro area, 2007–2014 

This is perhaps the biggest advantage of central-bank-issued fiat currency (at least when the central banks are credible) over any of the cryptocurrencies as currently envisioned. The supply of fiat money can be adjusted to best serve the economy.

Suppose then we don’t think fiat money does this well? It didn’t in the 1970s, giving us stagflation.

In a free market, the best money would win out, as eloquently expressed by Hayek’s 1977, “Free-Market Monetary System”. A good modern analysis of this is Jesús Fernández-Villaverde and Daniel Sanches, “Can currency competition work?

However, monetary policy has improved since the 1970s, and we now know that a credible central bank, with sufficient political cover, using inflation targeting, is the best way to achieve price stability and stable growth without too many deep recessions.

3. Freedom

Cryptocurrencies do promise freedom, as this article "Welcome to Liberland: the nation that Bitcoin built" stresses. This relates to ideas about self-sovereign identity.

Fiat money is controlled by the government, and governments are not shy in using their powers over money to control their citizens, and even other countries.

Therefore, for those who resent government control, forms of money that are outside of the control of government, and whose quantity and integrity are guaranteed by a technical solution, are attractive.

This is a long-running debate that predates cryptocurrencies. For example, in the US in the 19th century (witness the debate over the establishment of the Fed in 1913), and the free market monetary discussions in the 1970s.

For those to whom this matters, cryptocurrencies can make sense. This, however, is a tiny fraction of society.

Even then, I question the freedom one gets. Because even with cryptocurrencies, the governments can and will exercise control, as discussed here.

The idea that cryptocurrencies will provide freedom is just a dream. On planet Earth, it will not happen.

4. Trust

One of the most-hyped feature of cryptocurrencies is trust. Instead of untrustworthy institutions, our money and transactions are protected by an algorithm we can trust.

The use of electronic fiat money requires money to go through several systems, often starting with a payment processor, then a bank on both ends, and a payment system in the middle.

We have to trust that all these entities have our best interests at heart, and are keeping our money safe. We also have to trust the government not to confiscate or devalue our money.

Cryptocurrencies promise to replace that with algorithms (see Bitcoin security model: trust by computation). We trust the network because the interaction between market participants is protected by algorithms that are practically impossible to manipulate. If we want to hold an asset that does not require us to trust a third party, an asset that cannot be censored or confiscated, cryptocurrencies might seem an attractive way to do it.

In other words: as long as we trust the algorithm, we are safe.

But the algorithm is only the middle part of the transaction. There are a lot of practical implementation details that erode the trust.

To begin with, the mining process. We don't even know whom we are supposed to trust this week.

A tiny segment of the population is sufficiently technically adept to implement the entire thing themselves, and trust their own work. The rest of us have to rely on someone else for implementation. And then we are left with trusting unknown entities. Here is a small list of what can go wrong.

  • Front running. If we are trading cryptocurrencies there is nothing preventing the exchange from front running. It is not illegal, and it is not verifiable.
  • Cornering, though illegal in most markets, is common and legal in cryptocurrency trading.
  • Pump and dump is illegal, except for cryptocurrencies. One can even hire companies that will do pump and dump for you.
  • Hacking. The best practice in trading cryptocurrencies is to keep one’s keys on an air-gapped laptop. We are constantly hearing about people who have their money stolen, and that the various ways one transacts in cryptocurrencies are subject to hacking.
  • The intermediaries are by-and-large unknown. How do we know that the way they implement trading is not to their benefit, and not ours?
  • If something goes wrong, there is no recourse. There are no regulations, legal system or police that protect us. This is by design, because the cryptocurrencies are meant to operate outside the state. But that means less protection.

Electronic fiat money and traditional assets are of course subject to all of these to some extent, but on a much smaller scale than cryptocurrencies. We are protected by securities law, financial regulations and the legal system.

If we take elementary precautions, internet banking and electronic fiat money transactions are quite safe, and we are protected by multiple layers of security. The chance of hacking is very low and, in the event of a problem, we have recourse. I am perfectly happy to do online banking without constantly looking over my shoulders or resorting to air-gapped laptops.

The concept of trust does not only apply to the algorithm, it applies to the entire transaction. I trust my bank and my payment system much better than any cryptocurrency intermediary. So, from the point of view of trust, fiat money is much superior to cryptocurrencies.

5. Privacy and anonymity

Some cryptocurrencies, like Monero, promise privacy. I can enter into a transaction without anybody knowing about it, except myself and the person I am dealing with.

The most popular cryptocurrency, Bitcoin, does not offer this – unless I am really careful in hiding my tracks, using skills that are only available to a small group of users. The reason is that transaction records on the blockchain cannot be changed or deleted, and are therefore searchable.

