Is it simply speculation or will cryptocurrencies revolutionise our financial system? Monetary economist Ivo Arnold says: “If even your hairdresser mentions he bought into Bitcoin, it’s time to worry.”

Ivo Arnold is Professor of Monetary Economics at Nyenrode Business Universeit and Professor of Economics Education at the Erasmus School of Economics. He was awarded his doctoral degree in 1996 for his dissertation on European monetary policy; he is an expert on monetary policy, European integration and the pass rates in Economics.
If you would like to hear more about cryptocurrencies, come to Studio Erasmus on 27 March, when Ivo Arnold will be interviewed by Geert Maarse.

How is your cryptocurrency portfolio doing?

“Nothing’s happening – I didn’t buy any.”

Why not?

“I really hate taking risks and, in the unlikely case I invest anything in very risky products, I wouldn’t choose cryptocurrencies anyway. With bonds, you are paid interest and with shares you are paid dividend. But a Bitcoin won’t generate a cash flow at some point in the future – it’s pure speculation and you can compare it to other speculative investments, such as postage stamps or gold. It’s alright if you like to gamble.”

Last year was the year of the cryptocurrency and the mother of all cryptocurrencies, Bitcoin, skyrocketed, from a thousand dollars at the beginning of 2017 to twenty-thousand dollars in December, and then collapsed. What’s going on?

“Firstly, you need to realise that Bitcoin has been around for quite a bit as a means of payment, since 2009, in fact. Initially, it appealed to people because of its high-tech image and because it’s a bit anti-establishment. But its huge success can’t be explained by such libertine motives, or else the bubble would have appeared sooner. It can’t be explained by its supposedly being new, wonderfully modern and efficient payment technology either: we still can’t use it to buy bread.”

What does that mean?

“We should ask ourselves: what does explain the coin’s success? The answer is that Bitcoin has become invaluable for one particular sector of society: crime. The anonymity of cryptocurrencies makes them extremely useful for online illicit trading, such as drugs trafficking.”


‘If your hairdresser mentions he bought into Bitcoin, it’s time to worry’

Ivo Arnold

By now, a number of alternative cryptocoins have emerged that are becoming almost as popular. These alt coins are being churned out onto the market one after the other, by means of things like Initial Coin Offerings. What are your views on that, as a monetary economist?

“Last year, it suddenly became an exciting investment product for the masses: once prices have risen spectacularly, everyone’s interested. You can – if you have time for it – throw yourself into an unending study of cryptocoins. Investing is presented as a kind of game, too. These aspects are typical of a soap bubble’s course: success stories, people who are afraid of missing the boat, price trends that go through the roof. At a certain point, loads of people appear with books on Bitcoins and workshops on how to trade them. At that point, there’s not much money to be made with the actual product but it has produced a whole industry devoted to it.”

In a recent column, you claimed that the hype is a sign that this phenomenon has already peaked.

“At a certain stage, the bubble could burst. The warning signs are when people start making money by giving courses to novices instead of trading. If your hairdresser mentions he bought into Bitcoin, it’s time to worry.”

I invested a thousand Euros in Bitcoin, Ethereum and Ripple around Christmas, exactly when the prices reached their peak. Was that a bad move?

“I don’t give advice on investments. General feeling can’t be predicted, and anything might happen. Regardless of that, you should ask yourself whether you want to invest in a coin that’s used to conduct illegal activities. It’s not a sustainable investment either, if you look at the energy consumption.”


Image credit: Bas van der Schot

Many people say that the underlying technology, Blockchain, is going to start a revolution. Surely that means that investing in cryptocurrencies isn’t simply speculation?

“I’m no expert on Blockchain, but keeping a decentralised ledger of transactions, which is what Blockchain does and what most of the major cryptocurrencies are based on, may have a large impact in the long term. But not necessarily, and even if it does turn out to be a revolution, that’s not to say that everything involved will immediately turn to gold.

“Around the millennium, Internet companies were given valuations that were completely unrealistic, even though the technology on which the tech bubble was based has indeed proved to be invaluable. Another, much older, but just as famous example dates from the nineteenth century. When electricity was discovered, there were all sorts of private generators whose shares commanded very high prices on the American stock exchange, until the whole thing collapsed. We need to distinguish between the value of the underlying technology and the valuation of the product based on that technology.”

A researcher from Goldman Sachs recently said that he expected nearly all cryptocoins to crash, with a few exceptions which would skyrocket. In other words, we need to look for the Googles or the Facebooks of the cryptocurrencies.

“If there are any.”

I can see you’re sceptical. But, from the monetary perspective, what might be the value of a decentralised digital coin?

“According to the fans, its value is that it cuts out the middle man: institutions like the banks, credit card companies and Western Union. But in many cases, those institutions are still more efficient than Bitcoin, a coin involving high transaction costs, which is slow and which guzzles energy. Remember, the middle men actually do a lot of good: they provide stability and security. If you put your savings in the bank, your deposit is guaranteed up to a hundred thousand Euros. If a cryptocurrency exchange crashes, your bitcoins will be gone for good. It’s like the Wild West. Exchanges have been hacked and even shut down without any money being repaid. It’s investing without a safety net.”


Image credit: Bas van der Schot

The need for decentralisation is noticeable everywhere. Surely, it’s not odd that the general feeling is we’d rather do business without the intervention of the finance sector? The banks haven’t been popular since the credit crunch.

“That’s right. But I think you need to distinguish between the banks and the central banks. The cryptocurrency enthusiasts tend to focus on the ECBs and the FEDs of this world – mistakenly in my opinion. A lot went wrong in the banking industry but, broadly speaking, the central banks of the United States and Europe have succeeded quite well in keeping inflation down over the past decades. Pursuing a decent monetary policy means ensuring that the amount of money corresponds to an economy’s needs. The price stability that it produces is extremely important for a modern economy, because if you do business with a country, you want its currency to keep its value. The free market where cryptocurrencies are traded can’t do that any better than a central bank, as you can tell from the drastic fluctuations in exchange rates over the past year.”

Financial authorities are struggling to regulate cryptocoins. The AFM, the Dutch Authority for the Financial Markets, has issued warnings about the uncontrolled growth of Initial Coin Offerings and is worried about the gamification, which is supposedly making trading – and consequently losing – too easy. What would be your advice for the policy makers?

“They should at least make sure that the financial system is not exposed, that cryptocurrencies do not threaten the stability of the real economy. We’re talking about hundreds of billions here, which is nothing compared to the trillions in junk mortgages that lead to the subprime crisis in 2007. Nonetheless, if a bank invests in bitcoins, it needs a larger capital cushion, simply because it’s an extremely risky investment. Besides, we should be asking ourselves whether the government shouldn’t clamp down harder on a system that facilitates illegal activities. A while ago, the European Central Bank decided not to print any more five-hundred Euro notes because they were mainly used by criminals.”


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