If you want great criticisms of Bitcoin, follow the Bitcoin bear
- Future of Finance
- May 20, 2024
- 48 min read
Updated: Jul 10
A Future of Finance interview with Jürgen Schaaf, Advisor of Market Infrastructure and Payments at the European Central Bank
After Bitcoin first appeared in 2009 extravagant claims were made for its benefits. It would replace fiat currency as the money used by consumers in day-to-day transactions. Bitcoin would hold its value in a way that no fiat currency, being issued by central banks and intermediated by commercial banks, will ever manage. The centralised institutions profiting from the prevailing system of finance would all be disintermediated, giving way to a series of decentralised peer-to-peer networks that had no need of formal structures of trust or explicit measures to protect personal privacy. 15 years on, Bitcoin is a US$1.25 trillion speculative asset, which has proved spectacularly its uselessness as form of money and a means of disintermediation. Yet Bitcoin has remained surprisingly immune to searching criticism, in large part because its cheerleaders in social media and elsewhere have drowned out or ridiculed dissenting voices, and waged a successful (if ironic) campaign to turn Bitcoin into a respectable asset worthy of the attention of regulated banks and savings institutions. The success of these efforts in driving the value of Bitcoin upwards at a compound annual rate of 172 per cent since 2011 has not only made some of those voices extremely rich but made it hard for critics to build a sustained as well as coherent critique of the cryptocurrency. But since he published, in November 2022, “Bitcoin’s last stand,” the first of several papers questioning the economic rationale of Bitcoin, Jürgen Schaaf, an economic adviser at the European Central Bank (ECB), has developed exactly that. He spoke to Future of Finance Co-founder Dominic Hobson.
Key Insights
The volatility of Bitcoin renders it useless as a form of money and, as the El Salvador experience and early transactions in tokenised securities and funds have proved, neither consumers nor merchants nor investors wish to use Bitcoin as an alternative to traditional forms of payment such as fiat currency or fiat currency substitutes such as Stablecoins.
If Bitcoin is not money, it is not an investment (unlike bonds and equities it pays no interest or dividends) or a commodity (unlike gold it has no industrial usages or history as a hedge against inflation) either, but a purely speculative technological artefact whose fair value is zero and whose market value is dependent entirely on flows of speculative capital.
Speculative flows into Bitcoin are encouraged by a wide range of influencers, some drawn from fields far removed from finance that are paid to promote cryptocurrencies and some drawn from the ranks of large holders of Bitcoin that benefit directly from encouraging retail investors to buy, and their activities are not discouraged by law or regulation.
Speculative flows explain why Bitcoin has failed to fulfil another promise of its evangelists to provide an uncorrelated hedge against falls in the value of other assets such as equities or bonds, because in recent years the value of Bitcoin has proved to be highly correlated with interest rate and stock market movements in traditional financial markets.
Bitcoin nevertheless does have wider effects, since a high and rising price of Bitcoin encourages Bitcoin holders to spend and borrow more while a falling price of Bitcoin prompts holders to reduce their spending and borrowing, creating “wealth effects” that can spill over from the cryptocurrency markets into the traditional financial markets.
It is fallacious to believe that retail investors buy Bitcoin because it is easier than buying regulated funds or securities because it is equally easy to purchase conventional financial assets using apps downloaded on to mobile telephones, which means that the real reason retail investors buy Bitcoin is their belief that the price will rise and make them rich.
The pressure on institutional investors to invest in Bitcoin comes partly from a combination of venture capitalists invested in cryptocurrency infrastructure and services and asset managers that collect fees from retail investors that wish to buy Bitcoin, both of which have a vested interest in maintaining the euphoria which drives the speculative bubble.
Comparing the rewards paid to “miners” in a Proof of Work cryptocurrency such as Bitcoin with the seigniorage earned by central banks when they issue fiat currency is misleading because central banks are paid to fulfil a public function whereas miners are paid to protect the security and integrity of the blockchain-based network.
The valid comparator for the electricity consumption of the Proof of Work calculations needed to maintain Bitcoin (estimated by analysts at the Judge Business School at the University of Cambridge to be 95.5 TWh in 2022) is not data centres run by traditional financial institutions but the energy consumption of devices used by consumers playing video games.
Claims by Bitcoin enthusiasts that Proof of Work mining activities perform a socially useful function in consuming surplus electricity that cannot be stored are not valid, because Bitcoin is consuming electricity that could be put to more constructive uses, including an acceleration of the transition to carbon-neutral forms of electricity production.
It is a myth to claim that Bitcoin is invulnerable to theft because it has never been hacked, partly because Bitcoin was subject to a successful 51 per cent attack in 2014 by Ghash.io, which chose not to retain the proceeds, but mainly because digital technologies improve constantly and it is likely that the Bitcoin protocol will eventually prove vulnerable to malign actors.
If Bitcoin is hacked successfully and customer assets are lost, warnings by regulators that investing in Bitcoin is unregulated and risky and that investors might lose all their money without any possibility of compensation will count for nothing amid a public furore that will demand the government make retail investors whole.
Investors that put their faith in the knowledge that Bitcoin transactions can be traced to the digital wallets of individuals are under-estimating the ability of criminals to cover their traces by “washing” and “mixing” techniques, and over-estimating the willingness of law enforcement agencies to invest in tracing relatively small sums of money.
Regulators and legislators have a bias to inaction in regulating Bitcoin, partly because they do not wish to suppress any benefits that might flow from the innovation before they have had time to emerge and mature, and partly because they do not wish to suppress any malign effects of the innovation before they are susceptible to effective supervision and regulation.
Claims that Bitcoin is intrinsically hard to regulate because it lacks an issuer, and the exchanges where it is traded are sufficiently mobile to move between jurisdictions, are mistaken because the reputational consequences for firms of investing in or trading an instrument that lacks regulatory approval will be sufficient to reduce activity indirectly.
The regulation of cryptocurrencies such as Bitcoin has only just begun in Europe with the passage of the Markets in Crypto Assets Regulation (MiCA), and is progressing by enforcement rather than legislation in the United States, but proceeding cautiously is more likely to arrive at a better and more durable result than a China-style ban on Bitcoin or Bitcoin mining.
Regulators in the United States have not managed the regulation of Bitcoin well, having reassured investors by approving ETFs invested in less volatile Bitcoin futures, only to be forced by a court judgment to approve spot Bitcoin ETFs as well, not least because permitting Bitcoin futures ETFs undermined regulatory arguments against spot Bitcoin ETFs.
The series of spot Bitcoin ETFs launched by major asset managers after regulatory disapproval was withdrawn – praised, ironically, by Bitcoin enthusiasts which have for many years expressed extreme hostility to the entire system of traditional finance – will damage regulators more than asset managers if the Bitcoin price slumps and investors lose money.
For regulatory purposes, a distinction needs to be drawn between blockchain technology, which is potentially rich in useful innovations such tokenisation of securities and funds, and Bitcoin, which is a purely speculative asset best supervised and taxed as a form of gambling by those firms and individuals which choose to invest or trade in it.
The market capitalisation of cryptocurrencies (of which Bitcoin alone accounts for more than half) is not an accurate guide to the social damage that would be caused by an implosion of the market since it takes no account of the leverage driving the speculative bubble, much of which is likely hidden from view, though it would likely not create a credit crunch.
