AMERICAN ENTERPRISE INSTITUTE

CRYPTOCURRENCIES AND BLOCKCHAIN: TECHNO-GOLD OR FOOL’S GOLD?

INTRODUCTION: PAUL H. KUPIEC, AEI

PANEL DISCUSSION PARTICIPANTS:

JERRY DWYER, CLEMSON UNIVERSITY

BERT ELY, ELY & COMPANY INC.

PAUL H. KUPIEC, AEI

HADLEY STERN, FIDELITY INVESTMENTS

MODERATOR:

ALEX J. POLLOCK, R STREET INSTITUTE

5:00–6:30 PM MONDAY, FEBRUARY 12, 2018

EVENT PAGE: http://www.aei.org/events/cryptocurrencies-and-blockchain-techno- gold-or-fools-gold/

TRANSCRIPT PROVIDED BY DC TRANSCRIPTION — WWW.DCTMR.COM

PAUL KUPIEC: Good afternoon, and welcome to AEI and to AEI online if you’re watching us remotely today. My name is Paul Kupiec, and I’m a resident scholar and the organizer of today’s event. Today’s session, “Cryptocurrencies and blockchain: Techno- gold or fool’s gold?” is particularly timely. The tremendous swings in the prices of bitcoin and other cryptocurrencies are, by now, daily news. Similarly, stories describing the potential for new national prohibitions and regulations on cryptocurrency trading in Korea, China, Japan, and other places are weekly events.

While the US Treasury studies the issue, Agustin Carstens, the head of the Bank for International Settlements, has already concluded that cryptocurrencies are inherently evil, and I quote, “a combination of a bubble, a Ponzi scheme, and an environmental disaster.” Moreover, Mr. Carstens says they are a threat to financial stability.

Still, there are many finance professionals who think that bitcoin and other cryptocurrencies are the future of money. No matter how much credence you may place in the old saying “money is the root of all evil,” it is important to understand what features make virtual monies like bitcoin, Ether, and other cryptocurrencies more virtuous than the national currencies in our wallets.

I’m grateful to have assembled several renowned experts at AEI this afternoon to discuss these issues. I am certain that we’ll hear a lively exchange of views on the future of bitcoin and other virtual currencies.

Let me begin by introducing my friend, former AEI colleague, and today’s moderator, Alex Pollock, who will introduce today’s panelists. Alex is a distinguished senior fellow at the R Street Institute. He was president and CEO of the Federal Home Loan Bank of Chicago from 1991 to 2004. Alex is an authority on a host of financial issues. I’m sure you’ve read many of his opinions on financial-sector issues that have over the years appeared in The Wall Street Journal, the American Banker, The Hill, and other prominent places. Alex is the author of “Boom and Bust: Financial Cycles and Human Prosperity,” numerous articles, congressional testimonies, and what is perhaps his most consulted work, “Pollock’s Laws of Finance.” You will have to ask him about that.

Please join me in welcoming our moderator, Alex Pollock. (Applause.)

ALEX POLLOCK: Thank you, Paul. Ladies and gentlemen, it’s a pleasure to join in welcoming you to a discussion of bitcoin on the anniversary of Abraham Lincoln’s birthday today. The Lincoln administration was notable for financial innovation, so we might wonder what Lincoln himself might have thought of bitcoin had he known of it.

We’re glad you’re all with us to consider the extremely interesting phenomena of bitcoin and the related other cryptocurrencies, its price behavior, and the underlying technology. As we all know, bitcoin has generated huge amounts of commentary, price forecasts in various directions, endless media talking, and even a Japanese singing group, the Virtual Currency Girls.

Although, of course, there is no coin as we know associated in any fashion with bitcoin, the media cannot help themselves from constantly picturing shining metal coins with Bs on them whenever they write or convey some show about bitcoins, which is to convey exactly the opposite of the central idea. It’s curious, isn’t it, how that has happened? The central idea being a non-redeemable accounting entry in an electronic bookkeeping system with no coins ever involved.

Now, bitcoin and similar cryptocurrencies are private systems meant to produce private currencies outside the control of governments and the governments’ central banks. This has a strong appeal to libertarian thinkers and to citizens of countries, especially in Asia, who may feel an even stronger desire to escape the monetary control of their governments.

