The Nobel laureate, Paul Krugman, recently returned to the topic of cryptocurrencies from an angle that is not widely considered in the public debate, but which makes sense. He concerns the social aspect that the American economist sees in the system of cryptocurrency which risks not so much causing a systemic financial crisis, as developing a catastrophic impact on the public that is involved in it in a very similar way to what happened with the real estate mortgage crisis a go go of the 2000s.
The scheme of cryptocurrencies, in fact, is similar to that of subprime. It is that of an asymmetry between promises and outcomes, between risk awareness and real risk. As happened in 2007-2009, some may occur bad awakenings and it can happen to a large portion of the public. Recent research shows that the cryptocurrency investor is a minority, working class, or low-income family member. Let's follow Krugman's argument in a recent article in the New York Times, which we present in the Italian version and which really deserves attention.
Similarities with the subprime crisis
If the stock market isn't the economy – which it really isn't – a fortiori cryptocurrencies, like Bitcoin, aren't the economy at all. Yet they have become a very big phenomenon in terms of the market and have also generated huge returns for daring investors. Last fall the market value overall cryptocurrency has reached almost 3 trillion dollars.
Since then, however, values have plummeted, wiping out around $1.300 trillion of capitalization. At the end of January 2021, the price of Bitcoin had halved compared to the peak of November 2020. One wonders who was damaged by this crollo and what it might mean for the economy and society as a whole.
Well, I see some rather disheartening similarities to the subprime crisis of the 2000s. It's not so much about the threat of cryptocurrencies to the financial system – the numbers aren't big enough yet to generate the same scale of problems. But it is increasingly evident that the risks of cryptocurrencies fall unequally on the various actors involved. There is a sort of cognitive and distributive risk asymmetry.
Most of these fall on subjects who they are not aware of what they are undertaking without being equipped to handle any substantial losses.
The meaning of the cryptocurrency phenomenon
What is the meaning of the cryptocurrency phenomenon? Payments maybe? There are many ways to carry out digital payments, from Apple Pay to Google Pay to Venmo. The main payment methods are based on the same model: a third party – usually a bank – verifies that the values being transferred are actually covered. Cryptocurrencies, on the other hand, use a complex coding that allows you to do without these third parties.
Skeptics wonder what sense this model could make and argue that cryptocurrencies end up being an incomprehensible way and expensive to do what could be done easier and more understandable. Occam's razor.
This is the reason why cryptocurrencies still have modest legal uses, 13 years after the introduction of bitcoins. In my experience, the response to this objection takes the form of an incomprehensible blah blah blah.
The El Salvador experiment
Recent developments in El Salvador, which introduced bitcoins a few months ago as fiat currency, seem to confirm the skeptics' point of view: residents who try to use the currency are faced with high transaction costs.
Cryptocurrency, finally placed on the legal market, is proving to be something of a future as well as the haven for the ingrained fears of gold freaks that governments always end up eroding savings. Furthermore the expectations of big earnings have attracted investors worried about missing out on this opportunity.
So cryptocurrencies have become a huge asset, even if no one can clearly say what legitimate purpose they may have.
The risk is not financial
Now crypto has collapsed. Perhaps they will recover and reach new heights, as has already happened. For the moment, however, the values are very low. Who, then, are the losers? As I said, I see some unnerving affinities with the subprime crash 15 years ago. However, cryptocurrencies are unlikely to cause one economic crisis overall and comparable to that of subprime.
Outside of them is a whole world, and even $1.300 trillion in losses, albeit large, represent barely ten percent of US gross domestic product, an order of magnitude of scale well below that of the fall in prices. of housing when the housing bubble burst.
In addition, activities associated withbitcoin mining, as well as having a considerable environmental cost, are economically insignificant compared, for example, to the building activity, the collapse of which played an important role in causing the Great Recession.
Losers and damaged
However, it happens that many users come out and will come out damaged by the cryptocurrency game. Who are these losers? Investors in cryptocurrencies appear to be a different class of investors than those in other risky assets, which are mostly white, wealthy, college educated people.
According to a survey by research firm NORC, 44 percent of cryptocurrency investors are non-white and 55 percent have no college degrees. This data confirms the widespread feeling that cryptocurrencies are popular among minorities and the working population. NORC says this is a good thing. He comments: “Cryptocurrencies are opening up investment opportunities for investors from all walks of life.”
But I vividly remember the days when access to subprime mortgages was described in similar words – when it was extolled as theopportunity to make the dream come true of home ownership by previously excluded social groups.
It later emerged, however, that many of those who got into debt did not understand what tunnel they were getting into. In Gramlich, a Federal Reserve executive who had vainly warned of growing financial dangers asked, “Why are the riskiest types of loans given to the least informed borrowers?”
And then he stated: “The question answers itself”. In fact, once the bubble burst, homeowners found themselves having to hand over the keys to their houses to their creditors.
The logic of bitcoins
And cryptocurrencies, with their very large price fluctuations seemingly unrelated to fundamental economic factors, are just as risky as subprimes were. Perhaps those, like me, who still don't know how to realize the usefulness of cryptocurrencies – except for the money laundering and for activities of tax evasion – are losing sight of the bigger picture.
Perhaps the rising valuation of bitcoin and its competitors represents more than a bubble, within which this logic works: people buy an asset because other people made money off that asset. And perhaps it's good that investors are betting against the skeptics.
But these investors should be people well informed about the risks their investment runs and capitalized enough to bear the losses should the skeptics prove right.
Unfortunately, that's not what's happening. And if you ask me, regulators made the same mistake they did with subprime: they failed to protect the public against financial products that no one understands and many vulnerable families may end up paying the price.
Taken from: Paul Krugman, How Crypto Became the New Subprime, “The New York Times”, January 27, 2022
