It will probably come as no surprise that Paul Krugman is a cryptocurrency critic. The Nobel-winning economist and New York Times columnist is a known skeptic of laissez-faire alternatives to government interventions, and it makes sense that this doubt would carry over to distributed digital money. In 2013, he went so far as to claim that "bitcoin is evil" because he dislikes the "libertarian political agenda" he perceives at its core.
Recently, Krugman issued a more measured take on why he distrusts cryptocurrency. His opposition boils down to two things, transaction costs and volatility, which I'll get into more in a minute. Admirably, he admitted that he indeed could be wrong, and issued a challenge: "if you want to argue that I'm wrong, please answer the question, what problem does cryptocurrency solve?" I am happy to help.
Krugman begins his article with a high-level sweep over the contours of monetary history, starting with metallic standards, and then banknotes, to central bank-created "fiat" money, and finally digital payment systems managed by third parties. He says that the prime mover of monetary destiny is a currency's propensity to reduce the frictions of making a transaction. Governments are so superior in the creation and management of money, in this view, so it is natural and indeed beneficial that we have evolved this standard. Cryptocurrencies challenge this government monopoly, so they are therefore undesirable or perhaps even "evil."
As he puts it: "cryptocurrency enthusiasts are effectively celebrating the use of cutting-edge technology to set the monetary system back 300 years. Why would you want to do that? What problem does it solve? I have yet to see a clear answer to that question."
So, what is cryptocurrency good for, anyway?
Contrary to Krugman's argument that cryptocurrencies present an insurmountable level of transaction costs to an exchange, they can actually be the only remaining option when fiat currencies have failed.
The reason that bitcoin is so attractive as an alternative currency is because it is a censorship-resistant means of payment online regardless of what happens to existing financial institutions. The blockchain technology at its heart replaces the need to rely on a trusted third party–like a central bank, or a commercial bank, or a credit card company—to make payments online. Transfers are facilitated by a network of distributed computers that blindly run the code to create new currency at an expected rate (which means no unexpected inflation) and transfer money between parties. So long as you hold the cryptographic private key to your cryptocurrency files, there is nobody on Earth that can inflate away or confiscate your money.
For one timely but tragic use case, we can look to the ongoing monetary crisis in Turkey. Last week, the lira began plunging in value to record lows after U.S. sanctions and rocky responses from the Turkish government spooked investor confidence in domestic markets. This comes on the heels of years of poor monetary and fiscal management by the Turkish government. Things had deteriorated so much that the economists and financial journalists who reported honestly on the monetary situation feared retribution from agents of the government. Now, the Turkish economy is caught in a downward spiral of inflation, capital flight, and probable capital controls.
Krugman argues that "fiat currencies have underlying value because men with guns say they do. And this means that their value isn't a bubble that can collapse if people lose faith." The Turkish government has a lot of guns indeed, and yet the lira is still losing more value each day.
People will try to save value in the face of an inflationary event through any possible means. They will try to exchange their increasingly valueless domestic currency for any kind of asset or safer foreign currency so that they can salvage whatever value for themselves that they can. But governments try to crack down on this kind of thing, and people of lower income classes often do not have the means or connections to monetarily "get out" while they can.
This is a perfect use case for cryptocurrency, and in fact it is a route that others in Cyprus, Greece, and especially Venezuela have turned to in hard times. We can expect that others in Turkey may also turn to cryptocurrency.
Bitcoin is often dismissed as "volatile," and Krugman repeated this criticism. Yet bitcoin's volatility pales in comparison to nations in monetary distress and is therefore very attractive in those cases. As bitcoin use becomes more widespread, it is possible that its volatility will flatten out over time.
People in developed, stable economies with access to traditional banking options take it for granted that we will always be able to get the funds to make the payments that we want. But this is not the case in much of the world, nor is it always ensured for us.
So, to answer Mr. Krugman's question most simply: Cryptocurrencies are good for facilitating permissionless direct digital exchange when no other institution can be counted on to do so. The value of a cryptocurrency like bitcoin is therefore not entirely "[untethered] to reality," but rather is partially backed by the knowledge that a holder can always exercise this fundamental ability to exit.
Of course, in the grand scheme of things, bitcoin is an infant currency. There are a lot of kinks to iron out. It is true that bitcoin is currently much more volatile than established currencies like the dollar. A lot of people don't like the idea that other people would be given the ability to transact however they would like. They will surely dislike cryptocurrency for that reason. And there are technical improvements to be made as well. Right now, engineers are working on symbiotic technologies to interact with the bitcoin blockchain that will hopefully increase the throughput and affordability of transactions.
A skeptic may counter that bitcoin's use case as a "currency of last resort" does not justify its prevailing market price of several thousand dollars. Well, maybe not. But it is simply ignorant to claim that cryptocurrency has not presented a major innovation in the fields of money and commerce. If that innovation is as revolutionary a benefit as its proponents claim, then maybe that market price isn't as misaligned as it might appear to a neophyte. On a long enough time horizon, we may all be cryptocurrency holders.
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