Thinking for just a minute about the history of similar ideas, private currencies are nothing new. Nineteenth-century banks issued their own circulating notes, which were private currency. Local bank clearinghouses issued their own clearinghouse certificates as currency in times of crisis, which are private currency, and in the 1930s crisis, there were hundreds of experiments with what they then called scrip, or private currencies, issued, as we learned, by municipalities, business associations, companies, banks, local self-help organizations, local stores, and others.

Also accounting currencies are nothing new, like all the electronic debits and credits we’ve become so used to getting every day in our deposit accounts. But with those accounting money, with that accounting money in the bank, the bank at some point, if you demand it, promises to pay you in government currency, whereas, of course, bitcoin makes no promises to pay you anything ever.

Bitcoin’s central innovation, it seems to me, is thus to suggest a private accounting currency, which is also a fiat currency with permanent existence, unlike all of the other temporary currencies I mentioned a minute ago.

Now, one essential problem with private currencies, including bitcoin, is that governments may simply choose to put you under their control, whether you want it or not. Or even just put you out of business imposing through their sovereign force whatever penalties they choose in case you don’t obey.

As a historical example, suppose you tried to protect yourself in the 1920s and ’30s from the depreciation of the dollar by owning gold. Under Franklin Roosevelt’s executive orders, you had to just hand in your gold to the government, and if you didn’t, the government would impose truly enormous fines or even put you in prison or both. So we might think if bitcoin ever became a serious threat to the government’s currency monopoly, it’s a good bet that such sovereign actions would follow.

Of course, we all wonder what to make of bitcoin’s price behavior, the manic run- up, the steep drop afterward, and what now. Naturally, there are competing forecasts as always with the financial future. Nouriel Roubini, who made accurate forecasts of the depth of the 2007–2009 financial disaster, while speaking on an AEI panel, which I was chairing in the spring of 2007, says the price of bitcoin will go to zero.

On the other hand, there are bullish forecasts for renewed price appreciation well past the previous peak. Looking to its underlying value as a medium for financial transactions and doing the math of the number of transactions available, Richard Jackman and Savvas Savouri calculate a fundamental worth of $20 per bitcoin. Interestingly, that was the pre- depression price of gold, $20 an ounce, a curious coincidence.

Separate from the issue of bitcoin is, of course, the question of the underlying blockchain technology and what it may hold in all various areas. Well, our excellent panel is prepared to take on all of this. And let me introduce them in the order in which they will speak.

First will be Jerry Dwyer, who is professor of economics and BB&T Scholar at Clemson University and research associate at the Center for Applied Macroeconomic Analysis at the Australian National University. Jerry was previously director of the Center for Financial Innovation and Stability — those don’t necessarily go together, Jerry (Laughs.) — at the Federal Reserve Bank of Atlanta. He serves on the editorial boards of the Journal of Financial Stability, Economic Inquiry, and he was a founding member of the Society for Non-Linear Dynamics and Econometrics, which has just celebrated its 25th anniversary.

Next will be Hadley Stern, who is senior vice president and managing director of the Enterprise Services Group at Fidelity Investments, as we know, the largest mutual fund company in the United States. Since 2015, he has been managing the bitcoin and blockchain incubator at the Fidelity Center of Applied Technology, focusing on the disruptive potential of this technology. And Hadley is the holder of 10 patents for Fidelity.

Our third speaker will be Bert Ely, who’s been an independent and insightful consultant on banking and risk issues since he was an early and correct predictor of the savings and loan crisis and ensuing taxpayer bailout of the 1980s and through many cycles since. Bert analyzes conditions in the banking industry and monetary policy, including challenges arising from bubbles, the Dodd-Frank Act, housing finance distortions, the farm credit system, and most recently, cryptocurrencies and blockchain.

Our final speaker will be Paul Kupiec, who, as you know and as he said, is the organizer of this conference. Just before Christmas, Paul and I were having dinner and decided a bitcoin conference for February would probably be well timed, and we were right. And thank you, Paul, from all of us for bringing us all together today. Paul is a resident scholar at AEI, applying his innovative perspectives and iconoclastic analysis to the study of banks and financial markets, systemic risk, the impact of financial regulation on the economy. Previously, he was director of the Center for Financial Research at the Federal Deposit Insurance Corporation, chairman of the Research Task Force of the Basel Committee on Banking Supervision, and on the staff of the Federal Reserve Board.

