An Economist’s Response to “Valuing Cryptocurrencies As . . . Currencies?”


Daniel Gorfine — Chief Innovation Officer and Director of LabCFTC — released a piece this week that attempts to value Bitcoin (BTC) as a fiat currency such as the USD, EUR, GBP, and JPY. That is, according to the standard macroeconomic factors that affect the demand for a national currency: namely national interest rates, inflation rates, and production rates.

Mr. Gorfine’s piece, unintentionally, brings into sharp focus the mile-wide chasm between BTC and everyday fiat currencies.

As a former Econ Professor, I’ve seized this opportunity to flex my old skills a bit and delve into the specifics that were glossed over by Mr. Gorfine.

Let’s begin.

The US Federal Reserve, Washington DC (I’ve been inside, twice).

First, Gorfine mentions the level of a country’s interest rates (or the cost of borrowing) as an indicator of currency demand. National interest rates (on mortgages, car loans, corporate and sovereign debt) generally follow the trend of the Federal Funds Rate target as set by the national Central Bank (in the United States, referred to as the Federal Reserve or simply the Fed). The Federal Funds Rate represents the overnight borrowing rate between banks, regarding their reserve deposits. Targeting this rate via Open Market Operations, the Fed causes a domino effect on the interest rates of all other forms of debt within an economy (cars, houses, etc.).

The Federal Funds Rate since 1955 (shaded areas indicate Recessions)

This Federal Funds rate is not set in stone by the Fed or generally by any other national Central Bank — rather rates are influenced by Monetary Policy via Open Market Operations — the purchase or sale of government debt on the open market — which increases or decreases our national money supply respectively. Hence a “target” rate. Increasing money supply will push interest rates lower, and vice versa. If during the Federal Open Market Committee (FOMC) meeting it is decided that the economy is growing at a healthy rate, Board Governors may seek to keep the target rate level or even increase the target, and vice versa if they believe the economy is contracting (a lower target rate serves to stimulate spending and borrowing while a higher one is meant to tie up cash and prevent asset bubbles).

The FOMC under Former Fed Chairman Bernanke

Furthermore, in a healthy economy where investors view future economic growth positively, long-term debt will have a higher yield (return) than short-term debt. However, if investors are worried about future economic growth, nearer term debt will have a higher yield (producing the inverted yield curve).

As a comparison, countries that boast high-yield debt are usually countries that are below “investment-grade” and thus have a high probability of default (i.e. not paying back its debt obligations).

Countries at risk of default issue higher-yielding debt (Greece)

Gorfine states that a country with higher yields (interest rates) witness their currency appreciate in value, as a higher ROI drives demand toward that particular currency. This is true to the extent that the country’s debt does not fall below investment grade level (Greece in the example above, where holders of Greek sovereign debt were forced to accept repeated “haircuts”).

Since the Bitcoin network does not issue any debt-backed securities as related to its overall investment grade — or its ability to honor debt obligations — the interest rate analogy falls short. Although, technically, the BTC community of miners and HODLers could collaborate to issue BTC loans in order to spur additional investment into the BTC network. However, where would the proceeds go, and who would be responsible for oversight of the funds? There is no BTC national treasury since the network operations are decentralized — unlike sovereign nations in which the central entity is the country’s ruling government. Gov’t revenues are maintained by the National Treasury.

US Department of Treasury, Washington DC

It appears then that the most comparable metric to a country’s interest rates driving currency demand could be a Staking network. A Proof of Stake (PoS) system compensates “stakers” in return for holding/staking a proportionate amount of an owner’s tokens for an indefinite time period (similar to a T-bill or even a dividend, but with all the risk). In this case, everything else equal, comparing the returns of various PoS networks could serve as a very loose analogy to national interest rates.

Second, Gorfine mentions inflation rates as a currency demand factor. Inflation rates are a complement to interest rates, as the former is generally kept in check depending on the level of the latter. If interest rates are low for an extended period of time, rapid inflation may occur, and vice versa. This is why it is critical for the FOMC to determine a sweet-spot for the Federal Funds rate (the target rate) in order to keep inflation at a controllable, steady, healthy pace. (The Fed strives for a ~2% annual inflationary target.) Inflation (as measured by the Consumer Price Index — CPI) is a critical component for any growing economy — it’s a necessary characteristic to satisfy the medium of exchange definition of general money. Rapid inflation however is not beneficial and devalues a currency (i.e. Venezuela today; Germany in 1920s), but the opposite of inflation — deflation — has the effect of cash being hoarded instead of being used (this is the gist of BTC’s “digital gold” argument), which leads to severe negative effects on economic growth.

Consumer Price Index (CPI) vs. Federal Funds Rate (shaded areas represent Recessions)

As it pertains to cryptocurrencies, token inflation/deflation is directly related to the supply schedule and the so-called halving block-rewards that is eminent in all PoW systems. Obviously, a cryptocurrency with a deflationary supply schedule arguably has a higher valuation due to scarcity than one that employs a vast inflationary one (i.e. Stellar, or XLM).

