A lottery instead of a currency
Jan 2023
A lottery instead of a currency
Regulators should deflate the crypto bubble by treating cryptocurrencies like a lottery. That would be a signal to the markets that profits and returns are risky at best in this segment. A commentary by Joachim Voth.
This article was originally published in the newspaper «Finanz und Wirtschaft» on 20 December 2022. Translated and edited for layout purposes by the UBS Center.
At first, only a few people had even heard of cryptocurrencies - those digitally generated, "currencies" that are only electronically available, of which there are more than 10,000 different types. For a while, enterprising investors and media celebrities kept creating new "coins" at a rapid pace. In the years from 2015 onward, the word spread faster and faster: big profits awaited even small investments.
For example, an investor who bought Bitcoin in December 2015 would have made a profit of 5000% today, turning €10,000 into just under 400,000. That is significantly less than the 1.5 million that this happy investor could have called his own a year ago, but few investments have performed so profitably in the past seven years.
Cryptocurrencies generally have a decentralized register of owners and are often "mined" by solving mathematical problems on computers. The transfer and exchange of currency units is secured using cryptological keys. Later entries in the register validate earlier entries, which is designed to preclude manipulation ("blockchain"). Since the issuance of new currency units is limited, inflation remains under control quasi-mechanically; this is an important intention behind the currency.
Regulators should deflate the crypto bubble by treating cryptocurrencies like a lottery. That would be a signal to the markets that profits and returns are risky at best in this segment. A commentary by Joachim Voth.
This article was originally published in the newspaper «Finanz und Wirtschaft» on 20 December 2022. Translated and edited for layout purposes by the UBS Center.
At first, only a few people had even heard of cryptocurrencies - those digitally generated, "currencies" that are only electronically available, of which there are more than 10,000 different types. For a while, enterprising investors and media celebrities kept creating new "coins" at a rapid pace. In the years from 2015 onward, the word spread faster and faster: big profits awaited even small investments.
Joachim Voth, UBS Foundation Professor of Macroeconomics and Financial Markets
Dream of the brave new world
Many of the early investors, who often became very rich very quickly, believed that cryptocurrencies offered the promise of a new financial system without central banks and without government supervision. Their vision was that the brave new world of cryptocurrencies would soon sweep away the old one, consisting of paper money, coins, and state-controlled banks. This idea won many supporters.
Cryptocurrencies have become a retail product over the past five years. Financial websites regularly show prices of Ethereum and Bitcoin alongside the indices of the world's major stock exchanges, and the asset management industry recently began seriously considering whether crypto might not represent a new asset class in its own right, on a par with equities and bonds. The major U.S. broker Fidelity recently unveiled a study showing that more than half of institutional investors invest in digital assets. Despite recent turbulence, the total value of all cryptocurrencies still stands at $850 billion.
In view of this huge upswing, many observers are tempted to consider the scandals surrounding the crypto platform FTX in the Bahamas and its founder Sam Bankman-Fried as minor slip-ups in a new technology. More likely, however, the gigantic fraud and misappropriation of customer funds spell the beginning of the end for cryptocurrencies. To be clear, fraud exists in many asset classes, and stock investments have not disappeared, despite Bernie Madoff. But the unending scandals surrounding cryptocurrencies highlight fundamental weaknesses in their design.
Many of the early investors, who often became very rich very quickly, believed that cryptocurrencies offered the promise of a new financial system without central banks and without government supervision. Their vision was that the brave new world of cryptocurrencies would soon sweep away the old one, consisting of paper money, coins, and state-controlled banks. This idea won many supporters.
Cryptocurrencies have become a retail product over the past five years. Financial websites regularly show prices of Ethereum and Bitcoin alongside the indices of the world's major stock exchanges, and the asset management industry recently began seriously considering whether crypto might not represent a new asset class in its own right, on a par with equities and bonds. The major U.S. broker Fidelity recently unveiled a study showing that more than half of institutional investors invest in digital assets. Despite recent turbulence, the total value of all cryptocurrencies still stands at $850 billion.
Only three reasons to buy
Unlike stocks and bonds, cryptocurrencies do not generate interest or dividends. This leaves only three remaining logical reasons why someone would buy them: transactional utility, the benefit of a "safe haven" in bad times, and resale value.
Transactional utility is the core function of a currency - euros, dollars, and Swiss francs are just printed pieces of paper where value is created by the fact that they can be exchanged for desirable goods. But that is rarely the case with cryptocurrencies; neither dinner at the restaurant nor the used car at the dealership can be bought using Bitcoin and Co. Cryptocurrencies are almost completely absent in daily transactions. Even so-called stable coins like Luna and Tether, whose value is supposed to be fixed relative to traditional currencies, have floundered recently because they ultimately cannot guarantee the fixed link to a legacy currency. Cryptocurrencies are really only useful for illegal transactions. Because cryptocurrencies are difficult to trace, they are popular with drug traffickers, money launderers, gun runners, and extortionists.
There is also a lack of value protection. Cryptocurrencies have tended to run with stock prices instead of rising when the latter fall. In addition, crypto exchanges have been repeatedly hacked, and billions in currency have simply disappeared. Crypto is sometimes compared to gold, but it’s no good for jewelry, nor does it dampen portfolio fluctuations.