However, trust is provided by the blockchain being visible. If we want purely anonymous transactions, trust has to give. The question is, to what extent?

There is no such thing as 100% privacy when it comes to financial transactions. Fiat cash is fully anonymous, but someone might be monitoring the transaction. If we move to electronic fiat money, we are subject to tracking, both by private companies and government authorities.

Same with even the most privacy-focused cryptocurrency; the starting point is the internet. This makes monitoring possible.

It is conceivable that two entities are able to conduct business by using only a privacy-based cryptocurrency, with correctly implemented end-to-end encryption and no monitoring of the exchange of goods. Even then, the transaction would have to be based on some goods that are outside of the standard economy – like illegal drugs. An advocate of cryptocurrencies might say that, in the future, we will be able to buy real goods with them. But that is not true (discussed below).

And meanwhile, while Bitcoin is the most liquid cryptocurrency, it is not what one would call 'liquid' in the sense that fiat money is. Moving to an untested and highly illiquid cryptocurrency that promises privacy and trust needs a considerable leap in faith and belief.

This is this one area in which central banks might have an advantage if they issued cryptocurrency. But I don’t think they would want it.

6. Efficiency

Some cryptocurrencies, most prominently Ethereum, the second-largest, are not really designed to be replacements for money. They provide other services.

Ethereum emphasises smart contracts, something that sounds really clever until one tries to put them in practice, when it becomes distinctively pedestrian, even the interesting ones like Saga, discussed below.  

The starting point is a distributed ledger technology, like blockchain, for holding assets. Smart contracts replace the need to employ lawyers and even third-party escrow. This can be beneficial, and is likely to be increasingly implemented, but it can certainly be done without a cryptocurrency attached. A crypto-advocate might say that trust is provided by the cryptocurrency, but there is nothing conceptually preventing us from using trusted institutions. The legal system has provided trust for centuries and is a strong incumbent technology. 

If we don’t trust institutions, we are back to debating freedom, as above.

7. The unbanked and those living in countries with crap currencies

Many advocates of cryptocurrencies argue that, while there may be little reason to move to cryptocurrencies for those living in developed countries with relatively credible central banks and governments, that does not apply to all. Some countries have unstable governments, or have large unbanked segments of the population. Cryptocurrencies may solve that problem. Often-cited examples include places like Zimbabwe. Venezuela has even created its own cryptocurrency.

In countries with high inflation, people usually seek out other currencies, typically the US dollar. Transactions might be made entirely in dollars, or prices may be quoted in dollars while transactions take place in the local currency at the spot rate. This is called dollarization, or currency substitution. I can’t see how citizens of countries with unstable monetary policy are better served by cryptocurrencies than the most widely available fiat currency, the USD, or possibly the euro.

The problem of the unbanked can also be solved by fintech, or banking via mobile phones. This solution is currency agnostic, and one can plug in any currency. The unbanked would be much better served by a stable fiat currency that is accepted everywhere, coupled with innovative fintech solutions.

8. There is money to be made

Any asset can get into a bubble. People will buy it because they expect others to pay a higher price in the future, creating a positive feedback.

A Bitcoin was worth $0.06 in 2010, and $7.527 as I write this (May 2018). So: a 15-million-percent return.

Someone who invests early and gets out in time will make money, just like an early investor in a Ponzi scheme will make money provided she gets out early.

This leaves two questions:

  • What sort of investments are cryptocurrencies?
  • Does it make sense to invest in them?

Investments like stocks and bonds have value because we have expectation of future income.

Other assets have value because we expect people to pay for them in the future.

Collectibles are of the latter category. The Wall Street Journal ran an interesting story recently Sorry, Collectors, Nobody Wants Your Beanie Babies Anymore: “Over two decades after the great Beanie Baby craze, speculators are back, hoping someone will finally buy their floppy collectibles …” 

It is the same with collecting art and stamps. Collectable stamps have scarcity value, some cost more than $200k. Just make sure to buy at the right time.

Fiat money also falls into this category. It only holds value if the central bank and the government manage it properly, and in cases where they do not, the use of fiat money can be very costly, and in extremis result in hyperinflation.

Cryptocurrencies are like stamps, fiat money and Beanie Babies, not stocks or bonds. Their price is derived from what people will want to pay in the future, not from a revenue stream.

So what is the value proposition of cryptocurrencies? Recall Figure 3 above showing that the market cap of cryptocurrencies is about 1% of money supply in the form of M1 in the four largest currency areas.  While we can debate the specifics, the 1 in 100 provides a useful first order approximation. The promise of cash replacement cryptocurrencies like bitcoin is that they will, well replace, fiat money. Based on that, bitcoin may yet increase in price by 10,000%. If bitcoin will never replace fiat money, it only has one logical terminal price, 0.