The only factor capable of precipitating a collapse in the price of Bitcoin is a halt to the flow of new money into the cryptocurrency, which would require cessation of both the promotional hype surrounding Bitcoin and the worldwide search for new sources of money, but ultimately the supply of new capital is finite and the inflows will one day come to a halt.
The implosion of Bitcoin, when it comes, will lead to a major public outcry in leading financial jurisdictions, in which the retail investors that lose money will not distinguish between regulators that issued warnings that Bitcoin is a risky investment in which investors can lose all their money and the various intermediaries that facilitate investment in Bitcoin.
The criticisms levelled at the conventional system of finance after the great financial crisis of 2007-08 are valid, since institutions, products and regulations proved to be badly flawed, but the criticisms do not constitute a coherent argument for the wholesale replacement of the existing system by Bitcoin, whatever software engineers and libertarian thinkers may believe.
Bitcoin suffers from theoretical as well as practical flaws, in that its reliance on restricting the supply of Bitcoin to 21 million units applies an undoubtedly powerful deflationary technique to real economies that are too dynamic to be governed by control of the monetary base alone, and risks precipitating a deflationary spiral comparable with the Great Depression.The popularity of Bitcoin is a symptom of declining public confidence in established institutions, including elected governments as well as banks and central banks, and while the issuance of CBDCs by central banks could dissipate the idea that cryptocurrencies are socially useful, it is more important that central banks retain public trust than displace Bitcoin.
Transcript
00:09 Dominic Hobson: Hello, I’m Dominic Hobson, Co-founder of the Future of Finance. My guest today is Jürgen Schaaf, adviser since November 2019 to the senior management of market infrastructure and payments at the European Central Bank (ECB), which he joined in 2012 from his position as personal adviser to the governor of the Central Bank of Luxembourg. An economist by profession, Jürgen has also served as an economics commentator at Börsen Zeitung and as a senior economist at Deutsche Bank. In recent years, he has published a number of cogent critiques of Bitcoin, becoming an important critical voice in public discussions about the cryptocurrency. And it’s Bitcoin which is the subject of our conversation today. Jürgen, thanks very much for sparing the time to talk to us.
00:58 Jürgen Schaaf: Dominic, it’s a pleasure. Thank you for having me.
01:02 Dominic Hobson: Reading your papers, it’s very difficult to disagree with your analysis that Bitcoin has failed in its original ambition to become an alternative to fiat currency. It’s clearly useless in terms of day-to-day transactions because its price is so volatile; you can’t really use it to pay for your day-to-day expenses. We’ve even had a live experiment in it in El Salvador, which has proved pretty conclusively that neither the public nor merchants want to use Bitcoin to complete transactions. And it’s not even popular as the cash leg of token transactions in securities or funds on blockchain networks. Which leaves us with the possibility that … What’s the point of Bitcoin? Is it … If it’s not money, what is it? Is it a commodity or is it an investment? How should we judge Bitcoin?
01:56 Jürgen Schaaf: Well, indeed, it’s a difficult question, and it depends on who you ask, what you get as answer. As far as I’m concerned, I think if you want to have an investment in something, the object of investment should have some features. If it’s a financial asset you invest in, you would normally expect some cash flow, be it the coupon of a bond, be it the interest rate then, be it the dividend of a share, be it the profit you can make because of a high demand for industrial usage, like commodities that you sometimes have. But there should be something of value, and when it’s a financial asset, there should also be a cash flow. I don’t see that. So, as a financial investment, it’s hard to be convinced that it’s one. For other reasons, and this is very subjective and, of course, as you might know, the risk that it’s a full-fledged speculative bubble and a huge scam if there’s some intention behind, is high and apparent. The reasons that you mentioned, like it’s not money, it’s not used for payments and the like, depending on which discussion you follow … So if you enter a discussion of fully convinced Bitcoin followers, they still believe that at one point it will become this global means of payment and all the other promises that have been there in its origin.
03:38 Dominic Hobson: So it’s, whatever Bitcoin enthusiasts believe, it’s pretty difficult to use it as money. It’s not an investment because it produces no income, there’s no interest, no dividends, it’s not a commodity because it doesn’t have … We sometimes hear it referred to as digital gold, but gold has uses other than being a speculative asset, so you can do things with it. So it’s not even comparable with commodities. Which leaves us with one possibility, that the value of Bitcoin is entirely dependent on the flows of money into it, and indeed the flows of money out of it. And if we look at its volatile price performance since the peak back in 2022, I think, it was at the bottom in the autumn of 2022, when it was like US$20,000, it rose to US$70,000 ten days, two weeks ago. It’s now back to US$60,000. So, if I’ve understood your position correctly, what’s driving that value is simply flows of money in either direction. Is that right?
04:41 Jürgen Schaaf: One word on gold, first. Gold doesn’t pay dividends. That’s true. It can be used for industrial production. It’s used in smaller amounts in industrial production because of its features. But another difference is that it has an appreciation of its qualities as a raw material that goes back for 5-6,000 years, which established a reputation that is different from something that has a reputation or the perceived appreciation of being stable than something like 15 years or so. That’s a big difference. And its material qualities, so it doesn’t degenerate over time as a material. And if you compare that then to a technology – because basically Bitcoin is a technology or an algorithm, if you will, – that’s completely different. It’s easier to store, of course, Bitcoin, but as a technology, it’s much more prone to be replaced by a better technology. 99 per cent of all technologies will be replaced by better technologies in the near future. But to your question, where does the money come from? Indeed. So if we understand, and that’s my understanding, that it’s basically a huge speculative bubble, then, without intrinsic value, then the increased value comes from new money inflows, and that’s been the case for the last years. Many of those who hold it, in particular the big `whales,’ they don’t want to sell because it’s too risky, in particular when you are in a downswing of the market. And there’s a lot of new money flowing in. According to the management of huge asset managers, the most important inflow comes from retail investors. Now, after the approval of the SEC [Securities and Exchange Commission] as an [asset] for the spot ETF [Exchange Traded Fund], there were some reshufflings from trusts that were less accepted by the markets, that shifted the amounts to an ETF. And all this had an impact on the demand for Bitcoin. But the bulk of the new demand comes indeed from retail inflows.
07:34 Dominic Hobson: You mentioned these whales. You mentioned early on the possibility of some kind of intent behind the flows. Weve got a situation in which you’ve got retail investors as a source of money. You’ve got some very large holders of Bitcoin. Between those, you’ve also got professional trading firms. Now, do you think that these celebrities and other influencers, which talk about Bitcoin from time to time, are actually encouraging retail investors to buy cryptocurrencies? And if this was a security or some other regulated investment, would they be allowed to do that? Because you hold a large position and you talk it up, that sounds, in a regulated market, like something which the authorities would clamp down on you pretty hard. Do you think that’s actually going on? I’m talking here specifically of celebrities, influencers who are encouraging retail investors to buy Bitcoin because ‘its price is going to quadruple in the next six months.’