Each panelist is going to talk from 12 to 15 minutes, after which we’ll give them a short chance to react to each other or clarify points. Then we’re going to open the floor to your questions. We’ll adjourn promptly at 6:30 p.m., at which point you’re invited to join us for informal discussion at the reception. And I’m sure we’ll have plenty to continue talking about.

So are bitcoin and cryptocurrencies and blockchain techno-gold or fool’s gold? We’re about to find out.

Jerry, welcome to AEI, and you have the floor.

JERRY DWYER: Thank you. Yeah. Given the dramatic title of the whole conference here, I thought, oh, that’s a really boring title that I have. But I’m going to comment a little bit on the price actually. It’s hard to talk about the exchanges without talking about the price, and they’re basically where the prices come from, the exchanges.

So this is the price of bitcoin on Coin Base, which is — in dollars, which is a big exchange in the United States. And, as you’re all aware, I’m sure, you know, the price has gone from — in 2010, you could actually buy 20 bitcoins for a dollar on — (inaudible). Not anymore. According to Paul this afternoon, it was $9,000. This morning, it was $8,000. You know, it moves around just a little bit.

Now, that looks like it’s — you know, it didn’t do anything for a long time, and then it went up a lot. That’s actually a common characteristic of graphs, where there are big changes in the levels. And so this is what’s called a proportional scale that the slope of the line is the same percentage change. And what you can see on this graph a little differently is that the price has been going up all along, not every year, you know, but most of the time it’s going up a little more — a little faster recently but not like some kind of hockey stick kind of thing. And I think that’s worth being aware of.

Now, a question that comes up all the time, and I get this question, too, is: So what’s a bitcoin worth? I’m going to give you the economist’s answer: This afternoon it’s worth about nine grand. That’s what it’s worth. If —

MR. POLLOCK: This afternoon.

DR. DWYER: This afternoon. I’m sorry. That’s what I meant. This afternoon it’s worth nine grand. It’s that simple. If it’s not worth nine grand to you and you own one, sell it. And if it’s worth more than nine grand to you, then you should buy one. You know, it’s that simple. That’s how much they’re worth. Now, that’s a smart-aleck answer, and I know that.

The question people are asking is this bigger question that economists are not really well set up to answer, which is: So what’s it going to be worth 20 years from now? Good grief. Here’s the issue that arises. There’s a famous quote, OK, which he tries to get away from but he can’t really, by Ken Olsen, who was the president of DEC back in the ’70s, and the quote is — he made many computers. That’s what they did, DEC. And he said, “There’s no reason why anyone would ever want a computer in their house.” (Laughter.)

Now, the truth of the matter is — I’m not going to break it out because it’s too hard sitting down — but the fact of the matter is the telephone that is in my pocket is 20 times more powerful than a super-computer was in 1979; that is, if you were a benighted faculty member off on an island and nothing else to do, you could rig your phone and do all your research on it, and it would be way faster than what you could have done in the ’70s. Now, it’s way slower than your personal computer, obviously.

But the point remains: If we think about something like bitcoin, where is it going to go? I don’t know, you know. If you’d ask me and I was around, you can tell, in the ’70s, well, do you think everybody’s going to be walking around with a super-computer in their pocket by the time you’re — you know, by the time you get to 2015? Well, that sounds really unbelievable, but it’s true, you know.

So where is it going to go? I think the fact of the matter is we don’t really know. I mean, the underlying innovation — and I’m not going to talk about it — the underlying innovation in bitcoin is the blockchain. That’s the underlying innovation relative to prior electronic monies. Now, that doesn’t mean it’s the only thing that matters. It just means it’s the innovation.

Now, I’m going to talk about exchanges partly because the prices matter and how they’re generated matters, and I think a lot of people aren’t really very aware of it. There are a lot of exchanges trading a lot of different currencies for bitcoins. This is a list of all the exchanges that I have price by price trades for, by currency, US dollars being the biggest with 60. Now, you might say, well, yeah, but how many of those exist today? Well, in December 31 of this last year, there were 18 exchanges trading bitcoins for dollars.