While even the most hopeful crypto currency proponents don't usually emphasise the possibility that bitcoin fully replaces fiat money, we often hear them express the hope that we will take some steps towards that. Perhaps, the central banks will start holding cryptocurrencies as reserves or large retailers, like Amazon, will start accepting cryptocurrencies for transactions. Either eventuality will of course be highly profitable to existing holders.

Sticking to my back of the envelope calculation, a risk neutral investor will hold bitcoin if she expects the chance of bitcoin replacing M1 to be higher than 1%  If not, she should sell it short, at least in theory, it is likely to be very costly in practice to short bitcoin for any appreciable time.

Suppose then that cryptocurrencies are found to be superior to fiat money and set to displace them in the free market for money. Would existing holders of cryptocurrencies profit? Highly unlikely.  That would mean a transfer in the amount of $20 trillion from regular citizens to a handful of speculators. $20 trillion exceeds the annual GDP of the US. Any government would do what it takes to prevent that eventuality. And, as I discuss below, they have the power to do so.

There are some cryptocurrencies that are special cases, like Tether and Saga. They promise price stability viz. existing fiat currencies, USD and SDR respectively. They certainly serve a useful function, facilitating transactions and providing a store for value. But only in the special case of cryptocurrencies traders. They have no useful function outside of that community. Their economic usefulness is therefore derived from other cryptocurrencies, and the valuation of Tether and Saga is therefore subject to the same caveats.

That does not mean there is not money to be made. However, one is well advised to keep the lessons from global games in mind. You can see the model in my slides on this in a currency framework here, from page 57. It can be rational to invest in an asset that we know is irrational. Just keep close attention to the time to jump. 

It is also important not to be affected by hindsight bias. Just because the price of something increased in the past does not mean that it will increase in the future. Those who have made money out of cryptocurrencies have done so out of luck, not because of anything fundamental.

A counterargument might be that the supply of cryptocurrencies is limited by costly mining and may have a fixed asymptote – just like gold. Mining is sunk cost and should not affect the value of assets, but the limit to supply is more relevant as that imparts credibility. But that is only an advantage if the alternative is unstable fiat currencies and does not apply to countries with credible and well-managed central banks.

9. Even the central banks are in on the action

Most central banks are actively studying cryptocurrencies and have even considered issuing their own. See for example the Bank of England and the more academic BIS paper “Central bank cryptocurrencies” by Morten Bech and Rodney Garratt.

Besides just keeping up with popular technology, many central banks would like to get rid of cash, like the Bank of England (or at least its chief economist). While they might think they have good reasons to do it, this is a terrible idea.

But why should a central bank issue cryptocurrency? Bech and Garratt argue that retail clients might benefit from anonymity and the ability to hold accounts directly with the central bank, while wholesale clients might benefit from increased efficiencies. Furthermore, a central-bank-issued cryptocurrency might have the advantage of a fixed supply and one-to-one convertibility to other forms of money. Such money might solve the problem of the zero lower bound. A central bank cryptocurrency would likely have the price stability that other cryptocurrencies lack. Perhaps the main benefit would be international money transfers.

All of these make sense. But most seem to be minor advantages, except for avoiding the zero lower bound, anonymity, and the broader discussion of control of money supply. (I suspect the central banks could not countenance anonymity.) Under the current system, central banks do not fully control the money supply, except M0. This is why we had all the experimental monetary policies, low interest rates and QE over the past 10 years.

So, if the central bank issues cryptocurrencies, the supply of money, in all its forms, all the way from M0 to M3, can be controlled – in theory.

This might be a good idea because, conceptually, it would give more fine-grained control of inflation, might insulate failing intermediaries in a crisis, and perhaps most importantly, would provide control of higher forms of money in a crisis when everybody is rushing to convert M3 to M0.

Except, it is more complicated than that, because trust gets in the way of the efficiency.

This is because of what happens in a crisis, as discussed above. Suppose the economy is deleveraging rapidly. Theoretically, with central-bank-created cryptocurrencies, that process could be prevented by speeding up mining. But if the central bank tried to do so, its trust would evaporate. Trying to control deleveraging in times of crisis could well end up amplifying the same crisis.

As a practical matter, a central bank issued cryptocurrency would be indistinguishable from a central bank issued fiat currency. 

The power of the government

Advocates like to emphasise that cryptocurrencies exist outside existing economic and financial structures, away from the long hand of the law. A libertarian paradise. Then, under that narrative, it is only a question of when, not if, we will be able to go about our daily economic life, buying stuff on Amazon, paying in cryptocurrency. 