08:35 Jürgen Schaaf: Well, if you pay a celebrity from sports, from movies, to promote anything, of course the intention is that they create trust, use their reputation and possible integrity to convince potential customers and buyers. That’s the nature of that game. It depends on who are those celebrities. How to judge that? It’s a legal question. It’s difficult to judge in particular, as long as this was unregulated. If it’s not forbidden, if it’s not prohibited to invest into Bitcoin, why shouldn’t someone encourage you to do so? I’m not a lawyer, but it strikes me as difficult to say this is illegal. If you make it a moral question, it’s even more difficult. Where do you draw the line? If you don’t believe in the sustainability and quality of Bitcoin, it doesn’t make you an immoral person necessarily if you promote it. Still, where do you draw the line? Is it immoral to promote soft drinks with a lot of sugar or meat? I hesitate to judge this. My hope would be – and I don’t know whether the celebrities that made advertisements were aware of what they are promoting, so that’s difficult to judge – but my hope would be that on the demand side, the retail clients’ financial literacy would be higher – that people understand what they are doing. As I said, I don’t even know whether the celebrities understood it themselves, but if investors, potential investors, understood better what this is about, that would bethe best way to approach this.
10:44 Dominic Hobson: And do you think the success of Bitcoin, if we can call it that, reflects some wider failings in the savings industry? And by that I mean that one reason retail investors buy Bitcoin is because it’s a very simple thing to do. You can buy it on your phone. By comparison with buying, say, an industry mutual fund or other savings products, which is much more complicated, you can purchase Bitcoin instantly, pay for it instantly, and it promises you these sort of get-rich-quick returns because the price is so volatile. Do you, I mean, do you think we can blame the retail savings industry to some extent for failing to come up with a competing offer or not?
11:28 Jürgen Schaaf: I would untangle these sub-questions. The access and the ability to easily buy those things, be it an ETF [Exchange Traded Fund], be it shares and the like, that depends on the channel, the front-end on your mobile phone. I can easily, with my broker, buy any share I want. I have a decent and easy front-end from my bank account broker, and I can basically buy everything that’s traded on exchanges and the like. If you want a crypto asset like Bitcoin, with an infrastructure, with a custodian, it’s easy. It’s a bit more complicated if you want to have the “true thing” on your wallet and some claim that’s the most important thing. Regarding the access , there are not so much differences in how easy or not you can do it. The notion of getting rich quickly is a problem that refers to the asset. If you are lucky with Bitcoin and you buy it at a very low price, and you sell it at a very high price of its cycle, then you can get quickly rich. The same applies to lotteries. If you are lucky and get the right numbers with a low investment, you can make a lot of money, but that’s not how robust financial investments work. People should be made aware of the risks.To my knowledge, by and large, there’s no sustainable investment with very little input, very little effort, that makes you rich in a sustainable way. We face some real economic challenges with the ageing societies in the capitalist industrialised world, that weighs on the return on real investment. But I wouldn’t blame the fund industry for that.
13:52 Dominic Hobson: In your writings, you also identify a cryptocurrency lobby. And we have seen over the last couple of years, some pressure on institutional investors to get involved. And indeed some have. High profile asset managers, for example, have got, and wealth managers have got, involved in buying Bitcoin and private banks have intermediated transactions for high-net-worth clients. So institutional money is one of the targets of this cryptocurrency lobby. That lobby is visible, particularly in the US, but to some extent in Europe as well. And do you agree with that analysis that this lobby wants to increase the money flow into Bitcoin because it’ll drive up the price? And that’s really the only reason they’re suggesting institutional investors get involved.
14:40 Jürgen Schaaf: I guess you have to differentiate between the lobbyists. Lobbying is the representation of vested interests. And in our democracies, that’s an established and sanctioned intention and a way of approaching regulation, which is fine, basically. But the intentions might differ. What we’ve seen in recent years was a lot of money coming from venture capitalists (VCs) investing in lobby activities. Their intention is, of course, if they promote infrastructures and custodians of crypto assets, and manage to increase the wealth of these intermediaries, which can be sold then to a broader audience, they want to keep the machinery going. Asset managers, and others, might have an interest that the euphoria continues to grow so that people continue to invest and use their services, even without necessarily having skin in the game, so without necessarily having the asset managers investing themselves, but just getting some fees from the retail clients, or even bigger investors who use that. In order to profit from that, the machinery needs to keep on going. In that respect, it wouldn’t be “helpful” to them when the machinery stops, if there would be a ban on the production, mining of Bitcoin and the like, if it’s getting harder and the like. It’s hard to detect the ultimate motivation, the ultimate intention of why the lobby activity takes place. The likely intention is that, first, you don’t want to stop the whole thing by a ban or prohibition. And in the next step, you want to reach new highs and then new inflows are beneficial for those, for the incumbents, for those who hold already huge amounts of the asset.
17:02 Dominic Hobson: So it’s a partly defensive strategy and partly offensive strategy.
17:06 Jürgen Schaaf: Yes. And there are many differences, many intentions, and they might not be all the same.
17.14 Dominic Hobson: We were agreeing …
17.15 Jürgen Schaaf: By the way, to add that also to the defence of the industry, the lobby groups, the money flowing into lobby activities: if you have a look, and if you compare Bitcoin or crypto to the banks or the financial industry, that is much bigger, it’s established. It’s not that there is something completely new and that the order of magnitude is shocking.
17:46 Dominic Hobson: We were agreeing a few minutes ago that there is no income stream flowing from holding Bitcoin, and the industry has tried to address that by creating these services – and we see regulated stock exchanges and regulated banks offering these services to their clients – to get paid for validating transactions in Bitcoin, to be added to the block, which we could liken to the seigniorage which central banks earn when they issue physical currency. Is that comparison with the earnings of central banks, getting something for nothing, as it were, valid? And do you think that this mining activity to earn this income is a legitimate activity for regulated institutions to get involved with?
18:44 Jürgen Schaaf: Let’s start with the mining. What miners are doing, is that they are taking care that the system, that the network is protected, that it’s secure and the integrity is preserved and in order. When they do that, they get for new blocks, Bitcoins as a reward, plus fees. They function as a kind of an auditor, and the reward is paid out then in the unit that they produce or issue. The central bank is different. The central bank is a public institution, and its income stream and its seigniorage, is generated by the ability to issue a bond with a zero coupon that lasts forever. A bank note is a bond issued by the central bank, by the public sector of your jurisdiction. It doesn’t pay interest and it lasts forever. That’s on the one side of the balance sheet of a central bank, the liability side. On the asset side, the central bank can buy assets that yield interest. This combination of being able to issue liabilities without interest, and on the asset side, buy assets that generate interest, even very safe ones – that’s in a way a phenomenon only attributed to central banks. And it’s the reward for a public service, providing money with its traditional features, providing the unit of account, store of value and a means of exchange, which is not the case for the miners. To regulate the miners and the need for regulation: I see more a case for consumer protection. The level of pollution – I think we come to that later. The prevention of illicit activities using a particular means of payments. So other than that, I would say, in a free society, if you want to mine something, mine it, as long as you don’t cause damage. But the role of mining and issuing of real money, fiat money as many call it, is quite different by nature.
21:34 Dominic Hobson: Okay, understood. You raised the question of pollution and this is a criticism we often hear of cryptocurrencies in general. In fact, indeed it’s spreading to tokenisation now. And you have in your writings highlighted the environmental effects of the Proof of Work methodology behind Bitcoin, in particular this huge electricity consumption. Unusually, you’ve highlighted the waste of hardware as well – that’s often ignored. And I would say data centres which banks run today, and central banks run today, obviously consume electricity as well. So does this environmental pollution argument rest on the fact that Bitcoin is producing nothing of value, unlike a bank or a car factory or an energy facility?
