Bofinger breaks down Bitcoin hype: "Play money wrapped in computer science fog"

Wednesday January 13th 2021

Bofinger breaks down Bitcoin hype
Play money wrapped in "IT fog"

Bitcoin is experiencing a new boom. Big banks and institutional investors who have long been skeptical have also jumped on the bandwagon. In an interview with ntv.de, the Würzburg economist and long-standing economist Peter Bofinger remains undeterred in his assessment: In the long term, only "air" should remain of the "digital play money".

ntv.de: Three years have passed since the last big Bitcoin hype. In spite of all skepticism, the crypto currency not only survived, but recently reached record highs again. Has your view of Bitcoin changed?

Peter Bofinger: No, not at all. It's still nothing more than digital play money. The risk of it imploding remains. In the event of a loss of confidence, there is nothing that can slow such a development.

So far, the doom forecasts for Bitcoin have not occurred. The rate has multiplied year-on-year.

This can go on for a while as long as interest rates stay low and people have the money and fun they need to hold a very volatile asset. Speculation has a distinctly playful element. Compared to global financial assets, the amount invested in Bitcoin is still in the per mil range. But one has to be aware of the fact that while Bitcoin is fashionable today, that can change every day. There is a lot of competition among cryptocurrencies. Tomorrow, another currency may suddenly be perceived as sexy, with possibly more exciting functionality than Bitcoin, and then the speculators drop Bitcoin. So you have to see that there is great competition and permanent innovations here.

Can't one argue that Bitcoin now gets value precisely because a sufficient number of investors attach value to it?

Speculators buy assets because they believe that others believe that others are willing to pay a certain price for them. This is what John Maynard Keynes called third-degree speculation: expectations over expectations over expectations. That can go well for a while, but it can also suddenly collapse. I compare it to a fully occupied football stadium: as long as I'm the only one who wants to get out, that's no problem. But if panic breaks out and everyone rushes to the exit at the same time, that won't work – at least hardly without serious injuries. This is how speculative bubbles end for investors.

Didn't the entry of institutional investors and big banks bring about a certain stability?

Through the banks? During the financial crisis, banks did not necessarily distinguish themselves by being able to identify particularly secure commitments.

The argument that there is no real value or practical use largely applies to gold.

That's true. That is why there have been significant price movements in gold in the past. And the central banks hold huge gold reserves, relics from the past that they no longer need. If one of these central banks got the idea to sell it, the gold price would slide quite a bit. But gold still has a certain use value for making jewelry, for example. If the Bitcoin starts to slide, there is only air left.

Beyond Bitcoin, some see a benefit in blockchain technology for digital currencies, not least the central banks themselves.

I don't think that's convincing. The blockchain records for all time all transactions that have been made with a specific payment object. We would know, for example, from a ten-euro note: At some point it was issued by this central bank, then paid out by that bank to Ms. Müller, then paid to that dealer, etc. Every Bitcoin carries this ever-growing rat tail of information with him. What's that good for? This could be useful for some supply chains. When I buy frozen roast venison from Lithuania, it is good to know when the animal was shot, where it was processed, when and how it was transported, and there were breaks in the cold chain. But it's useless for currencies.

Enthusiasm for crypto currencies is often associated with skepticism towards the central banks. Can you understand that?

No, the central banks do a pretty good job! Inflation rates have been low since the 1990s. Even after the financial crisis, as today, there was great fear of inflation. But it did not materialize and is not to be feared now either.

Critics of cryptocurrencies are often accused of simply not understanding the complexities of how they work.

Economically, the principle is very simple. Someone gives out play money and gets others to give him real money for it. It's the same as if I were to write '100 Bofinger' on a piece of paper and find people who would give me 100 euros for it without me having any obligation to redeem them. With Bitcoin, this principle is only hidden in a computer science fog.

Max Borowski spoke to Peter Bofinger