Goldman Sachs interviews doomsday prophet Roubini: Can cryptocurrencies be considered a new asset class?

This article is sourced from Weiyang.com and compiled by Liu Bin.

Nouriel Roubini, a professor of economics at NYU Stern School of Business and CEO of Roubini Macro Associates LLC, recently gave an interview to Goldman Sachs analyst Allison Nathan, discussing his skepticism about the value of cryptocurrencies and their ability to fundamentally change the financial system.

Allison Nathan : Why do you think Bitcoin and other cryptocurrencies are in a bubble?

Nouriel Roubini: First of all, calling them currencies is a misnomer. A currency must have four characteristics: it must be a unit of account, a medium of exchange, a stable store of value, and serve as a single unit of pricing.

Bitcoin and most other cryptocurrencies lack these characteristics. They are not a unit of account; nothing is priced in Bitcoin. It is not a scalable means of payment; the Bitcoin network can only handle 7 transactions per second, while the VISA network can handle 65,000 transactions per second. It is not a stable store of value for goods and services; even at cryptocurrency conferences I have attended, Bitcoin payments are not accepted because price volatility can wipe out their profit margins overnight.

The cryptocurrency world does not provide a single unit of account in which the prices of different items can be denominated, as there are thousands of tokens, leading to limited price transparency. Even in ancient times, there was a more complex system that used shells as a single unit of account to compare the prices of different goods.

Bitcoin and other cryptocurrencies are also not assets. An asset has some cash flow or utility that can be used to determine its fundamental value. The dividends provided by stocks can be discounted to derive a valuation.

Bonds provide coupons, loans provide interest, and real estate provides rent or housing services. Commodities like oil and copper can be used directly in various ways. Gold has industrial uses, is used in jewelry, and has historically been a stable store of value against various tail risks (including inflation, currency devaluation, financial crises, and political and geopolitical risks).

Bitcoin and other cryptocurrencies have no income or utility, so there is no way to arrive at a fundamental value. A bubble occurs when something is priced far above its fundamental value.

But we cannot even determine the fundamental value of these cryptocurrencies, yet their prices have skyrocketed. In this sense, it seems to me like a bubble.

Allison Nathan **: *If there is a bubble, why are more institutions interested in participating in cryptocurrencies? Does this help stabilize and legitimize the market?*

Nouriel Roubini: Due to high trading volumes, facilitating trading activities, custody services, etc., it is worthwhile. But do institutional investors really want to get more involved? Maybe some do, but I don't think it will become mainstream.

There is a view that since only a small portion of institutional funds are currently invested in Bitcoin relative to gold, Bitcoin's price could soar due to asset reallocation from gold. But I doubt institutions want their asset exposure to drop 15% overnight. There is also a risk that investment products backed by real assets will eventually replace Bitcoin as an alternative store of value.

Bitcoin may one day disappear, but gold will not. The idea of CFOs investing in crypto assets is completely insane. No serious company would do this because treasury accounts must invest in the least risky stable assets, even if their returns are very low. Any CFO who invests in something that drops 15% in value overnight would be fired.

Of course, Elon Musk can do that because he is the boss, although he later somewhat abandoned Bitcoin due to environmental concerns. But very few people are in that position.

Allison Nathan **: *But didn’t gold also have periods of high volatility before it matured as an institutional asset?*

Nouriel Roubini: While gold has experienced periods of volatility, a series of economic fundamentals usually drive price fluctuations. Gold rises with inflation and inflation expectations because it is an inflation hedge, and it falls when the Fed tightens monetary policy and interest rates rise, both nominally and in real terms, for the same reasons.

Gold has an inverse relationship with the value of the dollar because a devaluation of the dollar leads to higher production costs and prices for commodities, including gold. When there are severe political or geopolitical risks or financial crises, the value of gold rises because it is a safe-haven asset, as do the Swiss franc, yen, and U.S. Treasury bonds. A whole set of variables can be used to determine the demand for gold relative to its supply, making it possible to establish a fundamental price.

In contrast, the prices of Bitcoin and other cryptocurrencies have no consistent relationship with economic fundamentals, which explains their volatility or suggests that it will eventually fade.

Allison Nathan **: *But given that Bitcoin does not face the risk of currency devaluation, can’t it serve as an inflation hedge like gold?*

Nouriel Roubini: Admittedly, inflation and inflation expectations have risen, the dollar has begun to weaken, and the U.S. breakeven point is now well above 2%. But while the prices of gold and other inflation hedges reflect these changes to some extent, at its peak, Bitcoin's price surged from a low of $5,000 to over $60,000 in just one year.

This cannot be explained by concerns about currency devaluation because if there were such strong concerns, other assets like gold and TIPS might have rebounded more. Therefore, the rise in Bitcoin and other crypto prices must be driven by other factors.

Does Bitcoin provide protection against devaluation? At least in the world of cryptocurrencies, it cannot, because the rules of crypto dictate the increase in supply and limit the total supply to 21 million.

However, just because something is scarce does not mean it has fundamental value. It is not difficult to create something with limited supply, and there is no reason to artificially create scarcity to make it valuable.

Apart from Bitcoin, the supply of most cryptocurrencies is determined by a group of whales and insiders based on arbitrary rules that can be used to temporarily increase supply. Given the explosion in the number of token types, their supply is actually growing much faster than any central bank's balance sheet.