22:24 Jürgen Schaaf: Let’s recall a couple of figures and also a word of qualification on that. I don’t want to bore you with the figures, but by and large, what we know is that …
22:34 Dominic Hobson: We love data. At Future of Finance, you can bore us with figures, no problem.
22:37 Jürgen Schaaf: Okay then.
22:39 Dominic Hobson: I know that the Cambridge centre [the Judge Business School at the University of Cambridge] studies how much electricity is being consumed.
22:44 Jürgen Schaaf: Yes. So I have one figure here from 2022 [from the] Cambridge Centre for Alternative Finance. It’s a non-peer reviewed study. It came out with 95.5 terawatt hours annually. That’s representing 0.4 per cent of the world’s entire electricity consumption, ranking it between the electricity consumption of Belgium and the Netherlands. Another non-peer reviewed commentary published in Joule was measuring the carbon emission and it came to 65 megatons of CO2, representing an amount of global emissions in the order of magnitude of 0.2 per cent. That’s comparable to the level of Greece. And what we also have from another study was the amount of electronic waste compared to the amount the entire Netherlands produced in one year. So the amounts are massive. Now we have to put this into perspective. First, the studies that I quoted come from authors who are in general critical towards crypto and Bitcoin. There are others from the crypto camp, who come with slightly more modest figures, but there’s no one who denies that the production and emission of Bitcoin is highly inefficient when it comes to energy consumption, which is justified normally by its blessing and also by the way the integrity of the network is secured. If you compare it to the energy usage and the pollution of the entire financial system as we use it, the established one, the key issue is the efficiency. You have to compare the transaction cost in terms of electricity and the emissions in terms of CO2, of, let’s say, a transaction based on a card payment or a payment transfer between banks and the Bitcoin transfer. That’s what is the measure of efficiency. To compare it with or to make the statement that it’s worth nothing, that I find difficult. There are some people who compare it to the energy consumption of, let’s say, video gaming or the like. That’s a position I would not take. Whether people take pleasure from playing with Game Boys, the …
25:54 Dominic Hobson: Utility is what you’re looking for here. Video gaming does produce utility in the sense of …
26:00 Jürgen Schaaf: That’s a subjective matter. That’s not up to me to judge. I would compare the energy usage of the PlayStation 5.0 to the Nintendo whatever – I’m not an expert here – that is what I would compare. S I would compare the energy consumption of Bitcoin as a means of payment – that it’s what it’s claimed to be. I would compare it to the energy consumption of an established means of payment. And whether you have studies from the more critical camps, if you will, or the enthusiasts, there is no doubt about that it’s highly inefficient. The only difference is there, then, that the enthusiasts say this inefficiency is justified. And some find ways of which energy you use it and some mitigation measures.
26:56 Dominic Hobson: Well, I was thinking from the figures you gave, that the sheer scale of the electricity consumption makes comparisons with established industries meaningless, because there’s no valid point of comparison. But, yes, on the point of mitigating features, we often hear from Bitcoin miners that they’re absorbing surplus electricity, usually from sources where it can’t be stored, which would otherwise go to waste. How valid do you find that argument?
27:29 Jürgen Schaaf: Not really, because you could use that energy for other purposes. You say you can’t store it. Why don’t industries which are not attached to some local spots move there and use energy there? Data centres and the like could use that surplus energy. Likewise, renewable energies are needed big time in order to finance, the electricity needs for the transition towards climate-neutral production. There was a public letter by agencies in Sweden who wanted to prevent Bitcoin miners to come to Scandinavia, Sweden in particular, to use their renewable energies there, because they need the energy coming from the renewable sources in order to finance the transition. And that’s the case everywhere where you are willing to move from non-renewable energy sources to renewable ones. And it’s not only the electricity needs that we have now. The need will increase big time when we move away from fossil energy sources. The key point here is the inefficiency of the production and the inefficiency of using, ensuring the integrity of the network.
29:16 Dominic Hobson: Bitcoin is also criticised for facilitating criminal activity. And I’d like us to approach this question really in two parts. One is whether Bitcoin itself is vulnerable to theft, in other words, transfers of value from legitimate investors, holders of the Bitcoin, to criminal interests. And then secondly, whether it’s actually being used to facilitate criminal activity, in the sense of money laundering or sanctions evasion. So, to take the first point, Bitcoin would argue, `Well, we’ve never been hacked, we’ve never suffered a 51 per cent attack, our technology is safe.’ I don’t know how legitimate you find that argument, but I’d be interested to know, and I wonder whether you think that will persist. Will it always be un-hackable?
30:10 Jürgen Schaaf: Right. It’s a very important question. To my knowledge, at least, the 50 per cent attack occurred in June 2014. There was one hack that managed to. And it was Ghash.io, who reached 55 per cent of the hash rate for about 24 hours. They gave it back and promised not to do that again. Since then, the network has probably become more robust. Still, it’s not excluded. As it happened, that’s what we call falsification in the theory of science. And even more so, there’s no reason to think, as we are talking about technology, and technologies are improving all the way, and we are seeing increased computing powers all the way, that one day people talk about quantum computers and the like, that this will be the case for, I don’t know, 100 years, 1,000 years. If you compare it to gold, we are talking about thousands of years. I have no evidence, I cannot guarantee, but there is a positive probability that the technology will be challenged one day. Also, the established way of paying and storing values in a regulated market has certain advantages to individuals in terms of keeping their value with them. If I’m a victim of a scam and pay with my bank account or credit card, something which is based on a scam, fraud and the like, quite often I get my money back because the intermediaries are regulated, or at least they are willing to give me the money back. And that’s the moment when people are very happy that not all of the payments are anonymous. The protection of consumers, in particular retail consumers, will not work that way if an individual is victim to a scam in a way that Bitcoin, for example, works, although there are voices who see the advantages of this in other cases. Likewise, we often hear that cash, for example, is often used for money laundering and plays a bigger role in criminal financing and the like. But let’s face it, cash is still a very important means of payment and store of value, so that a fraction of this, its use for criminal activity, is obvious. And even if the fraction is small, as the entire entity is much bigger, you would compare apples and pears.
33:17 Dominic Hobson: On that point of cryptocurrencies in general, and Bitcoin in particular, being used in criminal activity in the same way as you just described cash being used, we sometimes read these stories about how Bitcoin isn’t as opaque and inaccessible as it appears. You can actually trace people’s wallets. You can see where money is flowing and into whose hands it’s flowing. Is there any value to that? If you compare the fact that Bitcoin is being used by criminals, but at the same time, those criminals are to some extent making themselves more vulnerable than if they were simply handing over suitcases full of cash, I mean, is there an upside here to the non-bank nature of Bitcoin?
