Goldman Sachs interviews Dr. Doom Nouriel Roubini: Bitcoin and other cryptocurrencies are not assets

Translation: Liu Bin, Director of the Financial Research Office of China (Shanghai) Free Trade Zone Research Institute

Note: This article is for reference only. If reprinted, please indicate the source!

Original title: "Cryptocurrency: A new asset class? — Goldman Sachs report interviews Dr. Doomsday Roubini"

Nouriel Roubini is a professor of economics at New York University's Stern School of Business. He is CEO of Roubini Macro Advisors LLC, a global macroeconomic consulting firm. Below, he discusses his skepticism about the value of cryptocurrencies and their ability to revolutionize the financial system.
Allison Nathan is an analyst at Goldman Sachs

Allison Nathan: Why do you think there is a bubble in Bitcoin and other cryptocurrencies?

Nouriel Roubini: First, calling them currencies is a misnomer. A currency must have four characteristics: it must be a unit of account, a means of payment, a stable store of value, and serve as a single unit of account. Bitcoin and most other cryptocurrencies do not have these characteristics. It is not a unit of account; nothing is priced in Bitcoin. It is not a scalable method of payment; the Bitcoin network can only process 7 transactions per second, while the VISA network can process 65,000 transactions per second. It is not a stable store of value for goods and services; even conferences I have attended in the cryptocurrency space do not accept Bitcoin payments because price fluctuations could wipe out their profit margins overnight. The cryptocurrency world does not provide a single unit of account in which the prices of different items can be named, because there are thousands of tokens and therefore limited price transparency. Even primitive times had a more complex system using shells as a single unit of account to compare the prices of different goods.

Bitcoin and other cryptocurrencies are not assets either. Assets have some cash flow or utility that can be used to determine their fundamental value. Stocks provide dividends that can be discounted to arrive at a valuation. Bonds provide coupons, loans provide interest, and real estate provides rent or housing services. Commodities like oil and copper can be used directly in different ways. Gold is used in industry, jewelry, and has historically been a stable store of value against a variety of tail risks, including inflation, currency debasement, financial crises, and political and geopolitical risks. Bitcoin and other cryptocurrencies have no income or utility, so there is no way to arrive at a fundamental value. A bubble occurs when the price of something is far above its fundamental value. But we can't even determine the fundamental value of these cryptocurrencies, and yet their prices have risen dramatically. In that sense, this looks like a bubble to me.

Allison Nathan: If there is a bubble, why are more institutions interested in getting involved in cryptocurrencies? Will this help stabilize and authenticate the market?

Nouriel Roubini: Because of the high volume, it is worthwhile to facilitate trading activities, custody services, etc. But do institutional investors really want to get more involved? Maybe some will, but I don't think it will become mainstream. There is an argument that since only a small portion of institutional money is currently invested in Bitcoin relative to gold, the price of Bitcoin could surge due to asset reallocation from gold. But I doubt that institutions want their asset exposure to drop by 15% overnight. There is also a risk that investments backed by real assets will eventually replace Bitcoin as an alternative store of value. Bitcoin may disappear one day, but gold will not. The idea of ​​corporate treasurers investing in crypto assets is completely crazy. No serious company would do that because treasury accounts must be invested in stable assets with minimal risk, even if they have very low returns. Any treasurer who invests in something that drops in value by 15% overnight will be fired. Of course, Elon Musk can do this because he is the boss, although he later gave up on Bitcoin to some extent due to environmental issues. But few people are in that position.

Allison Nathan: But didn’t gold also have a period of high volatility before it matured as an institutional asset?

Nouriel Roubini: While gold has experienced periods of volatility, a range of economic fundamentals generally drive price movements. Gold rises with inflation and inflation expectations because it is an inflation hedge, and falls when the Fed tightens monetary policy and interest rates rise, not just in nominal terms but in real terms for the same reasons. Gold moves inversely to the value of the dollar because a falling dollar leads to higher production costs and prices for commodities, including gold. When there are serious political or geopolitical risks or financial crises, the value of gold rises because it is a safe haven asset, as do the Swiss franc, the Japanese yen, and U.S. Treasuries. A whole set of variables can be used to determine the demand for gold relative to its supply, which makes it possible to establish a fundamental price. In contrast, the price of Bitcoin and other cryptocurrencies has no consistent relationship to economic fundamentals, which explains their volatility or suggests that it will eventually fade.

Allison Nathan: But since Bitcoin doesn’t have the risk of currency debasement, can’t it be used as an inflation hedge like gold?

Nouriel Roubini: It is true that inflation and inflation expectations have risen, the dollar has begun to weaken, and the breakeven point in the U.S. is now well above 2%. But while the prices of gold and other inflation hedges have reflected these changes to some extent, at its peak, the price of Bitcoin rose more than 10 times from a low of $5,000 to more than $60,000 in a year. This cannot be explained by concerns about currency debasement, because if there were such strong concerns, gold and other assets such as TIPS would probably rebound more. Therefore, the rise in Bitcoin and other crypto prices must be caused by other factors.

Does Bitcoin offer protection against devaluation? At least in the cryptocurrency world, it can’t, because cryptographic rules dictate supply increases and limit the total supply to 21 million. But just because something is scarce doesn’t mean it has fundamental value. It’s not hard to create something with a limited supply, and there’s no reason artificial scarcity should be valuable.

