Friday, December 15, 2017

A question on the role of Bitcoin in the financial system

A question on the role of Bitcoin in the financial system

These days everybody is talking about bitcoin. While I am no expert in digital currency and economy. I do have to think hard as I believe bitcoin will ultimate impact tech stock in general. I am learning and asking question about bitcoin everyday as I read so many related news. This post is more like asking questions then trying to express any viewpoint.

I am not so concern with blockchain as a technology which attempts to improve transparency and accuracy of transactions in general. Whether blockchain is the ultimate version of the necessary technology or just a transitional first step, it's good stuff. What I am more concern with is the rapidly appreciating phenomena of bitcoins or other cryptocurrency causing the opposite of what bitcoin is trying to achieve. Again, this is a question from a novice rather than a challenge to bitcoin.

Bitcoin was inspired by the 2008 financial crisis to by pass financial institutions so to reinstall transparency in financial practice. It is a currency which we cannot "print more". However, as far as I could tell as an average person, the real issue with 2008 crisis was the non-transparent asset repackaging of low quality financial asset and falsely beautifying them into high quality asset.  The transactional mechanism of US dollar has little to do with the financial crisis. In the few years before 2008, basically we have financial institutions packing low quality sub-prime mortgage into credit default swap (CDS). If we drill down one more step, the issuing of these sub-prime mortgage was about overflowing of cheap credit driving unqualified people taking on mortgage bigger than they can handle. So, the real evil in our financial system today is really cheap credit! And cheap credit comes from our need to drive economic growth.

Credit in the right dosage is what's driving economy. It gives people the necessary financial support so they can commit themselves into development of new tech, new products or new business rather than being tied down into day to day regular operations. Effectively through the credit system the society sponsors those who have good ideas and skills to develop tools and practices that further advance the overall productivity of our economy. In return, society in general are benefited. So the right amount of credit is something modern economic development required. Creating credit beyond the base asset in the society is like creating a promise in the future that someone will pay the people to develop new technologies. Thus the de-pegging of US dollar from gold in 1971 help drove substantial economic growth in desperate time:

“Most economists now agree 90 percent of the reason why the U.S. got out of the Great Depression was the break with gold,”
Liaquat Ahamed, Lords of Finance

I like to say that the 2008 financial crisis was largely a result of overdosage of cheap credit. Perhaps it is the result of over printing of fiat currency. However, printing money is just the mechanical part of the process. The real cause is the over use of financial stimulation to drive our economic growth.  Such over dosage of economic stimulation, seeping through greedy financial institutions, into greedy and naive individuals was the real issue.

Therefore the issue with 2008 financial crisis was more about over simulating economy through the monetary policy.  Of course the de-pegging of dollar from gold enable the over simulation but it's nto the real cause of the issue. In theory, we could have fiat currency, totally de-pegging from gold and being potentially inflationary, perfectly driving economic development given the right monetary policies.

From a technology perspective, blockchain is a smart use of internet and crypto technologies to create a more efficient, more transparent and globally check and balanced currency transactional system. Bitcoin, as a specific simple implementation of blockchain to be a form of currency, is just a more transparent replacement of cash for more efficient exchanges. I do not see it as a form to resolve bigger issues such as those in 2008 financial crisis despite that bitcoin was inspired by the very incident. Blockchain in general, may play a bigger role in enforcing transparency of details within the complex financial engineering products and eventually enabling policy maker to see through the actual risk level in credit level. However, bitcoin play a rather small part of the overall financial system.

On the other hand, the current crazy of bitcoin exploding is reminding me of the various bubbles I have gone through in my experience since 1987. One may argue that it's a "developing" currency  therefore demand is driving the price appreciation in short term. However, it sure does not feel like an orderly appreciation. Such sheer speed of appreciation may scare the ultimate user away if one day it burst in big explosion. Fortunately I believe bitcoin is too small to have any real impact to the global financial system. However, as an investor, I need to be extra careful for what negative emotion it may cause to the tech sector in the equity market.

Appreciate anyone laving comment and correcting what I may be missing or logically incorrect.