34:06 Jürgen Schaaf: I’m an economist, I’m not an engineer. My take here is that the traces of Bitcoin payments can be detected to a certain extent. There are mitigation measures on the supply side, by wash trading, ‘mixing’ and so on. It makes it hard to follow the traces if you don’t want to be detected. By and large, my take is that it’s an order of proportions. If there have been some ransomware cases where the amounts were really big, up in the millions of US dollars, then it might make sense, and it’s worth trying to trace the origin, find the wallets, and ultimately find the scammer at the other end of the blockchain. If it’s smaller amounts, it’s probably very difficult to find them. Similarly, this is with money laundering via a chain of accounts across borders with different banks and the like. Whereas the banks have scaled up their staff, their investment, in order to fight that very much. My take is that the bottleneck is mostly on the prosecution and police side. Outside the financial sector, independent of the means. The key issue here is cash banking transfers and the like are like the blood system in a body. They are needed to keep the economies for non-illicit activities going. A fraction of them is used for illicit activities that we mentioned so far. With Bitcoin, it’s not used for normal payments, it’s only used for speculation and illicit activities. It’s a question of proportionality. There’s no use-case except for gambling, in the sense of speculating, which is the bulk of the activities. Wash tradings make that figure even higher, and illicit activities. The judgement when you compare the two is a bit difficult. But if you make that clear, I think it’s also quite easy to judge and come to a conclusion.
36:53 Dominic Hobson: Yeah, that seems to make sense. The illicit activity is already illegal and indeed cryptocurrency is already subject to the rules against money laundering and financing of terrorism and sanction screening and so on. But I’d like to pick up your point about speculative assets. It’s the second time you’ve used that description of Bitcoin in this conversation. And it’s relevant because we’re asking ourselves, what are regulators actually looking to regulate? Let’s say it’s a speculative asset. Of course, plenty of financial assets are used in speculation and that activity is regulated, but it’s also regarded as valuable. It’s always a zero-sum game. The side that does well out of a trade does so at the expense of the side that does badly out of a trade. But you can, as a regulator, as a central bank, you can defend that activity because it smooths out price fluctuations over time. My question is, does speculation in Bitcoin perform any useful function beyond Bitcoin itself? Can it help smooth out price fluctuations in markets generally? Or is it just an entirely self-contained system in which it’s a zero-sum game between winners and losers?
38:09 Jürgen Schaaf: Which price fluctuations are you talking about? Within the Bitcoin trades or beyond that?
38:17 Dominic Hobson: I’m talking about whether the ability to speculate on Bitcoin has wider benefits. That if you have a short position or a long position in Bitcoin, does that to some extent offset a shorter, long position you might have in another financial asset? Is it connected in any way to conventional financial assets and therefore has a useful function in smoothing out price fluctuations? Or is it entirely endogenous? Is it entirely about itself?
38:44 Jürgen Schaaf: That is in a way a good example for the adaptability of the narrative of Bitcoin. When it changed its phase from being a global, independent payment system for the world, empowering the individual and emancipating the citizen from the government and the State, when it was changing its nature towards an investment which makes you rich very quickly, there was also the sub-narrative of telling people that it is a hedge against the inflation of fiat and the movements of other established conventional financial markets, as it was a safe deflationary asset. But as we have seen in the last two or three years, was that it was actually not a hedge against downturns in stock markets – to the contrary. It was behaving like a very speculative asset. And when, in the context of discussions about potential interest rate increases by central banks, riskier assets dropped, Bitcoin was falling sharply. This idea of a hedge against the risks that traditional finance faces, that narrative was not sustainable. If you have a completely uncorrelated asset in your investment portfolio, if it goes up, you benefit, if it goes down, you lose. But its usefulness as a hedge is hard to defend. I have to admit that I’m slightly biased, but if someone thinks he or she should be invested in something that is not producing any value, cash flow or anything, but with a bit of luck, the price goes up, so be it.
40:57 Dominic Hobson: If Bitcoin was, for the sake of argument, correlated with the prices of other financial assets, it might be difficult to argue that it has an outsized influence. After all, the entire cryptocurrency market is worth US$1.5 trillion. You compare that with US$120 trillion in bonds, US$110 trillion in equities, US$70 trillion in funds, and US$600 odd trillion in swaps, US$1.2-1.5 trillion isn’t really going to sway things much. Do you think that’s one of the reasons why regulators have been adopting what might be called a wait-and-see attitude towards the regulation of cryptocurrency? As we’ve agreed, they are already subject to the KYC[Know Your Client] AML [Anti Money Laundering] CFT [Countering the Financing of Terrorism] sanction screening recommendations of the Financial Action Task Force [FATF]. And it’s up to the police, as you said, and the courts, to actually enforce those recommendations. But has it been okay for central banks and market regulators to say, `Well, let’s see what happens before we start regulating cryptocurrencies directly, because they’re not really going to disturb anything.’ Is that, has that been a reasonable judgment? And is that still a reasonable judgment?
42:19 Jürgen Schaaf: I think it played a role, but the order of magnitude is not that small. In particular, when you disaggregate and you have a look on the individual. If you have some holdings in a highly speculative asset without a sustainable core, and the value goes up, in your view, you have then subjective assessment of your wealth that exceeds its factual sustainable value, and then you might be tempted to overspend. Whereas with shares, if they go up, it’s based on the assumption that the productivity of the company and the whole economy will catch up at one point. You get financial markets, assess the future development of the profitability and the productivity of a company and an entire economy. And there might be some exaggerations from time to time, but by and large you pay the future development, which is likely if you subjectively think your wealth has increased fundamentally big time. And if at one point the speculative bubble bursts that can lead to very unpleasant deleveraging processes and can make aggregate demand drop and has some ugly consequences. The order of magnitude is small compared to the established financial markets, but I think it’s sufficiently big to reflect on its sustainability. Second, what is the motivation and attention of regulators and legislators? There is one problem attached to this phenomenon in particular, but also in general, there’s something that comes across as an innovation. And the legislators in the industrial world don’t want to be perceived as someone who stops innovation from bringing benefits and progress to the economy and society in particular, when they don’t fully grasp how this works, which is not too surprising for a very technical and new phenomenon like Bitcoin and crypto. And this holds in particular for the fact if you stop or ban something like this, the potential damage will never materialise, so you are exposed to the accusation that you stopped something and nothing has happened. If you enforce a vaccination and people don’t fall sick and disease doesn’t spread and kill many people, you might have a point later saying, `You see, nothing has happened, there was no need for the vaccination.’ That’s a reason. This logic applies to many innovations or potential needs for action for regulators and legislators. And it’s an inaction bias of regulators [and] supervisors because of the threat of being an unsung hero. Imagine – I take this from a book, Black Swanby Nassim Nicholas Taleb, someone had introduced a law that the door to the cockpit from the passengers of a plane cannot be opened two days prior to the terror attacks of September 11 in2001. The attack wouldn’t have taken place, but the effectiveness of that measure would have never been recognised because the damage wouldn’t have been taken place. There’s an implicit inaction bias for regulators when it comes to the confrontation with how to deal with innovation.
46:40 Dominic Hobson: This is the Sherlock Holmes point. The dog that didn’t bark in the night is the crucial clue. I guess one reason that regulators haven’t yet worked out in detail how to regulate Bitcoin is that it’s actually intrinsically hard to do. You don’t have an issuer you can go after. You’ve got these very highly mobile exchanges as the main intermediaries. They can move from Hong Kong to Bahamas and back again in no time at all. Most of the activity is taking place peer-to-peer rather than through intermediaries other than the exchanges. So it’s actually quite difficult for regulators to find somebody to get hold of and regulate the issuer or the exchanges or the intermediaries. Is that another reason why regulation has been relatively slow to come into the … or to bring Bitcoin within the sphere of regulation?
