Paul Krugman, 2008 Nobel Prize-winning economist and columnist for the New York Times, recently published a contribution detailing why he believes Bitcoin is going to “set the monetary system back 300 years.”
Krugman points out several reasons as to why cryptocurrency, (and Bitcoin specifically) will not take off as a viable payment source amongst the mainstream population.
The economist’s fundamental question is: what problem does cryptocurrency solve?
Firstly, it’s important to consider the efforts devoted by some of the world’s most talented and expert developers into solving high transaction costs. The Lightning Network, is a proposed solution that directly addresses the issues of instant payments, scalability, and high transactions costs. By creating a “second layer” or “sidechain” on top of the Bitcoin Core protocol, it allows a higher frequency of peer-to-peer transactions to occur in a series of subsidiary blockchains, which will then be broadcasted to the parent blockchain. Additionally, there are multiple emerging platform blockchain protocols that also address the inefficiencies of nodes having to download entire ledgers every time. Cardano, (among many other emerging blockchain protocols), aims to use compression, pruning, and partitioning to spread different parts of processing and storage amongst different nodes as the blockchain grows from MB to GB to TB, etc.
Secondly, with regards to banks and their propensity to preserve their reputation with governments and respective nation-populations, there’ve been recent instances where that hasn’t been the case. Currently, Venezuela is currently undergoing a severe humanitarian crisis caused by hyperinflation. With almost 90% of its population living in dire poverty, cryptocurrency has provided a way out for Venezuelans to obtain basic necessities such as food and medical supplies. One particular cryptocurrency, NANO, (targeting those looking to engage in micropayments), played a huge role in providing sustenance for a local Venezuelan community. After posting on Reddit about his community’s dire circumstances, user “Windows7733” received around 230 Nano ($600 USD) in donations from the NANO community, which enabled him to purchase over 224.4 pounds of food and additional medical support. The significance of this transaction lies within cryptocurrency’s ability to bypass restrictive, suppressive and/or ineffective governments, central banks, and financial institutions.
Thirdly, Krugman makes the argument that there is no physical tether to cryptocurrency, whereas the US dollar is backed by the US government’s acceptance of dollars as payment of tax liabilities, enforceable because the US is a government. Gold, according to Krugman, holds value because enough people believe it possesses value. But isn’t that latter argument the fundamental reason why anything holds value? If we take a minute to travel back in time, paper currency was once an outrageous idea, as merchants and authorities argued against it because of potential counterfeiting. Additionally, it did not hold the physical weight and feel to that of metal coins. But paper money eventually caught on because it could be mass produced and was easily transportable. Currently, only 10% of the world’s circulating US dollars are denominated in physical notes and coins. The world’s circulating currencies are by-and-large already digitized, no longer backed by a physical commodity, (like gold.) With consideration to the speculative nature of the cryptocurrency market, Bitcoin’s current valuation is largely derived by the individuals around the world who believe it has value. The fascinating thing about it is that many’ve predicted Bitcoin’s downfall since inception, but its price has steadily increased over time. Now Silicon Valley VC firms and Wall Street banks are pouring astronomical amounts of liquidity into it; it’s not just the little leagues who believe in its long-term value.
That brings us to Krugman’s final question: what problem does cryptocurrency solve? Cryptocurrency, in the long-term, will introduce a new economic paradigm that enables individuals all over the world to build and participate in a number of culturally-and-functionally-idiosyncratic virtual economies. That isn’t to say that financial institutions or governments will completely disintegrate- but the individual will feel just a bit more empowered.