I think such views underestimate both the power of the government and its strong desire for this not to happen. Governments have the power to ensure money controlled by them remains legal tender and they will certainly do so.

What might be the objections of the government to cryptocurrencies?

First, seigniorage, the profits the government gets from printing money. In Figure 3 we saw that the value of cryptocurrencies is a small fraction of the total value of money. If cryptocurrencies became real competitors to fiat money, then someone is going to make a profit. The government will want to be that 'someone'. It would be unfair otherwise.

Second, as discussed above, it is important to adjust the supply of money to suit the economy, both routinely and with lending of last resort. In order to do that, not only does the supply of money have to be variable, it also has to be under the control of the government.

Third, with all the profits made with cryptocurrencies, the government will want people to pay taxes on the profits, as this WSJ piece discusses. The US government forced Coinbase, a digital-currency wallet and platform, to turn over records on its 20 million customers: “The data include the customer’s name, taxpayer identification number, birth date and address, plus account statements and the names of counterparties.” 

I suspect other governments are not far behind. Will people be able to hide by keeping their money outside of the US? No, as discussed below.

Fourth, microprudential regulations are designed to protect consumers, and the regulators will want to extend that to cryptocurrency. For example, the US SEC has taken increasing interest, as have its counterparts in other countries.

Finally, the government wants to monitor transactions and prevent terrorists and criminals from receiving funds.

As one sometimes hears from cryptocurrencies advocates, none of this matters because cryptocurrencies live in cyberspace, outside of any government jurisdiction.


Any transaction involving fiat money is monitored and controlled by the government. If it is US dollars, transactions go through the US payment system in the New York Fed. Any entity that refuses to cooperate can be denied access to the payment system. That means it would be unable to transfer fiat money to or from cryptocurrencies, and any entity that does business with them would likewise be denied.  The US government has not been shy in taking advantage of its reserve currency powers in the past, I don't think it would be any less shy when it comes to cryptocurrencies in the future.

As long as money stays only within the cryptocurrency universe, that might not be all that relevant. However, the point of having money is to spend it. Most of our money is spent within a small radius of our house: real estate, schools, hospitals, grocery stores, hairdressers. All of these are directly monitored and controlled by government regulators. Merchants can be (and are) required to report any transaction, and can easily be prohibited from accepting payment in cryptocurrencies. Perhaps, as someone told me recently, Amazon will start to accept Bitcoin. But Amazon can easily be required to accept only national fiat money.

There is a reason why fiat money is also called “legal tender” and for governments to insist on having a monopoly on printing money.

What then?

For all its faults, I cannot see how fiat money issued by a credible central bank in the 21st century is worse than any cryptocurrency. There simply is no evidence to the contrary. Saying that fiat money is bad and therefore alternatives such as cryptocurrencies must be better does not make any sense unless one can show how. And that should be done in the context of the real world, how people actually use money, instead of some abstract theories of how we should think about money or computer algorithms.

Many of the cryptocurrency advocates who reference freedom, or trust, or theories of money, might be well advised to keep the words of John Maynard Keynes in mind:

Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.” 

We are not discussing cryptocurrencies in a vacuum. There is incumbent technology that works very well. Show how you plan to be better than fiat money, preferably without resorting to mysticism.


As I talk proponents of cryptocurrencies and read their work, I increasingly get the impression that they are not motivated by rational analysis of the world but rather by an almost religious belief that cryptocurrencies will both change the world and make them really really rich. Any counterargument therefore threatens that worldview. Discussing cryptocurrencies becomes akin to debating religion with the devout. 

It is not surprising that so much of the cryptocurrency discussion verges on this mysticism. Conventional fiat money also has mystical elements, as elegantly shown by John Moore’s Claredon Lecture “Evil is the Root of All Money”:

“[M]oney and religion have much in common. They both concern beliefs about eternity. The British put their faith in an infinite sequence: this pound note is a promise to pay the bearer on demand another pound note. Americans are more religious: on this dollar bill it says 'In God We Trust'. In case God defaults, it is countersigned by Larry Summers.”

The mysticism view is well expressed by Lou Kerner "Partner @ a community first Crypto VC. Believer that Crypto is the biggest thing to happen in the history of mankind."  expressed in an article titled "The Top 10 Reasons People Can’t See The Crypto Light".


When I wrote my first article here on VoxEU on why cryptocurrencies don't make sense, I got a lot of flack. Social media really lived up to its promise. 

I still think that cryptocurrencies are more like a religion or a cult than a rational economic phenomenon.

I still await my enlightenment. 



Topics:  Monetary policy

Tags:  cryptocurrencies, Bitcoin, fiat money

Director of the ESRC funded Systemic Risk Centre, London School of Economics

CEPR Policy Research