47:36 Jürgen Schaaf: It might play a role, but if we are just talking about the feasibility of banning or controlling this, I think it’s not too convincing. So that’s detached from the question whether it should be done or not. If there’s a will, there would be a way. The idea that Bitcoin is completely detached from human beings who act in the network, in the distribution, custodians and the like, that’s a myth. There’s a group of people who of, five people who are eligible and they are known to change the core code. And you could address those people. That’s feasible. If you see, China was banning the mining, which was quite effective. You have the miners, you have the people who control this. There might be niches where everybody could escape, but you can make the production and distribution and the role of custodians so unattractive and unpleasant that it would be highly affected. It might not be completely possible to get rid of it, but the effectiveness of measures is much higher than proposed by the enthusiasts of Bitcoin. I’ll give you an example. There was a different way of dealing with sanctions on Iran. A couple of years ago, the Europeans lifted the sanctions against Iran and the US didn’t want to. There was an issue with how to deal with the financing of this. The Europeans tried to set up special purpose vehicles for just that purpose, to have trade with Iran on certain commodities and products. It was pretty hard to find people who would manage that vehicle because they were fearing that they get on a blacklist for the US for their entire life, affecting their families and the like. So that’s an extreme comparison but – and I’m not comparing one to the other – just saying if there’s a will, there is certainly a way to tame that issue.
50:06 Dominic Hobson: And there does seem to be a will now to bring cryptocurrencies inside the regulatory perimeter. Is your feeling they’re not proceeding fast enough?
50:16: Jürgen Schaaf: Well, yes, I should have mentioned that even earlier. You’re right. So if you have a look at the European Union, we have MiCA [the Markets in Crypto Assets Regulation] in place. So the European Union has made major steps in order to regulate the crypto market as such. It’s a bit silent on Bitcoin, I have to admit, but something has happened. If you make yourself aware of the way, how legislation is produced and developed and decreed in modern liberal democracies, it takes time. But that’s a prize for us that we are willing to take in order to make it sound and also to take account of the various perspectives, in particular if there’s something new. So I have my position on the innovative power of crypto or of Bitcoin, but the legislator has to make sure that many voices are heard, and that takes time. The Chinese authorities were much faster and much more effective in banning the mining of Bitcoin. But of course, the system is different, and by and large, I would say we are profiting from our way, how we are drafting legislation and regulation. So if you ask me personally, as someone who was dealing with this phenomenon for a couple of years now, of course I would have been happy to have that process faster. But I’m definitely willing to accept and appreciate the time it takes in order to make it robust and bring in all the different perspectives. It’s, of course, a bit unfortunate that this also allows lobbyists to have their influence.
52:11 Dominic Hobson: You’ve mentioned MiCA [the Markets in Crypto Assets Regulation]. If we look at what’s been happening in the United States, particularly with the Securities and Exchange Commission [SEC], which recently – the SEC – approved spot Bitcoin ETFs [Exchange Traded Funds]. This is supplemental to their earlier approval of Bitcoin funds three or four years ago, and Gary Gensler [Chairman of the SEC] made pretty clear that he didn’t really want to do that spot Bitcoin ETF. It was kind of forced on him by the court’s decision in the Grayscale lawsuit. We’ve also had the FCA [Financia Conduct Authority] here in the United Kingdom saying they will start accepting Bitcoin and Ethereum ETN [Exchange Traded Note] applications. Does this … Are they adopting a different position from Europe? And why do you think the arguments you’ve been making, which are very cogent, very coherent, are not resonating with the FCA in particular? The SEC made pretty clear it’s unhappy about it, but do we need regulatory consensus on what to do about Bitcoin around the planet, or is there a risk that we’re going to get regulatory arbitrage happening here?
53:27 Jürgen Schaaf: Complex questions. The approval of the SEC was unfortunate, if you will, but it can be explained by the developments that took place earlier. We warned already a year or so, one and a half or two years earlier, when there was the approval of the futures ETF, while the spot ETF was prohibited. You probably recall that. We criticised that with an economic argument, because there you saw the Janus-headed, the two-edged sword character, the Janus-headed character of this approach. You approved one part of it. The reason was the future price is less volatile, so consumers are more protected, and in a kind of a political compromise, also to give them something. But you stick to the prohibition of the spot ETF. Our argument then was an economic one, saying, by doing this, you signal to, in particular retail investors, that it’s actually something you don’t need to worry about. That’s what I mean, with a two-edged sword. So that was an economic reasoning and argument. What happened then to the SEC? And you can see that from the reaction of Gensler in his statement when the approval was made public. What happened was a reaction of the courts based on the formalities of how law works. So you gave the approval for the one, so it wasn’t … The lawyers couldn’t understand why this shouldn’t be the case then for the other. That was an unfortunate development that can be understood from looking backwards. But I wouldn’t say that Gensler and the SEC, by and large, would not be convinced about our arguments.
55:58 Dominic Hobson: Well, I was going to say, the fear you’re expressing there of a kind of respectability being lent to Bitcoin by the court decision and the SEC going along with it. We’ve seen some of the biggest asset managers in the world, Blackrock, Fidelity, Franklin Templeton and Invesco, they’ve all issued these spot Bitcoin ETF’s now, and they’ve drawn in a lot of retail investors who probably wouldn’t previously have been able to touch, or wanted to touch, a cryptocurrency.
56:26 Jürgen Schaaf: Absolutely. Absolutely.
56:28 Dominic Hobson: BlackRock pulled in US$13.3 billion, and Fidelity US$6.9 billion, and, unsurprisingly, the Bitcoin price went up. I mean, so you have kind of seen regulatory encouragement for asset managers to behave differently than they did previously. I mean, are they behaving irresponsibly?
56:49 Jürgen Schaaf: Let me add something. What was quite funny and contradictory in that respect. So when the approval was there and asset managers started to promote this big time, the influencers on social media who are making money with promoting Bitcoin and other crypto units, they were praising this big time. Although the original narrative of Bitcoin was that it was invented to challenge the established financial world, to challenge the banks, to challenge the big asset managers. And now, as it was pouring new funds into their business, they were praising Wall Street and its representatives for accepting the blessing of the crypto world. Now, asset managers, they have a blessing, a vetting by official institutions that they can act as facilitators for retail investors to purchase those, in my view, very risky and non-sustainable assets. So in case there’s at one point an ultimate crash or something, it’s pretty hard to blame them. And they also don’t take too much risk when they only provide the custodian service, take some fees, but they don’t have skin in the game. So in a bit .. In a way, it reminds me of the originate-to-distribute model prior to the big financial crisis, where financial intermediaries were issuing financial products that they were not holding on their balance sheet. When the whole system collapsed, they thought they were off the hook. The category of moral responsibility, in a way, in this context, it’s difficult to take. It’s difficult to take. I would again have more emphasis on strengthening financial education and the like, because one thing you also should not forget [is] that although asset managers make a lot of money with this, without taking too much risks, the creed of retail investors, when they hear `my cousin has made a lot of money with that investment,’ is also a variable that plays a big role. The willingness of professional intermediaries to make money is as good as the creed of retail investors to make quick money without working for it.