Now, they’re not all located in the United States, but it’s still quite a few. And, in fact, if you take that first column, there’s 183 different exchanges in that first column, which is the biggest ones, obviously. And there’s still 64 of those existed on December 31 — roughly speaking, a third of them. So some of them come, some of them go. That is the exchanges that operate, it’s nothing like the New York Stock Exchange or BATS or other exchanges where there’s a few of them. They’re trading, you know, and they’re very prominent. A lot of these are little ones. Coinbase is not a little one, but there’s a lot of them.

So how are these things organized? They’re different than like the New York Stock Exchange. There’s a flowing trade on the stock exchange in the US. You have to get a brokerage account with somebody, Fidelity or Vanguard, whoever, Merrill Lynch. You get an account and then the broker submits the trades for you and then he clears them. And it takes a couple of days to trade, clear them, and all of that.

These exchanges operate very differently. What do you do? You send them money, you give them money, literally, or you give them bitcoins. You can do either one. They’ll take either one. And then you can trade. How much can you trade? Well, it’s going to depend on the value of your account. They’re going to let you trade based on that. And maybe a little bit more than that some of them, but it wouldn’t necessarily be very wise — on their part, that is.

And so you deposit funds. Now, the thing is actually this is really different than what Satoshi Nakamoto thought about when he brought up bitcoin. That is, the whole idea is this would be trustless. If you send your money off to Coinbase, you’re trusting them. If you sent your money off to Mt. Gox, you are trusting them that they would return something to you, you know. They’re not a bank. But, nonetheless, they require part of your assets, and it’s definitely not trustless by a long shot. So it’s really different, and it’s worth being aware of that because it means that they’re operating like exchanges.

Now, trading on a blockchain is different. That’s basically what Nakamoto thought about. You make a trade with a person, and the transaction is recorded on the blockchain. Most of the transactions on exchanges, as far as I know, are not recorded on the blockchain. There’s a lot more transactions that are done that way. It’s much cheaper. That’s what I’m going to show you in a few minutes. That’s part of the research we’ve been doing lately.

So the blockchain is trustless, and it’s got all these other advantages. But on the other hand, it may not be so cheap. Basically, what we did was we estimated bid-ask spreads for various exchanges, for dollars, for euros, and we used an estimator that’s based on what’s called bid-ask bounds. Basically it’s you’re bouncing from the bid price to the ask price, and it sets up a certain kind of serial correlation in a series. You know, either you already know about it or what I just explained to you, you say, whatever. (Laughter.) I know that.

But, basically, it’s a reasonable estimator of what the spread is, all right? And so this is the spread for the large exchanges that were in that other — that still exist in that other table or the very largest, the top 10 or 12. And what you can see is — what I want to highlight is — is that the spread is a percentage of price. That’s what’s on the vertical axis, and the percentage is really small. It’s nowhere near 1 percent. And so it’s quite inexpensive in that sense.

Now, with the price up as much as it is 1 percent actually could be quite a lot at $16,000, you know. It would be $160. So what are the spreads in dollars, all right, because you can calculate them that way too. There are advantages and disadvantages of doing it both ways.

What you can see on this graph is it’s increasing at the end. At this point — that’s December — at this point, we don’t know if that’s real or not. See, because the thing is prices went up a lot, and that actually messes around with the estimator. It can make it look bigger when it’s not really. But even if it is bigger, what you can see is — and I’m having trouble seeing it through my nameplate — is it’s $15, you know. So that’s 1 percent actually of the $16,000 that was trading that so that’s not really big. It’s not really small either.

Here’s prices on euro exchanges, just gives a comparison, you know. And they’re running $10, $15, and you have to figure roughly speaking, at the moment, the euro’s about $1.20, maybe a little more than that. And so you can take this exchange rate and just, you know, divide by that to get the dollars or multiply the dollar one.

This is a different setup. This is something called local bitcoin. This is actually on the blockchain. This is no joke. An undergraduate student of mine is using this data from last semester, right? What does he do? And what do these people do? Basically, it’s like Craig’s List for bitcoins. What people do is they say, I’m willing to buy bitcoins at this price. I’m willing to sell bitcoins at this price. And they list both of those, you know, and then they tell you where they’re willing to do it. Like they’re willing to do it in Clemson, South Carolina, or they’re willing to do it in Greenville or they’re willing to do it in Washington, DC, or wherever, all over the US, all over the world, really, not necessarily in dollars all over the world but — and so how big are those spreads?

