The market for cryptocurrencies.

• Author: White, Lawrence H.
• Position: Essay

Cryptocurrencies like Biteoin are transferable digital assets, secured by cryptography. To date, all of them have been created by private individuals, organizations, or firms. Unlike bank account balances, they are not anyone's liability. They are not redeemable for any government fiat money such as Federal Reserve Notes or for any commodity money such as silver or gold coins. The cryptocurrency market is thus a market of competing private irredeemable monies (or would-be monies). Friedrich A. Hayek (1978a) and other economists over the last 40 years could only imagine how market competition among issuers of private irredeemable monies would work. Today we have an actual market to study. In what follows I will discuss the main economic features of the market. I also discuss whether the market is purely a bubble.

As an introduction to the topic, I offer the following comic verse about the contrast between Biteoin and the physical gold coins of the past:

In the past, money's value was judged with our teeth; We bit coins to confirm they were real. Now a Bitcoin's just data, no gold underneath. That's okay if it buys you a meal. (1) The Size and Composition of the Cryptocurrency Market

Bitcoin rightly gets the lion's share of media attention, but it is not alone in the market for cryptocurrencies. The authoritative website CoinMarketCap.com tracks the U.S. dollar price and total "market cap" (price per unit multiplied by number of units outstanding) for each of more than 500 traded cryptocurrencies. Bitcoin is the largest by far. On a recent day (March 9, 2015), the site showed Bitcoin trading at $291 per unit, with a market cap of $4.05 billion. The second and third largest cryptocurrencies, Ripple and Litecoin, had market caps respectively 8.5 percent and 1.8 percent as large. The entire set of non-Bitcoin cryptocurrencies (known as "altcoins") had a market cap of roughly $619 million, or 15 percent of Bitcoin's. Stated differently, Bitcoin had roughly 87 percent of the market, altcoins 13 percent. In percentage terms, altcoins do a higher share of Bitcoin's business than Bitcoin does of the Federal Reserve Note's business (currently $1.35 trillion in circulation). In trading volume the percentage share of altcoins (led by litecoin and Ripple) has been similar.

The cryptocurrency market has grown about fourfold in market cap over the last 22 months, with altcoins growing faster than Bitcoin. This is seen by comparing recent data to the oldest snapshot of the CoinMarketCap site available via the Internet Archive "Wayback Machine," which reports data for May 9, 2013. On that date, Bitcoin had a price of $112 per unit, and a market cap of $1.2 billion. The two largest altcoins at that time, Litecoin and Peercoin (aka PPCoin), had market caps respectively 4.7 percent and 0.4 percent as large. Only 13 altcoins were listed. Jointly their market cap was about 6 percent of Bitcoin's, giving Bitcoin 95 percent of the market. Since then, the market share of altcoins has doubled, and their market cap has grown ninefold. Trading volumes then were not reported.

At $4.05 billion, the market cap of Bitcoin, as of March 2015, was slightly smaller than the dollar value of the September 2014 monetary bases of the Lithuanian litas ($5.8 billion) and the Guatemalan quetzal ($5.5 billion), but larger than those of the Costa Rican colon ($3.3 billion) and the Serbia dinar ($3.3 billion). (2) The August 2014 figures from the Central Bank of the Bahamas do not provide the monetary base, but count Bahamian dollar currency in circulation at $210 million, less than two-thirds of Ripple's recent market cap of around $344 million.

Medium of Exchange, Store of Value, and Medium of Remittance Functions

The retail use of Bitcoin as a medium of exchange for goods and services is small to date, but is growing. In December 2014, Microsoft began accepting bitcoin payments "to buy content such as games and videos on Xbox game consoles, add apps and services to Windows phones or to buy Microsoft software" (BBC 2014). In doing so it joined prominent online retailers Overstock, Dell, Expedia, TigerDirect, and Newegg, and the payment processors Paypal and Square. The list grows weekly. Payments processing firms Bitpay, Coinbase, Coinkite, and others are enabling (and recruiting) brick-and-mortar retail shops to accept Bitcoin from any consumer whose smartphone "Bitcoin wallet" application can display a QR code. On its website Bitpay claims a clientele of "44,000 businesses and organizations"; Coinbase claims 37,000. These processors offer to purchase the consumer's bitcoin as it is spent, paying the equivalent (minus a fee) in dollars or other preferred currency to the merchant. The merchant avoids all exchange rate risk of holding bitcoin. For the retailer on the front end of the transaction, "accepting bitcoin" via these services actually means receiving dollars (or euros, etc.), just like accepting a credit card or debit card does. Bitpay and Coinbase thereby remove the barrier against transacting in cryptocurrency posed by the incumbency advantage of the established domestic currency unit (Luther and White 2014), just as Visa and Mastercard enable merchants to accept credit and debit cards from a customers whose accounts are denominated in a foreign currency.