59:40 Dominic Hobson: I think if you ask most regulators what their ultimate purpose is, it would be to protect investors, and retail investors in particular. And I don’t think what I’m about to say is particularly contentious – I think the data bears it out – [which is] that the cryptocurrency markets generally are an environment in which retail investors supply the cash, professional investors collect the profits. And many people would say that’s a pretty accurate description of the traditional financial markets as well, with all their regulated intermediaries. Is it possible to come up with a form of regulation here which protects investors, but doesn’t suppress the useful innovations which Bitcoin and the various technologies it’s produced – tokenisation in particular – and also keeps the activity in this area above the surface. That looking out for that dog which doesn’t bark in the night we were talking about earlier. There is a risk here that if you over-regulate this, you drive it underground, people are driven offshore, you get the opposite of the intended effect. There is a balance to be struck here somehow. But if your guiding star is protecting investors, do you not sense that maybe regulation is proceeding down the wrong path here by legitimising those professional insiders?
01:01:04 Jürgen Schaaf: Yeah, I think you described the dilemma quite well. There is a risk of over-regulation, and I would clearly distinguish the underlying technology from the application. So let’s say blockchain and distributed ledger technologies, which might have a potential that could be materialising in the coming years or decades, that remains to be seen. So that’s one thing. The other thing is the usage and investment into Bitcoin, which I think is a special case and needs particular treatment. I’m quite critical about that. And the best way to deal with that would be transparency. So people need to be aware of what it is, and regulation should play a role there. If it’s not generating any cash flow, if it’s not generating any interest, no dividend, if it’s not used to live in, like when you invest in real estate, not … it cannot be used in the industry for production, like raw materials, then it shouldn’t be treated like these things. The closer it comes to, in my view, is gambling. So lottery, casino and the like. If you are lucky and there’s an upswing, you might make some money with it, but there is no guarantee that this happens. And the comparison with traditional finance is actually wrong. If you look at the development of financial markets over the last 100 years or so, if you have bought shares or an index of a certain economy in the Western world, if you exceed ten to 15 years, you are positive as an investor, big time. So there are ups and downs, but the trend over time is beneficial because there’s an attachment to the real economy and the growth dynamics of the industrial industries. Regulation could be, if you look only on the investment part, I would say comparing it to gambling makes sense. Treat it, tax it like gambling. But if you augment the dimension and have a look at for what it is used, in particular illicit activities, if you also have a look at the environmental damage it causes, without having any additional benefit [other] than the gambling aspect, you could go further and be a bit more restrictive as regulator and legislator. But it would be certainly [be] beneficial if regulators would talk to each other and would have an agreement on the key principles and avoid regulatory arbitrage.
01:04:14 Dominic Hobson: You’ve actually described that – you’ve, I think, put a number on that – wider environmental damage. You were not referring there to the climate impact, but just the wider environmental damage to the financial system. So if cryptocurrencies are valued at US$1.5- 2.5 trillion, that’s a pretty accurate measure of the social damage which they might cause if they imploded. Rather in the same way that regulated banks imploded in the 2007-08 great financial crisis. They appear to be making amazing profits, but those profits actually turned out in the end to be pure risk, and that cost fell on the taxpayers. Do you think we’re looking at a similar risk here if the cryptocurrency markets eventually implode, and we can talk a bit about what we think might happen over the next year or two, but have I summarised your view accurately?
01:05:09 Jürgen Schaaf: Well, the order of magnitude of the crypto universe is, to my knowledge, much smaller, of course. So the potential damage of a complete implosion should be smaller, in particular, as long as there is not so much leverage involved. To my knowledge, it’s not … .
01:05:38 Dominic Hobson: There is leverage, but less than in the banking system ahead of 2007-08, that’s for sure. Yeah.
01:05:44 Jürgen Schaaf: So there might be some leverage. It might be hidden. If it’s on a retail basis, you don’t know, probably. But the order of magnitude is most likely very different, and it’s getting really ugly when you have big leverage involved in the implosion of a speculative bubble. You could have negative impact via the wealth effect. When people realise that what they assume, what they have in their wallets, based on the inflated value of the crypto unit, if this implodes, then they realise they are much poorer than they thought, they start to save instead of consuming and investing. This might, on aggregate, have an impact, but this is pretty hard to calculate and predict. The good thing is, different from a banking crisis, of which the core business is providing credit and loans to the real economy, this is probably not the case. Having said that, that’s not a reason not to deal and tackle the issue.
01:06:52 Dominic Hobson: What do you think might precipitate Bitcoin into a death spiral down to its fair value, which you put at zero? From what you’ve said, I assume it’s when the flows of money cease to come into it, partly because of the wealth effect and other phenomena you’ve just described. But Bitcoin’s proved amazingly resilient in surviving all sorts of things which ought to have called it into fundamental question, not least of which is all these thousands of imitators which are out there, all of which are to all intents and purposes dead. And I assume you’d agree we can just forget about those. But there are lots of failed Bitcoins out there. I wonder what is going to happen when – and this is seen as a positive thing, that there are only 21 million Bitcoins ever going to be in existence, and that’s what gives it its inflation-busting power, as were talking about a minute ago – but when those 21 million are all out there, how is anyone going to make money out of a speculative asset? You will have the miners carrying on validating transactions and getting some fees out of that. But a lot of that speculative force, that there’s new waves of money, the expectation that there’s a supply of Bitcoins to going to keep coming, that will have gone away. What’s your feeling about what will tip Bitcoin into a death spiral, and when do you think that might happen?
01:08:24 Jürgen Schaaf: That’s a good question. Let’s say there are two elements. The structural death of the inflation of the bubble will be when the inflow of money will come to a halt. It’s hard to predict when this will because I would assume there’s a lot of manipulation inside. If you have something like the view of an approval of the spot ETF [Exchange Traded Fund], for example, accompanied with a huge advertisement, promotion campaign of the influencers, the industry, the lobbyists, that attracts new inflows, that’s hard to predict when this comes. When you have then an expansion of channels that attract inflows, let’s say in emerging markets, that you come up with asset managers that go on other places and manage inflows. That are ways how new inflows could be generated. If the assessment that it’s a speculative bubble is right, this will come to an end at one point. Because similarly to the supply of Bitcoins is limited, the number of greater fools will also come to an end at one point. When this is the case, no one knows. Structurally one can predict that there will be an end when the inflows stop. The needle that pricks the bubble, that’s hard to identify.
01:10:18 Dominic Hobson: But it does imply that what’s keeping Bitcoin alive is it needs to keep manufacturing greater fools, as you say.
01:10:29 Jürgen Schaaf: That’s my conviction indeed. And one thing could be if, let’s say there are a couple of big players who are assumed to be manipulating the price. If one of them fails, that could have a huge impact. But, yeah, to predict a precise date, it’s probably not possible.
01:10:58 Dominic Hobson: Do you think … I mean, one thing Bitcoin is not is a Ponzi scheme, but we’ve seen plenty of Ponzi schemes down the years. Which do you think is likely to have greatly more social damage? Do you think a Bitcoin implosion will have a worse effect than, say, the Madoff Ponzi scheme on the wider marketplace?
01:11:18 Jürgen Schaaf: Yes, I think so. I’m not too familiar with the Madoff case, but I think he was getting money not so much from the retail side but correct me if I’m wrong. But by now, the new inflows over the last year, by and large, came, according to the big asset managers that collected the money, came from the retail side. And that gives another blow and hit to the trust that the society has in the robustness of our financial system. Because once the bubble bursts, the retail clients who will lose money will not make a difference between those who warned [and those who did not], will not make a difference between the good guys and the bad guys. They will feel betrayed, and they will actually see it as a repetition of the financial crisis, independent of how big or small the damage in social terms will be.