Well, if you look at those spreads, they’re much bigger. Why are they much bigger? There’s a couple of reasons they’re much bigger actually. One reason they’re much bigger is because the person who’s buying and selling bitcoin is operating as a dealer, like this undergraduate student of mine — I mean, he’s a smart guy. He wanted to be flat at the end of the day; that is, he wanted to own no bitcoins at the end of the day because then he had the price risk overnight, while he was asleep, you know, and $1,000 here, $1,000 there, and pretty soon you’re broke. And so the spread is going to be bigger. And that’s — I don’t know that that’s the major explanation, but it’s part of it.

So the point is — why do people use exchanges? They’re cheap. You know, they don’t really fulfill the — I mean, because I know I have some people, you know, they go, oh, it’s not really the idea. No, I know that, but it’s cheap and people migrate to cheap things. I’m getting short on time. I actually thought I was going to be short on things to say. I’m sorry. (Laughter.) I’m not kidding you. OK.

MR. POLLOCK: I’ll give you five minutes for one bitcoin. (Laughter.)

DR. DWYER: OK. So regulation is a big deal, and I thought this wouldn’t be very interesting. So I’m in the Atlanta Airport this morning. What do I see? Christine Lagarde regulation of bitcoin is inevitable, of cryptocurrencies is inevitable. That was the big thing in Davos. That’s what she talked about no less. Why? Arguably the major thing is its money laundering stuff, you know, anti-money laundering, know your customer, Mt. Gox, the exchange in Japan that sort of was big for a while. Got in trouble with the US government and FINCEN for that. I mean, it’s a big issue.

I want to mention one thing. How much time do I have left?

MR. POLLOCK: You have two minutes.

DR. DWYER: I have two minutes. OK. I want to mention this anyway. So anyway, this is — well, because this is — there’s a sense in which this is a waste of time. Either you’re going to like this or you’re going to hate it. So Stiglitz was quoted in the newspaper a couple of days ago. He wants to ban bitcoin and cryptocurrencies in general. Why? Well, they serve no socially useful function. It’s like, what? I mean, he may think they serve no socially useful function, and maybe they don’t, you know. It’s like one of my sons and I, we play Need for Speed, which is a computer game. I mean, it doesn’t serve any socially useful function, and who cares? (Laughter.)

You know, it boils down to whether you’re going to permit things or whether you’re going to let people do what they want to do and only if it’s really bad do you stop them. I mean, the money laundering stuff is — I think it’s overblown, but it’s serious, all right? The different kind of regulation is regulation for systemic risk. And, you know, Alex mentioned this actually, that somebody takes this seriously. I don’t. I guess that’s about all I’ll say about that.

How about investor protection? That’s the other possible explanation for regulation. There’s one thing really wrong with this. I don’t want to encourage anybody to think that buying bitcoins is investing, you know. I mean, there’s a big distinction between investing and speculating, you know, and whether there is such a thing as speculation, but it’s speculation, you know. It could go to zero. I mean, you might want to have things — because you do run into this on the exchanges where there’s very little information available, and they may just — some of them — there was one actually five years, six years ago that was totally fraudulent. You know, so that’s an issue.

But the fact is people may lose a lot of money on bitcoin, and if they do — well, they do — it’s their money. So, concluding, bitcoin exchanges show how really lightly regulated exchanges can operate these days. With computers and everything else, they’re 24/7, you know. I can execute a trade 24/7, which I can’t do in US stocks. And I can clear it, poof. I don’t have to wait two days, which is a big improvement over three days. I think there’s really no obvious gains from the regulation to protect investors for sure. I think money laundering actually is a big issue. Thank you.

MR. POLLOCK: Thanks very much, Jerry.

Hadley.

HADLEY STERN: Thank you. So my name is Hadley Stern. I come from a division of Fidelity called Fidelity Labs, which is an innovation R&D group within Fidelity. And you may sort of ask yourself: Why would a company like Fidelity be so interested in something like bitcoin and cryptocurrencies?

And this really started about four years ago. The company at the senior executive level does a whole variety of what we call scenario planning. And there was a lot of interest about four years ago in the phenomenon of bitcoin. And I’ll do a little explanation of what I think bitcoin is, and maybe, hopefully, you’ll see why.

So I have a little prop here, which is a US dollar, which we all know is a dollar. And what’s really —

MR. POLLOCK: Hadley, excuse me.

MR. STERN: Yes.