What remains is the potential advantage of selling to third parties. Buy low today, and sell high tomorrow – that has indeed been the strategy of many investors in recent years. The American financial historian Charles Kindleberger defined speculative bubbles in precisely this way: a commodity whose only benefit is that it can possibly be sold to someone. These bubbles have been numerous in the long years of low interest rates, and crypto is perhaps the purest form of a bubble. The only effective “use case” is illegal transfer of funds; everything else is either worthless or meaningless. The idea of using blockchain to trigger secure and automated transactions is attractive, but despite all of the investment in the sector, there is no apparent technical breakthrough that would be superior to traditional clearing houses.
Unlike stocks and bonds, cryptocurrencies do not generate interest or dividends. This leaves only three remaining logical reasons why someone would buy them: transactional utility, the benefit of a "safe haven" in bad times, and resale value.
Transactional utility is the core function of a currency - euros, dollars, and Swiss francs are just printed pieces of paper where value is created by the fact that they can be exchanged for desirable goods. But that is rarely the case with cryptocurrencies; neither dinner at the restaurant nor the used car at the dealership can be bought using Bitcoin and Co. Cryptocurrencies are almost completely absent in daily transactions. Even so-called stable coins like Luna and Tether, whose value is supposed to be fixed relative to traditional currencies, have floundered recently because they ultimately cannot guarantee the fixed link to a legacy currency. Cryptocurrencies are really only useful for illegal transactions. Because cryptocurrencies are difficult to trace, they are popular with drug traffickers, money launderers, gun runners, and extortionists.
It is not innovation
Why do financial regulators and central banks sit idly by and watch the crypto fraud and wealth destruction? While ever-smaller amounts of cash are criminalized, ostensibly to curb money laundering, regulators have largely left crypto unsupervised so as not to "stifle innovation." Regulatory policies with an eye on fads and false hurrahs for all things new and technical on social media have left many, often poorer, investors out in the cold.
Recently, some of the big investors in crypto assets have been calling for more regulation to make the market more transparent and fairer. This call is not without irony - after all, crypto was supposed to establish a brave new world beyond national authorities and legal rules, where everything runs automatically, high-tech, and efficiently. The only kind of regulation that makes sense is to treat crypto like any other game of chance.
Anyone can go to the casino to have fun and lose money for the most part. Every developed country restricts and regulates access to gambling in order to avoid excesses. In the same way, crypto should be brought under control, and by treating it like gambling or any other lottery game, a clear signal would be sent to investors that should not hope for solid, long-term returns.
Why do financial regulators and central banks sit idly by and watch the crypto fraud and wealth destruction? While ever-smaller amounts of cash are criminalized, ostensibly to curb money laundering, regulators have largely left crypto unsupervised so as not to "stifle innovation." Regulatory policies with an eye on fads and false hurrahs for all things new and technical on social media have left many, often poorer, investors out in the cold.
Recently, some of the big investors in crypto assets have been calling for more regulation to make the market more transparent and fairer. This call is not without irony - after all, crypto was supposed to establish a brave new world beyond national authorities and legal rules, where everything runs automatically, high-tech, and efficiently. The only kind of regulation that makes sense is to treat crypto like any other game of chance.
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Unlike stocks and bonds, cryptocurrencies do not generate interest or dividends.
Joachim Voth
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UBS Foundation Professor of Macroeconomics and Financial Markets
Joachim Voth received his PhD from Oxford in 1996. He works on financial crises, long-run growth, as well as on the origins of political extremism. He has examined public debt dynamics and bank lending to the first serial defaulter in history, analysed risk-taking behaviour by lenders as a result of personal shocks, and the investor performance during speculative bubbles. Joachim has also examined the deep historical roots of anti-Semitism, showing that the same cities where pogroms occurred in the Middle Age also persecuted Jews more in the 1930s; he has analyzed the extent to which schooling can create radical racial stereotypes over the long run, and how dense social networks (“social capital”) facilitated the spread of the Nazi party. In his work on long-run growth, he has investigated the effects of fertility restriction, the role of warfare, and the importance of state capacity. Joachim has published more than 80 academic articles and 3 academic books, 5 trade books and more than 50 newspaper columns, op-eds and book reviews. His research has been highlighted in The Economist, the Financial Times, the Wall Street Journal, the Guardian, El Pais, Vanguardia, La Repubblica, the Frankfurter Allgemeine, NZZ, der Standard, der Spiegel, CNN, RTN, Swiss and German TV and radio.
UBS Foundation Professor of Macroeconomics and Financial Markets
Joachim Voth received his PhD from Oxford in 1996. He works on financial crises, long-run growth, as well as on the origins of political extremism. He has examined public debt dynamics and bank lending to the first serial defaulter in history, analysed risk-taking behaviour by lenders as a result of personal shocks, and the investor performance during speculative bubbles. Joachim has also examined the deep historical roots of anti-Semitism, showing that the same cities where pogroms occurred in the Middle Age also persecuted Jews more in the 1930s; he has analyzed the extent to which schooling can create radical racial stereotypes over the long run, and how dense social networks (“social capital”) facilitated the spread of the Nazi party. In his work on long-run growth, he has investigated the effects of fertility restriction, the role of warfare, and the importance of state capacity. Joachim has published more than 80 academic articles and 3 academic books, 5 trade books and more than 50 newspaper columns, op-eds and book reviews. His research has been highlighted in The Economist, the Financial Times, the Wall Street Journal, the Guardian, El Pais, Vanguardia, La Repubblica, the Frankfurter Allgemeine, NZZ, der Standard, der Spiegel, CNN, RTN, Swiss and German TV and radio.