01:12:33 Dominic Hobson: Oddly enough, I think you can see some of the same private banks, wealth advisers who put their high net worth clients into Madoff, are in fact providing services for those same clients to trade Bitcoin and Ether. There are possibly some similarities there which have just occurred to me, talking to you. Lastly, could we talk about some wider issues here? The policy response, I’d call it, to the lessons which Bitcoin is reminding us of. And the Bitcoin enthusiasts would … The original enthusiasts – and you’ll remember from reading Nakamoto’s original paper – [ said] this was conceived as a solution in the aftermath of that financial crisis back in 2007-08. ‘But, oh, all these governments issuing fiat currencies had debased them over the years and a pound or a euro or a dollar wasn’t worth what it was 20 years before.’ Now .. Whether or not Bitcoin is a good answer to that question, I think it is a real one. I mean, the question is valid, is it not, would you say?
01:13:48 Jürgen Schaaf: The critical voices raised after the great financial crisis were valid. There can be no doubt about it. The system had its flaws. There were products, business models that were flawed. There was greed, maybe even worse. And the damage was huge and it cost a lot of taxpayers’ money. There’s no doubt about it. Everybody with a bit of sense realises that there were issues. Now the question is, do you need to replace the entire system with something that is not tested, not even theoretically, when you realise there were flaws? Or do you repair the flaws? If you have an accident on the highway because you have a flat tyre, does this mean that you need to get rid of all the cars, all the streets, and come up with a completely new logistical system for society? Probably not. The idea of Bitcoin as answer to some of the weaknesses of the established financial system is appealing. And it’s no surprise that the enthusiasts come from engineers who find the technology approach very innovative and appealing, and also from some political camps who find the political idea of establishing a means of payment that is independent of the governments, the central bank and the financial system. But strangely enough, I’m not aware of any economist or expert in monetary policy, for example, who is supportive of the counter-approach. The lack of economic knowledge played a role in development of this counter-approach, and it’s probably one of the reasons why it has already huge theoretical flaws and has never managed to work and deliver on its promises. So again, the critical voices addressing the issues with the financial system as we knew it, they were valid, and a lot of measures have been undertaken since then to address the issues. But it is by no means a justification to replace what we have now with Bitcoin crypto.
01:16:31 Dominic Hobson: Let’s just linger on some of those theoretical flaws you’ve identified. Somebody like me, looking at the theory behind Bitcoin, sees it as a rather naive application of the quantity theory of money. It didn’t appear to pay much attention to velocity of money as a factor in maintaining stable financial conditions. It didn’t appear that interested in the risk of tipping economies into these deflationary spirals if you have too little money. Are those the type of theoretical flaws you’re talking about?
01:17:03 Jürgen Schaaf: Yeah, these are quite common approaches or theories that are known. Quantity theory of money – in practical monetary policy and economics, this doesn’t play a role anymore, for various reasons. Now we see some revival of the ideas that say that if you have higher inflation rates, times of higher inflation, accelerated inflation, the quantity of money may play a role, but in times of low inflation, it actually doesn’t matter so much. But if you are not into that field, be it academically, theoretically, or a practitioner, the rationale of the quantity theory of money is quite appealing. But our financial system, our monetary system has become much more complex, and that’s … It’s not really helpful to just dwell on that. The other thing is, the idea of having a money, or base money, that is deflationary by nature, might be appealing for the individual that is invested. But as you say, this was the reason why we needed to get rid of the gold standard. We were having very dynamic economies. We were adding growth. And these economies, the firms that were growing, increasing productivity, were needing liquidity. And if you can’t expand your monetary base, you go into a deflationary spiral with all the negative impacts that we know from the late 1920s. So the influencers who promote the perceived benefits of Bitcoin, they tend to confuse the listeners and retail clients with some appealing theories, but actually, they are not very much applicable nowadays.
01:19:22 Dominic Hobson: One final question for you, Jürgen, which is, is Bitcoin a symptom of wider social, political, economic failures in Western markets? And I’m not suggesting here that voting for Donald Trump or the AfD [Alternative für Deutschland]is necessarily the same thing as being an enthusiast for Bitcoin, but they might both be expressing some kind of malaise – a loss of trust in established financial institutions, by which I mean central banks as well as commercial banks, and a wider loss of faith in democracy, in elected parliaments, in the ability of finance ministers to get things right, a loss of confidence in large corporations to do the right thing. And if so, is there an opportunity here to absorb a lesson from Bitcoin, which is that if you don’t take policy decisions of your own, the risk is that people might come up with a solution which is, shall we say, sub-optimal? And is there something which central banks can do to help restore public confidence in the socio-political system of the Western world more widely? And I’m thinking here specifically of central bank digital currencies [CBDCs]? Could those be a kind of knock-out blow to the cryptocurrency sector, in the sense that they create a form of trusted currency, which is well adapted to e-commerce, which is programmable, which can fulfil certain social functions? Is there an opportunity which has been brought to our attention by Bitcoin to actually do something to help heal and restore our fractured societies?
01:21:14 Jürgen Schaaf: I hesitate a bit to bring the two things together. I would certainly agree that the emergence of Bitcoin, the appetite to believe in its narrative, and the degeneration and adapted narratives that it produced, is certainly based on the disappointment and dissatisfaction of huge parts of the societies and democracies have, with the way governments, the state or democracies have worked in the last decades or so. And it has been accelerated by the power of social media, with all the protagonists that they have. And it has produced something that is misleading and, in my personal view, it’s more damaging than beneficial. The role of central banks I would see slightly differently, because it’s not really part of the issues that democracies have, because the central bank is taken out of the democratic process. There’s a mandate given to technocrats that they have to fulfil, accountable to the people, at least in Europe. And it’s not so much prone to polls trying to please. There’s a clear mandate most of the time. The issue with CBDCs? I wouldn’t say it’s an opportunity to bring something better than Bitcoin for example. I would detach it from that. There is an obligation for central banks to deliver on that mandate that they have, which requires trust when they react to developments that we see. That is the withdrawal of cash as a means of payment in the industrialised world, that’s happening. And we need to continue to provide central bank money also to the citizens, and therefore we need to bring something as a complement to cash. As the role is getting smaller, we continue to provide cash, but the importance is getting smaller. That is supposed to provide the same level of trust, the same useability as cash did in the past. So there’s an obligation to react to something that we cannot deny, trying to serve the citizens in this context as good as we did before. One important thing there is the respect, and we have to honour, the wish for privacy that people have. So the ECB [European Central Bank], for example, is doing it at most when we develop a digital euro to implement the highest level of privacy, what we can do technically. So there’s an obligation. It’s less an opportunity to show that we could do better than Bitcoin. I would detach the two a bit, but there’s a very strict, tough obligation for us to deliver in order to keep the trust that the people rightly demand.
01:24:49 Dominic Hobson: Trust and privacy. That’s a great note to end our discussion of Bitcoin and the future of digital money more generally. Jürgen Schaff, thank you very much for spending so much time with the members of future of finance and sharing with them your thoughts on Bitcoin. Thank you very much.
01:25:09 Jürgen Schaaf: Thank you, Dominic, for having me.
