11/10/2018/By Nouriel Roubini
Being the Testimony for the Hearing of the US Senate Committee on Banking, Housing and Community Affairs On “Exploring the Cryptocurrency and Blockchain Ecosystem” – Crypto is the Mother of All Scams and (Now Busted) Bubbles While Blockchain Is The Most Over-Hyped Technology Ever, No Better than a Spreadsheet/Database by Nouriel Roubini, Stern School of Business, New York University, October 10, 2018
Download Full Submission Here.
Chairman Crapo, Ranking Member Brown and members of the committee, thank you for the opportunity to testify today on the topic of the Cryptocurrency and Blockchain Ecosystem.
My name is Nouriel Roubini and I am a Professor of Economics at the Stern School of Business at New York University. I am an expert of the global economy, international financial markets, asset and credit bubbles and their bust, and the related financial crises. I was one of the few economists warning about and predicting in advance the Global Financial Crisis of 2007-2009 and I am one of the leading global scholars on the topic of bubbles and financial crises. My most recent book “Crisis Economics: A Crash Course in the Future of Finance” is a seminal treatise on the topic of asset bubbles and financial crises. I have written dozens of papers and other contributions on the topic of bubbles and their bust and the causes and consequences of financial crises.
Crypto Bubble (2017) and Crypto Apocalypse and Bust (2018)
It is clear by now that Bitcoin and other cryptocurrencies represent the mother of all bubbles, which explains why literally every human being I met between Thanksgiving and Christmas of 2017 asked me first if they should buy them. Especially folks with zero financial literacy – individuals who could not tell the difference between stocks and bonds – went into a literal manic frenzy of Bitcoin and Crypto buying. Scammers, swindlers, criminals, charlatans, insider whales and carnival barkers (all conflicted insiders) tapped into clueless retail investors’ FOMO (“fear of missing out”), and took them for a ride selling them and dumping on them scammy crappy assets at the peak that then went into a bust and crash – in a matter of months – like you have not seen in any history of financial bubbles.
A chart of Bitcoin prices compared to other famous historical bubbles and scams – like Tulip-mania, the Mississippi Bubble, the South Sea Bubble – shows that the price increase of Bitcoin and other crypto junk-coins was 2X or 3X bigger than previous bubbles and the ensuing collapse and bust as fast and furious and deeper. Bitcoin rapidly exploded in 2017 from $1k to 10K and then peaked almost at $20K in December 2017 only to collapse to below $6k (down 70% from that peak) in a matter of four months and it has been close to $6k since then. And a 70% capital loss was a “good” deal compared to thousands of alt-coins (otherwise better known as shitcoins) that have lost on average 95% of their value since the peak. Actually calling this useless vaporware garbage a “shitcoin” is a grave insult to manure that is a most useful, precious and productive good as a fertilizer in agriculture.
Now that the crypto bloodbath is in full view the new refuge of the crypto scoundrels is “blockchain”, the technology underlying crypto that is now alleged to be the cure of all global problems, including poverty, famines and even diseases. But as discussed in detail below blockchain is the most over-hyped – and least useful – technology in human history: in practice it is nothing better than a glorified spreadsheet or database.
The entire crypto-currency land has now gone into a crypto-apocalypse as the mother and father of all bubbles has now gone bust. Since the peak of the bubble late last year Bitcoin has fallen by about 70% in value (depending on the week). And that is generous. Other leading crypto-currencies such as Ether, EOS, Litecoin, XRP have fallen by over 80% (or more depending on the week). While thousands of other crypto-currencies – literally scam-coins and scam-tokens – have fallen in value between 90% and 99%. No wonder as a recent study showed that 81% of all ICOs were scams in the first place, 11% of them are dead or failing while only 8% of them are traded in exchanges. And out of this 8% the top 10 coins traded – after Bitcoin – have lost between 83% and 95% of their value since peak with an average loss of over 90%. This is a true Crypt-Apocalypse. No wonder that a recent study this week argued and conclude that the crypto industry is on the “brink of an implosion”.
No asset class in human history has ever experienced such a rapid boom and total utter bust and implosion that includes thousands of different crypt-assets
Crypto is not money, not scalable
To be a currency, Bitcoin – or any crypto-currencies – should be a serviceable unit of account, means of payments, and a stable store of value. It is none of those things. No one prices anything in Bitcoin. Few retailers accept it. And it is a poor store of value, because its price can fluctuate by 20-30% in a single day. And since its price has been so unstable or volatile almost no merchant will ever use it as a means of payment: the profit margin of any merchant can be wiped out in a matter of minutes – if he or she accepts Bitcoin or any other crypto-currency –by the change in the dollar price of a crypto-currency. Proper means of payments need to have stable purchasing power; otherwise no one will ever use them.
