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Did the Coal-Mine Canary Just Byte the Dust? 

NOTHING EXEMPLIFIES today’s progressive abstraction of reality and value  better than bitcoin–or say better than cryptocurrencies (bitcoin is the largest of many).   Over the last few hundred years, systems for a medium of exchange (and store of value, etc.) went from physical gold and silver coins to paper currency (notes) that did represent some quantity of a valued commodity (e.g. pound sterling or gold standard US dollar) to a completely confidence-based currency (“fiat” currency e.g. most world currencies today) to bitcoin (a unique algorithm among a finite supply of them).

As I looked back on the economics class I taught about five or six years ago where we talked about bitcoin, then priced at a few hundred dollars, we acknowledged how bitcoin checked most of the boxes in the requirements of a currency.  First, it had to have some rarity. Bitcoin did: each algorithm was unique and the supply was to be controlled in a pre-specified way. Next, a currency should require an amount of work that would represent commensurate value. For example, in a rich mining claim it takes the filtering of a ton of ore to yield half an ounce of gold. With bitcoin,  a bank of computers runs for weeks hoping to “mine” one bitcoin.  Then there was the idea of duplication: bitcoin is difficult to counterfeit, though early hacking or crashes did disrupt early cryptocurrency efforts. And a currency should be widely agreed upon as having value. Not only is bitcoin quite widely accepted now, it’s been a source of private wealth, hidden from eyes of all kinds–and up till recently it was thought you could even evade the taxman with it.

Lastly a good “commodity” currency should have value in and of itself: gold has some commercial value in dentistry and jewelry. It’s a good conductor of electricity, it doesn’t rust, and it’s malleable. Yet though the shipwreck that stranded Robinson Crusoe included a chest with quite a wealth of gold doubloons, he had little interest in them as they offered no sustenance at all.

Poor bitcoin serves no purpose at all other than as a symbol, as an abstraction.

So as a class we reviewed the burgeoning commitment of human affairs to the digital world. Banking, dating, storing records, pictures, information. In a word, the digital or virtual reality had  been granted a sizable amount of TRUST.  Critics asked why bitcoin should be worth anything when it was for all intents and purposes “intangible.”  But how tangible is the US dollar? –It’s not backed by anything tangible: only by consensus does it have value.

TRUST.

Onward to the canary. ..

The price of bitcoin hit about $58,00o recently, up in price by almost 200 times from when the class and I discussed it. There are a lot of possible explanations for the tremendous rise, but that is not the reason for this post. The bigger question is whether the even more recent plunge of about 40% is a sign that risk is going out of fashion quickly. The other concern is that while a commodity like that is rising, it creates paper wealth–which might be invested in or spent on other things that might have to be sold if bought with debt. But the drop destroys wealth. Bitcoin alone was worth over one trillion $US at the higher levels. If you include the other “cryptos”–which plunged as well–you have a tremendous loss of wealth.

Bubbles, manias, panics are all emotion-driven events. Risk can seem as if it were a thing of the past one week, only to find the next week that everywhere you look, risk is staring you in the face. I didn’t write this to pan bitcoin or any other crypto. I only wonder if the bitcoin crash–and it is a crash–will change the perception of risk in months to come.

In looking for evidence of a market top, the bitcoin event might be viewed as one piece of evidence along with ultra high  levels of borrowing (margin) to buy stock and any reduction (tapering) of the  Federal Reserve  $120 billion monthly QE. There are of lot of other variables, but these are three that have my attention right now.

WRH