Source: CoinTelegraph

As mentioned, a non-existent inflation rate (or a deflationary currency such as BTC) makes the currency unusable in daily transactions for the obvious reason that everyone would simply hoard the currency as opposed to using it — hence the digital gold argument for BTC that Gorfine also mentions in this section, which is a perfectly valid point. Although, gold has a vastly larger use case than BTC as it is used within most electronic devices today.

(Further, on the issue of true scarcity, why not issue a similar cryptocurrency to BTC where the supply is just 10, 5, or simply a single, lone token? Start the bidding!)

Wu-Tang Clan’s “Once Upon a Time in Shaolin” album — only one copy exists.

The last metric Gorfine looks at in relation to valuing a currency’s demand is Economic Strength, or the projected growth rate of the total production of goods and services within a country’s borders as measured by Gross Domestic Product or GDP (which includes net exports). For a growing economy, there will be more business and investment occurring within that country, therefore there is an increased need of that country’s currency — hence subsequent currency appreciation.

International Monetary Fund 2015 GDP Rankings

This utter lack of economic production (besides mining rig/data center + electricity demand figures) of Bitcoin is what separates myself from the majority of crypto believers. Many so-called crypto pundits have tried to use the number of transactions as a stand-in to GDP (i.e. network transaction value). If Bitcoin was indeed being substituted for cash this would be a valid, analogous metric. But, it is not.

Bitcoin simply is a deflationary creation where one can hide wealth from authoritarian governments, similar to hiding treasure in so called digital caves. It is not procuring any value-add from any other means. Hence, its only value-add is censorship-resistance, as well as speculation.

The cave is a cold-wallet while the skeleton is the multi-sig option

On the contrary to Gorfine’s championing of BTC versus the inflationary dollar, just comparing BTC’s price volatility to the basically non-existent inflation that the USD has experienced in the past decade, inflation-eroded cash appears the more rational choice. (Of course, those that invested in BTC pre-2017 will beg to differ.)

Gorfine moves on to state that the production of goods and services may be more measurable for utility tokens or platforms that require a token for usage of the service. This is certainly a valid point, however, to date no utility token platforms are actually being utilized save for decentralized gambling platforms like EOSBet (which is spurred by grandiose monetary incentives — basically speculation). This brings us to a very important point that for any utility token platform to adequately function, token speculation must be kept in check, hence the need for a particular peg (I touch on this in a previous piece). However, requiring a token to be pegged begs the question of why even use the token in the first place as opposed to digital fiat.

(Interestingly, one tokenized project that I am consulting with requires the use of a digital cryptographic token for a highly specialized medical service that requires a high-tech device, in which the token serves as a paywall/gateway for the use of the patented device and the complementary software for a specific period of time. Certified practitioners must purchase the token at a fixed price for device use, and afterwards can resell them on the platform to the highest bidder. Thus, specific niche cases perhaps exist for tokenized networks, yet certainly not on a broad scale).

Moving back to currency valuation, let us scrutinize a real-world example: the Turkish government recently experienced a free-fall in the value of its currency (Lira) relative to the USD, as a result of weak economic growth and an impending recession (two or more quarters of negative Real GDP growth) of the Turkish economy. Not only are investors pulling out of the Lira, they are borrowing immense amounts to sell it short, accelerating the devaluation. In response, the Turkish government banned local banks from lending the Lira to foreign counterparties, which immediately has stymied its drop in value. However, this move is but a short-term pain remedy for a much more serious condition — as long as the Turkish economy remains stagnant, the currency will continuously drop in value in tandem with decreasing demand as investors pull out (in fact, deflation is near for the Lira, which spells an even grimmer scenario — people in Turkey will hoard the Lira instead of spending it on goods and services, further depressing growth).

As it relates to decentralized cryptocurrencies, certain measures could be taken to prevent a decline in value, such as the founding team dramatically reducing supply (which has been done on several occasions). Yet, these actions, similar to the Turkish government, definitively centralizes the currency— so it begs the question, what’s the point? I’d rather the trust the currency backed by the full faith and credit of the US government than one backed by the actions of Vitalik Buterin/ConsenSys, as I need the former for everyday living.

“Providence favors our Undertakings”; “A New Order of the Ages”

Obviously, the “broad adoption” case for crypto Gorfine pushes for in lieu of goods and services as measured by GDP does not hold — it is still easier for everyone to use fiat to acquire basic necessities (food, water, shelter, clothing) and to pay our bills. Cash still rules everything around us.

Ultimately, a digital currency that has the potential to be used in our everyday lives (micro payments et. al) would have to be issued by a sovereign entity (i.e. a Federal Reserve Digital Dollar), thus going against the decentralization mantra the crypto-sphere loves to champion.

Gorfine’s attempt at valuing cryptocurrencies as fiat currencies is an interesting take (especially to an Economist) and one of the more rational thought pieces out there (there are not many). Most importantly however, it clarifies the stark distinction between the practical applicability of cryptocurrencies and fiat within national economies.

Brian Koralewski is the Founder of Austere Capital — a Digital Asset Advisory and Consulting Firm.