As is typical of a financial bubble, investors were buying cryptocurrencies not to use in transactions, but because they expected them to increase in value. Indeed, if someone actually wanted to use Bitcoin, they would have a hard time doing so. It is so energy-intensive (and thus environmentally toxic) to produce, and carries such high transaction costs, that even Bitcoin conferences do not accept it as a valid form of payment. Paying $55 dollars of transaction costs to buy a $2 coffee cup is obviously never going to lead Bitcoin to become a transaction currency.
Until now, Bitcoin’s only real use has been to facilitate illegal activities such as drug transactions, tax evasion, avoidance of capital controls, or money laundering. Not surprisingly, G20 member states are now working together to regulate cryptocurrencies and eliminate the anonymity they supposedly afford, by requiring that all income- or capital-gains-generating transactions be reported. Even the US Treasury Secretary Steve Mnuchin has publicly stated that we cannot allow crypto-currencies to become the next Swiss bank account.
Since the invention of money thousands of years ago, there has never been a monetary system with hundreds of different currencies operating alongside one another. The entire point of money is that it allows parties to transact without having to barter. But for money to have value, and to generate economies of scale, only so many currencies can operate at the same time.
In the US, the reason we do not use euros or yen in addition to dollars is obvious: doing so would be pointless, and it would make the economy far less efficient. The idea that hundreds of cryptocurrencies could viably operate together not only contradicts the very concept of money with a single numeraire that can be used for the price discovery of the relative price of thousands of good; it is utterly idiotic as the use of multiple numeraires is like the stone age of barter before money was created.
Supply of crypto is massive. Bitcoin is deflationary
But so, too, is the idea that even a single cryptocurrency could substitute for fiat money.
Cryptocurrencies have no intrinsic value, whereas fiat currencies certainly do, because they can be used to pay taxes. Fiat currencies are legal tender and can be used and are used to buy any good or service; and they can be used to pay for tax liabilities. They are also protected from value debasement by central banks committed to price stability; and if a fiat currency loses credibility, as in some weak monetary systems with high inflation, it will be swapped out for more stable foreign fiat currencies – like the dollar or the euro – or real assets such as real estate, equities and possibly gold. Fiat money also is not created out of thin air: these liabilities of a central bank such as the Fed are backed by the Fed assets: their holdings of short term and longer term Treasury securities (that have near AAA sovereign credit status in the US) and holding of foreign reserves including gold and other stable foreign currencies.
The usual crypto critique of fiat currencies that can be debased via inflation is nonsense: for the last 30 years commitment to inflation targeting in advanced economies and most emerging markets has led to price stability (the 2% inflation target of most central banks) and for the last decade the biggest problem of central banks has been that achieving the inflation target of 2% after the GFC has become extremely difficult as, in spite of unconventional monetary policies, the inflation rate has systematically undershot its 2% target.
Instead 99.9% all crypto-currencies instead have no backing whatsoever of any sort and have no intrinsic value of any sort; and even the so-called “stable coins” have only partial backing at best with true US dollars reserves or, like Tether, most likely no backing at all as there has never been a proper audit of their accounts.
As it happens, Bitcoin’s supposed advantage is also its Achilles’s heel, because even if it actually did have a steady-state supply of 21 million units, that would disqualify it as a viable currency. Unless the supply of a currency tracks potential nominal GDP, prices will undergo deflation.
That means if a steady- state supply of Bitcoin really did gradually replace a fiat currency, the price index of all goods and services would continuously fall. By extension, any nominal debt contract denominated in Bitcoin would rise in real value over time, leading to the kind of debt deflation that economist Irving Fisher believed precipitated the Great Depression. At the same time, nominal wages in Bitcoin would increase forever in real terms, regardless of productivity growth, adding further to the likelihood of an economic disaster.
Worse, cryptocurrencies in general are based on a false premise. According to its promoters, Bitcoin has a steady-state supply of 21 million units, so it cannot be debased like fiat currencies. But that claim is clearly fraudulent, considering that it has already forked off into several branches and spin-offs: Bitcoin Cash and Bitcoin Gold. Ditto for the various forks and spin-off of Ether from the Ethereum cartel. It took a century for Coca Cola to create the new Coke and call the old one Coke Classic. But it took three years to Ethereum to dump the first ETH into Ethereum Classic and create and brand new spin-off, ETH.
