Bitcoin May Lack Economic Anchor But It Isn’t Relevant

This is not empirically true on the short history of bitcoin. In the past, buying bitcoin when the price was falling has been as attractive as buying it when it is rising. But Taleb made an economic claim, not a statistical one.

The first thing to note is that there are many other “transition-driven” assets without an “economic anchor”. Art, diamonds, gold and many other things have value only because other people value them, not for any direct economic use. One particularly important contagion-driven asset that lacks an economic anchor is the US dollar. Unlike bitcoin, it has a strong uptrend. If the dollar is falling due to inflation, it is likely to continue to fall. No one buys the greenback because it is cheap during inflation or sells because it is expensive during a depression. The opposite happens.

The dollar has something that bitcoin does not, which is a government and banking system that sometimes acts to stabilize its value. But it is not an anchor, and the US Federal Reserve does not seek to return the dollar to pre-inflation values. Rather, it is an engine to prevent the ship from drifting too fast. If the dollar is rapidly losing value, the Fed will generate forces that can slow the decline, but not reverse it, to bring it back to its previous value.

The world’s primary reserve currency dropped any economic anchor in 1971 when President Richard Nixon abolished the gold standard—and that was only a loose anchor for gold, which itself lacked an anchor—and a decade After the mismanagement of the U.S. a strong belief was established that its value would not fade away too quickly to make it useful for transactions and savings. That confidence was shaken in the financial crisis of 2007–09, but not inflation because of fears of institutional collapse. Another major currency, the euro, went through an even deeper crisis from 2009 to 2014, driven primarily by fears of government and central bank defaults.

This is the world in which bitcoin was born and gained trust among technophiles, the financially oppressed, and skeptics of the government and banks. Bitcoin was a lifeboat for those thrown overboard by a government ship, and all but failed due to the lack of anchorage in the traditional financial system. Lifeboats do not need anchors.

However, as bitcoin’s value and acceptance grew, it acquired an initial economic anchor in the form of the belief that some fiat currencies and financial institutions would be unattractive enough for significant demand for bitcoin transactions and savings. Later, as crypto projects offered actual services to interested customers, the value anchor for bitcoin became the belief that it would be a major store of value for the crypto-economy and a main exchange currency alongside the traditional financial system.

Over the past two years, progress in the crypto-economy has been almost as expected, without major successes or failures. It is the traditional financial system that has been hit by pandemics, lockdowns, supply chain issues, aggressive fiscal and loose monetary policies, political dysfunction and threats of war. Therefore, it seems to me that the volatility in the number of dollars people pay for bitcoin has more to do with uncertainty about the long-term value of the dollar than a re-evaluation of the prospects of the crypto-economic sector. When the price of bitcoin falls in dollar terms, it doesn’t say much about whether bitcoin is cheap or expensive, but it does suggest that people are more confident in the dollar, perhaps due to anticipated Fed monetary policy tightening. Due to lower expectations of government spending, the fear of pandemics and war is also decreasing.

Mainstream financial markets give their opinion on such things through interest rates, equity volatility, exchange rates and inflationary break-even rates. These are good indicators of mediocre views. The bitcoin and crypto markets help us understand the 5% of contradictions, the opinions of skeptics, technology experts and the financially oppressed. Wise investors will listen to both.

Aaron Brown is a former Managing Director and Head of Financial Markets Research at AQR Capital Management. He is the author of ‘The Poker Face of Wall Street’.