A potentially vast market for bitcoin and altcoin use is international remittances. For example, workers abroad send an estimated $25 billion per year to the Philippines, where remittances contribute a remarkable 10 percent of national income. The established remittance services Western Union and MoneyGram commonly charge more than 10 percent in fees. Bitcoin remitters, by contrast, are charging only 1 percent. As the CEO of a recently launched bitcoin remittance service remarked to a reporter: "We thought: with Bitcoin we can do it cheaper." A Filipino working in Singapore or Hong Kong (say) doesn't need to have online access or a Bitcoin wallet. The worker can purchase bitcoins at a BTM (bitcoin teller machine), bring the QB code printout to the local "rebittance" provider's office, and the service delivers Philippine pesos as a direct deposit into a designated recipient's account at a participating bank back home or (for an addition fee but still much less than the legacy firms) as cash (Ferraz 2014, Buenaventura 2014).

Market Competition

The market for cryptocurrencies has always been characterized by free entry. A new development in the past two years is competition from profit-seeking enterprises. Free entry is exhibited by the remarkable growth in the number of altcoins, from the 13 listed in May 2013 to the 500+ listed in March 2015. Profit-seeking by new entrants is especially conspicuous in systems like Ripple (2nd behind Bitcoin in market cap as of March 9, 2015), BitShares (4th), Nxt (6th), and MaidSafeCoin (8th). In each of these systems a substantial share of "pre-mined" coins was initially held by their developer-entrepreneurs. The entrepreneurs hope to profit by raising the coin's market price through efforts to promote wider use of the coin and its associated proprietary payment network or trading platform, such that they can eventually realize a market value for their coin holdings greater than their expenditures on development and promotion.

Bitcoin, by contrast, was launched by a pseudonymous programmer (or set of programmers) apparently as a public-spirited experiment. Revenue from producing ("mining") new coins, the reward for validating peer-to-peer transfers, is open to anyone with the computing power to participate successfully. While Federal Reserve Bank of Chicago economist Francois Velde (2013) is thus right to contrast the nonprofit Bitcoin system to the profit-seeking firms that Hayek (1978a) foresaw, the contrast does not apply to the new enterprises that are launching altcoins for profit. (3) In these new altcoin enterprises we see a working embodiment of competitive issue of irredeemable money by profit-seeking private firms. It is no longer correct--if it ever was--to say that Bitcoin is not "operating in a competitive environment." Bitcoin competes with altcoins in the same way that the giant nonprofit YMCA competes with smaller nonprofit and forprofit health clubs, or a large nonprofit hospital competes with smaller nonprofit and for-profit immediate-care clinics.

The Novel Implementation of Quantity Commitments

We should not be too surprised that the features of competing irredeemable privately issued currencies are different from what Hayek (and other economists) imagined, for two reasons. First, market competition is a discovery procedure as Hayek (1978b) elsewhere emphasized, in which successful entrepreneurs discover profit in overlooked or unforeseen ways of producing products and reconfiguring product features. Secondly and more specifically, Hayek imagined that the issuer of a successful irredeemable private currency issuer would retain discretion to vary its quantity. The issuer would promise (but not make any contractual commitment) to maintain a stable purchasing power per unit. (4) A naked promise of that sort unfortunately appears to be time-inconsistent (Taub 1985; White 1989: 382-83; White 1999: ch. 12). An issuer whose promise was believed could reap a large one-time payoff by spending a massive batch of new money into circulation until the public caught on. The one-time profit would exceed the normal rate of return from staying in business. By assumption, there would be no legal recourse against the decline of the money's value...