Moreover, hundreds of other cryptocurrencies are invented every day, alongside scams known as “initial coin offerings,” which are mostly designed to skirt securities laws. And their supply is created and debased every day by pure fiat and in the most arbitrary way. So crypto-currencies are creating crypto money supply and debasing it at a much faster pace than any major central bank ever has. No wonder that the average crypto-currency has lost 95% of its value in a matter of a year.
At least in the case of Bitcoin the increase in supply is controlled by a rigorous mining process and the supply is capped – at the limit – to 21 million bitcoins. Instead, most other alt-coins starting with the leading ETH, have an arbitrary supply that was created via pre-mining and pre-sale; and the change of supply of that and thousands of other crypto-currencies is now subject to arbitrary decision of self-appointed “central bankers”.
And the biggest scam of all is the case of “stable coins” – starting with Tether – that claimed to be pegged one to one to the US dollar but are not fully collateralized by an equal backing of true US dollars. Bitfinex – behind the scammy Tether – has persistently refused to be properly audited and its creation of fiat Tether has been systematically used to prop up manipulate upward the price of Bitcoin and other crypto-currencies according to a recent academic paper.
Financial crises occurred well before fiat currencies and central banking; and are now less virulent thanks to central banks and fiat money.
Another totally false argument is that asset and credit bubbles are caused by central banks and the existence of fiat currencies. Any student of financial crises knows that asset and credit bubbles were widespread before fiat currencies and central banks were created; see for example Tulipmania, the Mississipi Bubble and the South Sea Bubble.
These bubbles and their busts were frequent, virulent and had massive economic and financial costs including severe recessions, deflations, defaults and financial crisis.
Central banks – instead – were initially created not to provide goods price stability but rather to provide financial stability and avoid the destructive bank, sovereign and currency runs that do occur when a bubble goes bust. Indeed, the Fed was created in 1913 when the last of many bubbles gone bust that had caused massive bank runs led to the realization that an institution that could provide with lender of last resort to the financial system was needed. That and the creation of deposit insurance after the Great Depression is the reason why bank runs are so rare. And the purpose of fiat currencies whose supply is regulated by credible and independent central bank is to reduce the frequency, virulence and severity of economic recessions, deflations and asset and credit bubbles gone bust. And indeed the economic and financial history of US and other countries shows that severe economic recessions, depressions, deflations and financial crises are less frequent and less costly after the creation of fiat currencies and central banks.
Crypto-currencies instead have not and will never have the tools to pursue economic and financial stability. The few like Bitcoin whose supply is truly constrained by an arbitrary mathematical rule will never be able to stabilize recessions, deflations and financial crises; they will rather lead to permanent and pernicious deflation. While the rest – 99% – have an arbitrary supply generation mechanism that is worse than any fiat currency and, at the same time, will never be able to provide either economic or price or financial stability. They will rather be tools of massive financial instability if their use were to become widespread.
The real revolution in financial services is FinTech and it has nothing to do with Blockchain or Crypto
The financial-services industry has been undergoing a revolution. But the driving force is not overhyped blockchain applications such as Bitcoin. It is a revolution built on artificial intelligence, big data, and the Internet of Things.
Already, thousands of real businesses are using these technologies to disrupt every aspect of financial intermediation. Dozens of online-payment services – PayPal, Venmo, Square and so forth – have hundreds of millions of daily users in the US. Billions more use similar low cost, efficient digital payment systems all over the world: Alypay and WeChat Pay in China; UPI-based systems in India; M-Pesa in Kenya and Africa. And financial institutions are making precise lending decisions in seconds rather than weeks, thanks to a wealth of online data on individuals and firms. With time, such data-driven improvements in credit allocation could even eliminate cyclical credit-driven booms and busts.
Similarly, insurance underwriting, claims assessment and management, and fraud monitoring have all become faster and more precise. And actively managed portfolios are increasingly being replaced by passive robo-advisers, which can perform just as well or better than conflicted, high-fee financial advisers.
Now, compare this real and ongoing fintech revolution that has nothing to do with blockchain or crypto-currencies with the record of blockchain, which has existed for almost a decade, and still has only one failing and imploding application: cryptocurrencies.
Buterin’s inconsistent trinity: crypto is not scalable, is not decentralized, is not secure
There is a deeper fundamental flaw and inconsistency in the crypto/blockchain space. As Vitalik Buterin correctly wrote a while ago there is a fundamental “inconsistent trinity” in blockchain: you cannot have at the same time scalability, decentralization and security.
Bitcoin, for example, is partially decentralized – even if its mining is now massively centralized – but it is not scalable given its proof of work (PoW) authentication mechanism – that allows only for 5 to 7 transactions a second. And it is secure – so far – but at the cost of no scalability. And since its mining is now massively centralized – as an oligopoly of miners now control its mining – its security is at risk.