Scarcity also does not make something a reliable store of value. The dollar took a hundred years to truly devalue by 90%. In 2018, thousands of cryptocurrencies lost as much value in just 12 months, and even Bitcoin dropped by over 80%. That is devaluation.

Bitcoin is not even a reliable hedge against risk events, let alone inflation shocks. In fact, it is highly pro-cyclical. At the peak of the COVID-19 shock in early 2020, the U.S. stock market fell about 35%, but Bitcoin plummeted about 50%. The other top ten cryptocurrencies fell even more.

In tough times, crypto assets did not rise; they fell significantly. If investors want inflation hedges, various assets have proven to be good inflation hedges over the decades, including commodities and their stocks, gold, TIPS, inflation-adjusted bonds, and other forms of inflation-indexed bonds.

I do worry that monetized deficits could eventually lead to fiscal advantages and higher inflation. But I do not recommend using Bitcoin or other cryptocurrencies to hedge against this risk.

Allison Nathan **: *New technologies are often unstable during the adoption phase. What makes this cryptocurrency different from the early days of the internet?*

Nouriel Roubini: Bitcoin has been around for over a decade, and it is far from being as transformative as the internet was during the same period. The World Wide Web has had about a billion users for a decade.

While it is difficult to know the total number of cryptocurrency users now, the active users of the most traded cryptocurrencies may be as high as 100 million. The growth of cryptocurrency trading is slower than that of the internet, transaction costs remain high, and mining still accounts for a significant proportion of total transactions.

After a decade of internet development, we saw the emergence of email, millions of useful websites and applications, and technologies like TCP and HTML protocols with broader applications. In the case of cryptocurrencies, there are so-called "decentralized applications," but 75% of these decentralized applications are games like CryptoKitties or pyramid or Ponzi schemes.

The other 25% are "DEXs," or decentralized exchanges, which currently have almost no trading and liquidity. So the comparison to the internet does not seem accurate.

Allison Nathan **: *However, doesn’t the concept of decentralized ledgers and networks have value?*

Nouriel Roubini: I am not sure it exists, but the fact is that the crypto ecosystem is not decentralized. Mining oligopolies essentially control about 70-80% of Bitcoin and Ethereum mining.

These mining operations are located in places like China, Russia, and Belarus, which are strategic adversaries of the U.S. and have different rule of law. This is why the U.S. National Security Council has begun to worry about the risks it may pose to the U.S.

99% of crypto transactions occur on centralized exchanges. Many cryptocurrencies also have a centralized core group of developers who act as the police, judges, and juries whenever there are updates or conflicts in the blockchain. In these cases, the assumed fixed rules have changed. So blockchain is not immutable.

There is evidence that the ownership of crypto wealth is also highly concentrated.

According to CoinMarketCap, less than 0.5% of addresses hold about 85% of Bitcoin. There is also evidence that whales holding large amounts of Bitcoin and other cryptocurrencies actively manipulate prices. Thousands of news articles detail active manipulation in chat rooms through pump and dump schemes, spoofing, wash trading, front-running, etc.

This behavior is even worse than that of small-cap stocks, indicating that there is a high likelihood that regulators will eventually crack down.

Allison Nathan **: *What innovations in the crypto ecosystem do you find promising?*

Nouriel Roubini: None. In the next decade, there will be radical financial innovations across multiple dimensions that will disrupt the traditional financial system. But this has nothing to do with cryptocurrencies. The driving force behind this innovation will be a revolution in financial technology, fueled by the combination of artificial intelligence, machine learning, and the use of the Internet of Things to collect big data.

Fintech has already been transforming payment systems, lending, credit allocation, insurance, asset management, and parts of capital markets. In the context of payment systems, billions of transactions are conducted daily in China using Alipay and WeChat Pay, in Kenya and most sub-Saharan African countries using M-Pesa, and in the U.S. using Venmo, PayPal, and Square. These are great companies that are scalable, secure, and are disrupting financial services. They are not based on decentralized finance and have nothing to do with crypto or blockchain.

To be honest, I have spent a lot of time researching this issue because more and more people say that while these may not be currencies, the technology of blockchain could be revolutionary.

Now there are trendy terms like "enterprise distributed ledger technology (DLT)" or "enterprise blockchain," but I refer to most of these projects as BINO—"Blockchain In Name Only." Anything that is truly based on blockchain technology should be open, decentralized, permissionless, and trustless. But looking at the experiments of DLT and blockchain companies, almost all experiments are private, centralized, and permissioned—because a small number of people have the ability to validate transactions—and most are validated by a trusted institution.

Even in these projects, there is rarely anything truly useful.

One study examined 43 applications of blockchain technology in the nonprofit sector, including providing banking services to the unbanked, issuing IDs to refugees, and remittances, and found that none were actually effective. The fundamental problem with this entire field is that it assumes technology can create trust.

But that is an impossible task. Solving the challenge of certifying ownership or quality requires due diligence and testing. Why should I trust a DLT network that says my tomatoes are organic? I trust Whole Foods to actually test the chemical composition of tomatoes. The idea that technology can solve trust issues is delusional.

Therefore, I am very skeptical that blockchain, DLT, and cryptocurrencies will be the revolutionary technologies that their supporters believe they are.