What Paul Krugman got wrong about crypto

In mid-November, as crypto markets reeled from the collapse of FTX, Nobel Prize-winning economist Paul Krugman used a New York Times column to decry crypto assets. Despite his undoubted academic credentials, Krugman repeated a common misunderstanding in his attempt to understand crypto assets – conflating Bitcoin (BTC) with other cryptocurrencies.

Despite being the oldest, most valuable, and best-known member of this emerging digital asset class, Bitcoin has a unique use case that stands out from the rest. Therefore, it would make more sense to choose an asset with a more tangible benefit as your starting point to understand this asset class as a whole. For example, Filecoin provides storage for digital files, similar to Google Drive or Dropbox, but in a decentralized manner. This network allows users with excess storage to rent that capacity to other users for a fee. This fee is paid with the network’s local token, which is called Filecoin. This example is more representative of most cryptocurrencies: a network that provides financial incentives for services in a decentralized manner, with added efficiency and reduced costs due to the absence of intermediaries and central counterparties. However, Bitcoin is different.

But what exactly is Bitcoin? This seems to be another blind spot in Paul Krugman’s understanding. Bitcoin has evolved over time, both in terms of its technology, updates and improvements to its functionality, and its most prominent investment thesis. According to his column, Krugman accepts Bitcoin (and arguably other crypto assets) as a form of payment. This was, in fact, the stated goal in the white paper that launched Bitcoin in 2008, and it remained so soon after its publication.

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However, this thesis has evolved over time. Most importantly, in 2017, there was a huge debate in the Bitcoin community about whether to prioritize its functionality as a means of payment or its properties as a store of value. The will of the store of value supporters prevailed and the dissidents created Bitcoin Cash. The prevailing consensus since then has been that Bitcoin should seek to be a substitute for gold rather than fiat currencies, with the added benefits of greater portability and resistance to capture.

In light of these characteristics, Bitcoin, as Krugman wrongly suggests, has become highly sought after in extreme situations—like the war in Ukraine and the hyperinflationary crisis in Venezuela—by ordinary people, not criminals. As it turns out, Bitcoin has a long way to go before it can effectively establish itself as a true store of value – the first step of which would be to achieve greater price stability. In addition, there are other use cases in development. The necessary scalability improvements that allow it to evolve as a means of payment are left to so-called layer 2 solutions such as the Lightning Network. One of the most recent updates to Bitcoin, implemented in September, allowed the creation of tokens within the network. Crypto has continued to evolve, but Krugman is still hanging on to his 2008 white paper. The failure of Bitcoin as a means of payment does not mean the end of Bitcoin itself, nor does it mean the end of all cryptocurrencies.

Building on this misunderstanding of the general nature of crypto-assets, and Bitcoin in particular, Krugman concludes that, while internally coherent, they are completely wrong, such as his argument that the crypto-currency industry will not survive. an increase in the level of regulation. Discussing a comparable topic in 1998, Krugman mistakenly said, “By 2005, the Internet had no more impact on the economy than the fax machine.” His bias against cryptocurrencies can lead to inaccurate predictions, such as his now infamous quote about the future impact of the internet.

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A well-designed regulation for companies providing services related to cryptocurrency assets is welcomed by the vast majority of industry participants and is actually seen as a development that will boost confidence among investors to encourage mass adoption of this technology. Furthermore, many of the services these companies offer are financial in nature, and as a series of events this year have shown us, there are contagion effects. This in itself justifies the need for more extensive regulation. As Krugman notes in the first line of his article, “recent events have clearly shown the need to regulate cryptocurrency.” He was right about that.

It is likely that the crisis created by FTX will prompt regulators around the world to accelerate their efforts, ultimately helping to integrate cryptocurrencies and blockchain technology. Just as Krugman’s wrong predictions did not spell the end of his reputation, this crisis is not the endgame for cryptocurrency.

João Marco Braga da Cunha He is a portfolio manager at Hashdex. He received a master of science in economics from Fundação Getulio Vargas before earning a doctorate in electrical and electronics engineering from the Pontifical Catholic University of Rio de Janeiro.

This article does not contain investment advice or recommendations. Every investment and trading action involves risk and readers should do their own research before making a decision. The views, opinions and opinions expressed herein are solely those of the author and do not reflect or represent the views and opinions of Cointelegraph.

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