Supporters of crypto have been promising forever – Buterin spoke of Proof of Stake (PoS) in 2013 – systems that are vastly scalable. But leaving aside that PoS is not live yet and Ethereum is still based on PoW, the reality is that once Proof of Stake is properly launched it will be massively centralized and thus not secure. The whole logic of PoS is to give greater voting power to those who have a stake in a coin – those who own it the most and mine it the most. But that leads to a massive centralization problem. Even Bitcoin that is based on PoW has seen a massive centralization and concentration of mining power in a small oligopolistic group. This problem of concentration of mining power among an oligopoly becomes much worse with PoS as those with greater initial stake – and Ethereum is massively concentrated in ownership of ETH – will get a greater stake over time. So the problems of oligopolistic cartelization of mining power that is already very serious in PoW will become exponentially worse in PoS.
More generally, while cryptography scientists are busy inventing every day another “consensus” mechanism and there are dozens of new ones after PoW and PoS and their variant the reality is that – given Buterin’s inconsistent trinity it will never be possible to create a consensus mechanism that is scalable while also being decentralized and secure.
One solution to the problem of scalability is to use many alt-coins rather than increasing the block size of each blockchain; but that solution is highly inefficient and is not secure. A second solution is to increase the block size; but then nodes running on a smaller computer or laptop would drop out of the system as they will not be able to store every transaction or state. So you would end up relying on a small number of super-computers for running the blockchain; so you end up with an oligopoly with market power, concentration and lack of security.
A third solution is where most of the crypto industry is trying to go, ie merge mining and variant of proof of stake. In this system there are many chains but all such chains share the same mining power or stake. But this approach increases the computational and storage demands on each miner by a massive factor that most miners will not be able to support. So this solution is a backdoor way of increasing the size of the blocks. Thus, it leads to only very few powerful miners to participate into this proof of stake, ie participating in merge-mining each chain. So it leads again to centralization, oligopolies of mining and thus lack of security.
Whichever way you try to slice it blockchain leads to centralization and lack of security. And this fundamental problem when you try scalability will never be resolved. Thus, no decentralized blockchain will ever be able to achieve scalability that is critical to make it useful for large scale financial or any other type of transactions.
Indeed, even those blockchains that do not have any scalability, like Bitcoin and those based on PoW, have massive mining concentration problems. The nature of mining implies that any form of mining has economies of scale that require massive scale – think of the massive energy hogging mining factories of crypto-land – and lead to massive oligopolistic concentration of power and lack of security.
With the centralization of power comes a serious problem of lack of security, starting with 51% attacks. Supporters of crypto argue that it would not be in the interest of an oligopoly of miners to start a 51% as it would destroy their source of income/fees. But leaving aside that such an attack would allow them to steal the underlying assets – worth is some cases dozens of billions of dollars as in the case of BTC. The main problem is any oligopolistic cartel will end up behaving like an oligopoly: using its market power to jack up prices, fees for transactions and increase its profit margins. Indeed, as concentration of mining has increased over the last year transaction costs of crypto – as measured by miners’ fees divided by number of transactions – have skyrocketed.
No security in crypto-currencies
So even PoW that is not scalable leads to concentration/centralization and thus lack of security. PoS and other authentication mechanisms that are scalable are much worse: bigger concentrated oligopolistic cartels and thus lack of security.
Also 51% attacks are not a theoretic possibility that is impossible in practice. Dozens of successful 51% attacks have occurred recently. In smaller coins with a small market capitalization you don’t even need a 51% hash power to mount a successful 51% attack. And since market cap is low a few hundreds of thousands of dollars – or at best a couple of millions – are sufficient to mount a successful 51% attack whose gain is a 10 to 20X multiple of the cost of the attack. No wonder that dozens of successful 51% attack have occurred recently against smaller crypto-currencies.
Fundamental flaws of lack of security in crypto land go well beyond the fact that mining is highly concentrated in oligopolies in shady and non-transparent and unsecure jurisdictions – China, Russia, Belarus, Georgia, etc. It also goes beyond the possibility and reality of massive and regular 51% attacks.
There is a deeper and more fundamentals set of security flaws in crypto land. Conventional payment systems based on fiat currencies, central banks and private banks are scalable and secure but centralized; so they resolve Buterin’s inconsistent trinity principle by giving up decentralization and relying on trusted permissioned authorities to resolve the “double spend” problem.
Instead, blockchains and cryptocurrencies not only are not scalable and are massively centralized; they are also massively not secure.
Download Full Submission Here.