Cryptocurrency Is Not Necessarily the Future: Tyler Cowen

As Bitcoin soared to above $28,000 over the weekend, talk resumed about the promising and dramatic future of cryptocurrency. The chief global strategist of Morgan Stanley Investment Management even suggested that Bitcoin could replace the dollar as a global reserve currency.

Cryptocurrency serves some useful purposes. But there are some pretty wild speculations going around. One of the more fundamental problems is that crypto assets can be either useful hedges, or useful forms of payment — but not easily both.

There is a demand for a non-intermediated, direct payment asset, and crypto can serve that function. That is why stablecoins, such as crypto assets pegged to the dollar, have proven of enduring interest. People want to transfer something dollar-denominated but with crypto-like features. Yet the very stability of these coins means they have to create institutional layers to preserve their value. For the foreseeable future, the institutions building dollar-linked stablecoins will be riskier, less transparent and more difficult to deal with than the dollar-based system itself, including the surrounding banks.

If you hold or trade with a stablecoin, you incur several risks. First, the stablecoin peg to the dollar may someday be broken, an old problem with pegged exchange rates that Milton Friedman often warned about. Second, to the extent stablecoins and other crypto assets become a major part of the financial system, they will attract more regulatory interest. That in turn will limit many of their advantages over the traditional bank sector. The U.S. government does not want a financial system that evolves outside the purview of the Federal Reserve, FDIC and other regulatory institutions.

Third, the formal banking sector will improve, for instance by moving to more rapid clearing, or by introducing electronic reserve currencies. With the latter, you could transfer your electronically-based dollars within the accounting system of the central bank, and achieve a non-intermediated transfer without resorting to crypto. It is not obvious that crypto will be the market winner once more mainstream institutions learn some lessons from the success of crypto.