With the exception of Bitcoin, the supply of most cryptocurrencies is determined by a group of whales and insiders based on random rules that can be used to temporarily increase the supply. Given the explosion in the number of token types, their supply is actually growing at a much faster rate than any central bank balance sheet. Scarcity also does not make something a reliable store of value. It took a hundred years for the dollar to actually lose 90% of its value. In 2018, it took only 12 months for thousands of cryptocurrencies to lose the same amount of value, and even Bitcoin fell by more than 80%. That's devaluation.

Bitcoin is not even a reliable hedge against risk events, let alone inflation shocks. It is in fact highly procyclical. At the peak of the COVID-19 shock in early 2020, the U.S. stock market fell about 35%, but Bitcoin plunged about 50%. The other top ten cryptocurrencies fell even more. Crypto assets don't go up in difficult times; they also fall sharply. If investors want inflation hedges, a wide variety of assets have proven to be good inflation hedges over the decades, including commodities and their stocks, gold, TIPS, inflation-adjusted bonds and other forms of inflation-indexed bonds. I do worry that monetized deficits may eventually lead to fiscal dominance and higher inflation. But I don't recommend using Bitcoin or other cryptocurrencies to protect against this risk.

Allison Nathan: Nascent technologies are often shaky in their adoption phase. What makes this cryptocurrency different from the early days of the internet?

Nouriel Roubini: Bitcoin has been around for more than a decade, and it is nowhere near as transformative as the Internet was during the same period. In a decade, the World Wide Web has had about a billion users. While it is difficult to know the total number of cryptocurrency users today, the most traded cryptocurrencies probably have as many as 100 million active users. Cryptocurrency trading has grown more slowly than the Internet, transaction costs are still high, and mining as a percentage of total transactions is still high. After a decade of Internet development, email, millions of useful websites and applications, and technologies with wider applications like TCP and HTML protocols have emerged. In the case of cryptocurrencies, there are so-called “decentralized applications”, but 75% of decentralized applications are games like CryptoKitties or pyramid or Ponzi schemes. The other 25% are “DEXs”, decentralized exchanges, which currently have almost no trading and liquidity. So the comparison with the Internet does not ring true.

Allison Nathan: However, isn’t there value in the concept of a decentralized ledger and network?

Nouriel Roubini: I'm not sure it exists, but the fact is that the crypto ecosystem is not decentralized. Mining oligarchs basically control about 70-80% of Bitcoin and Ethereum mining. These mines are located in places like China, Russia, and Belarus, which are strategic adversaries of the United States and have different rule of law. That's why the US National Security Council has started to worry about the risks it could bring to the United States. 99% of crypto trading happens on centralized exchanges. Many cryptocurrencies also have a centralized core group of developers who are the police, judge, and jury whenever there is an update or conflict on the blockchain. In these cases, the rules that were assumed to be fixed have changed. So blockchain is not immutable.

There is evidence that ownership of crypto wealth is also highly concentrated. According to CoinMarketCap, less than 0.5% of addresses own about 85% of all Bitcoin. There is also evidence that whales holding large amounts of Bitcoin and other cryptocurrencies actively manipulate prices. Thousands of news articles detail active manipulation in the form of pump and dumps, spoofing, wash trading, front running, and more in chat rooms. This behavior is even worse than in small-cap stocks, suggesting the likelihood of an eventual crackdown by regulators is high.

Allison Nathan: What innovations in the crypto ecosystem are promising to you?

Nouriel Roubini: No, in the next decade, there will be radical financial innovation across multiple dimensions that will disrupt the traditional financial system. But this has nothing to do with cryptocurrencies. Driving this innovation will be a revolution in financial technology, thanks to a combination of artificial intelligence, machine learning, and the collection of big data using the Internet of Things. Fintech is already transforming payment systems, lending, credit allocation, insurance, asset management, and parts of capital markets. In the context of payment systems, billions of transactions are made every day using Alipay and WeChat Pay in China, M-Pesa in Kenya and most sub-Saharan African countries, and Venmo, PayPal, and Square in the United States. These are great companies that are scalable, secure, and are disrupting financial services. They are not based on decentralized finance and have nothing to do with crypto or blockchain.

To be honest, I spent a lot of time researching this because more and more people are saying that while these may not be currencies, blockchain technology could be revolutionary. There are buzzwords like "enterprise distributed ledger technology (DLT)" or "enterprise blockchain" but I call most of these projects BINO - "blockchain in name only". Something based on real blockchain technology should be open, decentralized, permissionless and trustless. But looking at the experiments of DLT and blockchain companies, almost all of them are private, centralized and permissioned - because a small group of people have the ability to verify transactions - and most of them are verified by a trusted institution.

Even among these projects, few are actually useful. One study that looked at 43 applications of blockchain technology in the nonprofit sector for reasons ranging from banking the unbanked to issuing ID cards to refugees and sending remittances found that none of them actually worked. The fundamental problem with this entire space is that it assumes that technology can create trust. But that is an impossible task. Solving the challenge of certifying ownership or quality requires due diligence and testing. Why should I trust a DLT network when it says my tomatoes are organic? I believe Whole Foods actually tests the chemistry of tomatoes. The idea that technology can solve the trust problem is delusional. As a result, I am very skeptical that blockchain, DLT, and cryptocurrencies will be the revolutionary technologies their proponents believe them to be.

Translation: Liu Bin, Director of the Financial Research Office of China (Shanghai) Free Trade Zone Research Institute

Note: This article is for reference only. If reprinted, please indicate the source!