In-Depth Opinion

Nobel Economist Paul Krugman Outlines His Issues with Cryptocurrency

Cole Petersen | August 1, 2018 | 1:30 pm

Nobel Economist Paul Krugman Outlines His Issues with Cryptocurrency

Cole Petersen | August 1, 2018 | 1:30 pm

In a recent New York Times op-ed titled “Transaction Costs and Tethers: Why I’m a Crypto Skeptic” Nobel Prize winning economist Paul Krugman gave another explanation as to why he is a skeptic of the usefulness and future of cryptocurrencies.

Paul Krugman has been an Op-Ed columnist for the New York Times who writes the occasional article lambasting cryptocurrencies.  His articles on cryptocurrency frequently reference the Tulip Bulb mania that occurred in the 17th century, and don’t ever efficiently criticize, or even confront, the technology behind cryptocurrencies.  His criticisms are solely focused on the general concept of virtual currency, and his comments on the technology backing crypto at largely appears to be uninformed.

Nevertheless, as a distinguished economist, his opinion is valued by many and should be noted. In his latest Op-Ed piece, Krugman confronts what he sees to be the two biggest issues with cryptocurrencies – transaction costs and the absence of tethering.

Paul Krugman: First issue is Transaction Costs

Krugman begins his Op-Ed by outlining the natural progression of monetary systems, referencing the constant reduction of transactional friction that has occurred in society. First, Krugman notes, there were gold and silver coins, which eventually transitioned to bank notes backed by fractional reserves. He also importantly notes the transition away from physical bank notes to digital banking, like debit and credit cards.

When looking at next progression of transactional technologies, cryptocurrencies immediately comes to mind, but Krugman objects, asserting that cryptocurrencies are aiming to set the monetary system back 300 years.

“Set against this history, the enthusiasm for cryptocurrencies seems very odd, because it goes exactly in the opposite of the long-run trend. Instead of near-frictionless transactions, we have high costs of doing business, because transferring a Bitcoin or other cryptocurrency unit requires providing a complete history of past transactions. Instead of money created by the click of a mouse, we have money that must be mined — created through resource-intensive computations…In other words, cryptocurrency enthusiasts are effectively celebrating the use of cutting-edge technology to set the monetary system back 300 years.”

Krugman’s assumptions on the effectiveness of fiat currency are all based around the ideal monetary system, in which governments dutifully create money and banks responsibly manage their monetary supplies.  As seen from the collapse of Lehman Brothers bank in the US, and recent banking issues in Greece, individuals cannot fully trust their banking systems. Krugman simply doesn’t seem to grasp the benefits of a decentralized monetary supply.

Moreover, Krugman does not confront the benefits incurred by digital currency, and the problems that can stem from using fiat currency.  Currently, the international settlement of funds is a lengthy and expensive process, and individuals sending small amounts can see sizeable fees stemming from wire transfer fees, a margin on the exchange rate, and foreign wire fees.

For businesses and banks sending large amounts abroad, the process can be much costlier. The current process requires funds to be passed through a chain of banks, with each bank representing a fee and a delay. Cryptocurrencies remove the delays and fees incurred by the banks and allow for nearly instant transactions with minimal fees.

Paul Krugman: Second Issue is the Absence of Tethering

Krugman then proceeds to explain the importance of what he describes as tethering.  He asserts that the value of fiat currency is largely based on the fact that the government forces it to be worth a certain value, saying:

“It’s backstopped by the fact that the U.S. government will accept dollars as payment of tax liabilities — liabilities it’s able to enforce because it’s a government. If you like, fiat currencies have underlying value because men with guns say they do. And this means that their value isn’t a bubble that can collapse if people lose faith.”

He also explains that the same situation is applicable to gold and other precious metals, as they are tethered by the fact that in addition to acting as a store of value, they “have real-world uses, both for jewelry and for things like filling teeth, that provide a weak but real tether to the real economy.”

Krugman notes that the absence of tethering is one of cryptocurrency’s greatest weaknesses, saying:

“Cryptocurrencies, by contrast, have no backstop, no tether to reality. Their value depends entirely on self-fulfilling expectations — which means that total collapse is a real possibility. If speculators were to have a collective moment of doubt, suddenly fearing that Bitcoins were worthless, well, Bitcoins would become worthless.”

Three features of Bitcoin that do in fact tether it to reality would be its transactional efficiency, resistance to censorship, and fixed supply.  Unlike traditional currency, Bitcoin can, in fact, be transferred to wallets located anywhere in the world in a relatively small amount of time.  Investors, holders, and users of Bitcoin can also rest assured knowing that there will never be more than 21 million Bitcoins in existence, unlike fiat currency, which inherently loses value to inflation each year.  Also, the peer-to-peer decentralized nature of Bitcoin does not allow for censorship, which will always provide utility for a select group of people, no matter what the price is.

Krugman ends his Op-Ed with a request for cryptocurrency enthusiast to confront the question of what problem cryptocurrency solves, without trying to “shout down the skeptics with a mixture of technobabble and libertarian derp.”

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