‘The Tulip Folly’, an 1882 painting by French artist Jean-Léon Gérôme
‘The Tulip Folly’, an 1882 painting by Jean-Léon Gérôme, illustrates the 17th-century Dutch tulip bubble, an event that could provide a lesson for bitcoin traders © Heritage Image Partnership Ltd/Alamy

The writer is chief executive and chief investment officer of Richard Bernstein Advisors

Proof of concept typically means evidence that a design idea is feasible. Cryptocurrency enthusiasts have suggested that the approval of bitcoin ETFs by the US Securities and Exchange Commission this week is substantial proof of concept that cryptocurrencies are viable and marks a big step towards their integration into the financial system. The question, however, is viable and feasible as what?

The primary purpose of currencies throughout economic history has been to facilitate consumption, business dealings and capital investment. Trading, speculating and hedging happen after a currency begins to be widely used and its transactional economic purpose is well established. 

No one actively traded or speculated in the dollar, the pound, the yen or other major global currencies before they were used for economic transactions. The required proof of concept is their economic use. Of course, not all currencies achieve this. Some emerging countries’ inflation rates are so high that locals prefer to use established currencies, such as the US dollar, in day-to-day transactions. Cryptocurrency boosters have suggested that bitcoin might be a preferable option.

El Salvador is famous for trying to make the connection between bitcoin speculation and economic reality but, so far, the results are questionable. Despite claims that the flow of funds into El Salvador using bitcoin would be cheaper and easier than those using the US dollar, the El Salvadoran central bank estimates that only about 1 per cent of received remittances in the first six months of 2023 were in bitcoin.

If cryptocurrencies are indeed currencies, and not speculative collectible fads like baseball cards or Beanie Babies, then they would be the world’s first traded currency with no economic purpose. Outside of relatively small constructive uses in some emerging economies, one might be able to pay for fentanyl or arms shipments covertly, hide wealth or fund terrorists, but they are of little value for day-to-day transactions like buying groceries or paying most bills.  

And despite the enthusiasm surrounding issuance of bitcoin ETFs this week, this does not facilitate the broader transactional use of cryptocurrencies in the US or global economies. It will still be hard to buy a cup of coffee with it.

However, if Bitcoin’s purpose is purely as a vehicle for trading and speculation, then these ETFs might indeed be proof of concept. They will probably encourage participation among individual investors who feel traditional exchange trading via better-known financial institutions is safer than the previously existing means of trading cryptos.

Well-established financial institutions might want to be wary. The deflation of both the technology and housing bubbles revealed legal and financial liabilities they didn’t anticipate. The spread of bitcoin speculation and any subsequent deflation could expose similar risks.

Democratisation of the market is a common characteristic of financial bubbles. The idea that the playing field has been levelled and everyone now gets access to an asset has historically been a siren’s song luring investors to participate in financial bubbles. Bitcoin ETFs seem to be this bubble’s bait. 

They could even be an impediment to the US Federal Reserve’s inflation fighting. Bubbles are inherently inflationary because an economy diverts capital to bubble assets instead of to productive resources. Simply put, money flows to things the economy doesn’t need at the expense of things it does. If the resulting undersupply of goods and services can’t keep up with aggregate demand, or productivity doesn’t significantly improve, then a bubble’s misallocation of capital ignites inflationary pressures.

As evidence mounts that globalisation is starting to contract, the US is in a somewhat precarious position because of its massive trade deficit. One might therefore expect capital flows to shift towards improving the country’s woefully inadequate infrastructure and capital base. The advent of bitcoin ETFs could further sidetrack capital towards unproductive speculative use.

Some have suggested that bitcoin is a digital version of gold. That seems to ignore the fact that such precious metals and commodities have economic uses and aren’t merely a means of speculation or a store of value. The fillings in my mouth or my wedding ring won’t ever be made of bitcoin.

In fact, it better resembles digital tulips, echoing the Dutch tulip bubble of the 1600s. This craze got so extreme that the Amsterdam Stock Exchange began to regularly trade bulbs alongside equities. The cryptocurrency rage is now extreme enough that established exchanges including the NYSE and Nasdaq will start trading bitcoin ETFs. This will probably spur additional public interest, but for the wrong reasons.

Those looking to pile in should remember that bitcoin and other cryptocurrencies still seem a tool for speculation, rather than currencies with proven economic merit. The actions of this week will simply expand that speculation to a broader, and likely unsuspecting, audience.



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