The Economic Report of the President (ERP) is an annual report produced by the Council of Economic Advisers and published by the White House. An important vehicle for presenting the Administration’s domestic and international economic policies, it provides an overview of the nation’s economic progress with text and extensive data appendices[1].
The annual report 2023, devoted Chapter 8 to “Digital Assets: Relearning Economic Principles”. This is a basic summary of the chapter.
The first insight is about financial centralization against decentralization. In this sense the report states that multiple financial crises have struck the United States during the last two centuries. Many of these crises have been caused by institutions that function like banks but are not registered or regulated as banks, so-called shadow banks. For example, the 1907 crisis—then called a “panic”—was mainly caused by trust companies, which were State-chartered entities that competed with banks for deposits. That was precisely the reason for the creation of a central institution as the Federal Reserve.
Crypto assets on the other hand are a subset of digital assets that use cryptographic techniques and distributed ledger technology (DLT) but exclude central bank digital currencies. DLTs rely on networks to store and process transactions.
It has been argued that crypto assets may provide benefits, such as improving payment systems, increasing financial inclusion, and creating mechanisms for the distribution of intellectual property and financial value that bypass intermediaries that extract value from both the provider and recipient. But for the “ERP”, so far, crypto assets have brought none of these benefits.
Indeed, crypto assets to date do not appear to offer investments with any fundamental value, nor do they act as an effective alternative to fiat money, improve financial inclusion, or make payments more efficient. For “ERP” instead, their innovation has been mostly about creating artificial scarcity in order to support crypto assets’ prices—and many of them have no fundamental value. In this context “ERP” do not mention any benefits regarding Bitcoin or Ethereum, and the new technology they are really apporting.
For the “ERP” a crypto asset may be, among other things, a security, a commodity, a derivative, or another type of financial product, depending on the facts and circumstances. Nonfungible tokens are the other primary type of crypto asset; they use DLT to track ownership of digital goods ….
The estimated market values of selected crypto assets have increased significantly in recent years and reached a collective peak of nearly $3 trillion in November 2021. As of the end of December 2022, crypto assets collectively had a reported market value of a little under $1 trillion, due to a large downturn in prices over the year, and largely reflecting the failures of certain prominent crypto asset projects and firms.
The report gives a brief summary of what Bitcoin is. Nothing remarkable about it.
Then the report refers that there are several possible benefits that proponents claim for this popularity of crypto assets. These claims are reviewed in the next subsections:
- Claim: Crypto Assets Could Be Investment Vehicles.
- Claim: Cryptocurrencies Could Offer Money-like Functions without Relying on a Single Authority.
- Claim: Crypto Assets Could Enable Fast Digital Payments.
- Claim: Crypto Assets Could Increase Financial Inclusion.
- Claim: Crypto Assets Could Improve the United States’ Current Financial Technology Infrastructure.
Then the report refer “The Reality of Crypto Assets” (not very positive not surprisingly).
Crypto Assets Are Mostly Speculative Investment Vehicles.
For the report, crypto assets are very volatile, and, hence, highly risky. Because they are very volatile, crypto assets can be used for speculation, an investment strategy that seeks to make a profit from short-run trading. One reason many crypto assets are highly volatile is that many of them do not have a fundamental value. For example, stocks are claims on the future profits of firms and debt is a claim on interest and principal payments. Even commodities such as gold and
silver have fundamental values, because they can be used in jewelry and for special manufacturing purposes. Conversely, unbacked crypto assets are traded without fundamental anchors, suggesting that their market prices only reflect speculative demand, or market sentiment, not claims on cash flow. Recall that one of the purported benefits of crypto assets like Bitcoin was to hedge against inflation, meaning that their value does not erode as inflation
increases. But as inflation increased globally in the second half of 2021 and in 2022, the prices of crypto assets collapsed, proving them to be, at best, an ineffective inflation hedge.
It is true that there are crypto projects that are worthless and purely speculative. This is normal in a market that has just been born (we can remember the beginning of the internet). But at the same time there are projects that have value, such as Bitcoin, Ethereum, Chainlink, to name a few.
The report does not refer to Bitcoin’s rises, from its birth (3 January 2009) until now. Nor does not mention that the halving of bitcoin (usually every 4 years) has a very important deflationary effect (you can study the figures regarding bitcoin halving). The report does not mention that after the collapse of Silicon Valley Bank, banking stocks in general are falling, while bitcoin is rising in value.
Cryptocurrencies Generally Do Not Perform All the Functions of Money as Effectively as Sovereign Money, such as the U.S. Dollar.
The report states that money serves three functions: as a unit of account (which means that it acts as a benchmark upon which the values of different goods and services can be compared); as a medium of exchange (which means that it can be used to trade goods and services); and as a store of value, (which means that the amount of goods and services that a unit of the money can buy does not fluctuate dramatically over short intervals of time).
Although cryptocurrencies currently serve each of these functions, they only do so in limited ways in the United States, so they do not serve, from an economic perspective, as an effective alternative to the U.S. dollar.
For the first monetary function question, cryptocurrencies can serve as a unit of account, given that the relative values of goods and services can be expressed in cryptocurrency (e.g., a single chicken in commerce is worth roughly 0.0001 bitcoin). However, individuals would likely need to first convert bitcoins or other cryptocurrencies to dollars to understand relative values as cryptocurrencies are not as effective as the U.S. dollar as a medium of exchange (discussed below). Thus, cryptocurrencies currently do not fully serve as units of account.
There are two problems regarding this statement:
First, stable cryptocurrencies (fixed in dollar) do not require an exchange into dollar fiat, which therefore allows a cryptocurrency to be a de facto unit of value.
Two, bitcoin is not currently the world’s reference currency, but the same is true for all fiat currencies except the dollar. The bitcoin proposal is that gold (in this case digital) should once again become a currency of value.
The second question is whether cryptocurrencies can serve as a medium of exchange. The answer is that in the United States, they are not as effective a medium of exchange as the U.S. dollar. This is because they can be used to purchase other cryptocurrencies and to buy goods and services at a smaller number of firms relative to the U.S. dollar. The strength of the U.S. dollar is derived from several important factors, such as faith in government institutions and the legal system, but cryptocurrencies lack these factors.
The fact that today it is not a better measure of exchange than the dollar does not mean that tomorrow it will be better. It is a matter of having more people using cryptoassets.
Third, cryptocurrencies currently experience substantial amounts of volatility, and thus are not stable stores of value. For example, the value of a bitcoin (relative to the U.S. dollar) increased by over 1,000 percent from March 2019 to March 2021, and then decreased by over 70 percent from November 2021 to October 2022. This volatility means that anyone who is using bitcoins to store their savings is subject to high-volatility risk in their purchasing power.
The answer to this argument is that Bitcoin is a long-term store of value. Bitcoin is limited (21 million) while fiat money is not. Long-term fiat money tends to be worth zero, Bitcoin does not. After the bitcoin halving in 2024 (April) we will see what happens.
Regarding stablecoins the report states that can be subject to run risk
After criticises algorithmic stablecoins (of course Terra Luna case) the report states that bank deposits are subject to a comprehensive set of regulatory and supervisory requirements. In contrast, stablecoins are not subject to requirements designed to maintain this exchange rate.
But this was not the case of Circle, USDC and the Silicon Valley Bank Collapse. Although Circle deposited the collateral in a traditional Bank, it collapsed. So, perhaps it is not rally true that deposit the collateral in a bank is the best solution.
[1] https://www.whitehouse.gov/cea/economic-report-of-the-president/