MR. POLLOCK: We have to say that your slides aren’t up here, but are —

MR. STERN: I will refer to the slides when I get to them. This is a sideshow before the slides.

MR. POLLOCK: Oh, I see. Thank you.

MR. STERN: Yeah. So this is a US dollar, and what’s really interesting and powerful about this is everyone knows right now that I own this US dollar. When I hand it to Bert and give it to him, everyone knows that Bert has that US dollar, and he has taken it. And when Bert gives it back to me, we all know that this happened.

Now, if I told Bert I have a picture on my cell phone of one of my kids and, Bert, I’m going to text it to you and I’m only going to text one copy of that photo of my daughter and I’m going to delete the copy of the picture on my phone and not send it to anyone else, Bert would look at me like I was crazy. How could I prove that I didn’t send that photo to a million other people? How could I prove that I didn’t keep it for myself?

This is the breakthrough of bitcoin, which was really the first blockchain. What bitcoin does is it allows digital objects to act like physical objects. So this is a physical bearer token, it’s printed on special paper, it’s stamped by our government, we all agree about it, and we can see it. Bitcoin is a digital bearer token.

So the reason why Fidelity was interested in that is that is a powerful innovation. You can debate whether bitcoin should be worth anything, and it’s a really interesting discussion. It sort of in some ways doesn’t matter. There’s a great VC Marc Andreessen, who has a quote, “Software will eat the world,” making the point that software doesn’t really care. It will just go wherever it goes. And we’ve seen that with Amazon. We’ve seen that with Google. We’ve seen that with the web. And so if there is this breakthrough that allows digital things to be immutable, unique, we think this could eat the world.

And so when we look at Fidelity’s businesses and what we do and how we serve our customers, in many ways, we’re a record keeper of those digital assets. We’re the ledger. And that is a responsibility we take very seriously. And we have websites and iPhone apps and Android apps and all kinds of digital things, but at the end of the day we’re not truly a digital business. Our money, the way we exchange value, the way we exchange stocks does not really fundamentally act in the way that bitcoin acts.

So that’s why about four years ago, the senior team took a very serious look at bitcoin and had this scenario called frictionless capital markets. So this idea that we have all these digital things and these intermediaries like PayPal, Visa, Fidelity, but what if you didn’t need those anymore? What if software was the thing that validated the transactions? So that’s why we were interested in it.

Since then, we’ve endeavored on a lot of research and development efforts. When we started, no one really talked much about bitcoin’s value. There wasn’t much interest.

So in 2015, there was a lot of interest in bitcoin as a payment vehicle. We were very focused on that. 2017 was the year of the B word, blockchain, so no one said bitcoin because bitcoin was for bad things so let’s talk about blockchain. And a lot of people don’t realize that bitcoin was the first blockchain.

Without the invention of bitcoin, there would be no blockchain. But still, we did a number of research areas and topics and how this could be used to allow us to do our business better, faster, cheaper. And then last year, 2017, I would say really was the growth of this notion of this new asset class. What if bitcoin, Ethereum, ZCash, all these tokens that were underlying protocols in technologies, what if people could build new products and businesses off of them, and what if they were worth something because of that?

Put another way, if I came to you in 1994 and said, you can invest in TCPIP or you can invest in Amazon, Google, et cetera, you’d probably invest in TCPIP because that protocol underlines everything to do with how the internet works today. So one of the investment hypothesis, although we’re very early, is that these crypto assets, these tokens will be utilities that people will build new products and services off of.

Now, getting to my slides, which we decided to leave you, the first few slides, if you go to the slide here, this is really just illustrating what I did with money. So instead of a text of — an image of my daughter, here we have the image of a sunset. And we have a network, and one person tries to send the image of the sunset to another person on the network. And what you see on this slide is the — basically, that image is copied.

And so what bitcoin does — if you bear with me and go to the next slide — is bitcoin creates this encrypted network that allows the movement of bitcoin from one node on the network to another and it’s not copied. And you can prove that cryptographically. So that’s just another way of my dollar circus act.

And what this really means, and I mentioned this, is the notion of an era where we’re going to go from a physical bearer token, money, to a digital bearer token. And that’s really the power of bitcoin.

So, hopefully, that gives some explanation. One of the challenges with this technology is it’s incredibly hard to explain. I’ve seen many people — I’ve tried to do it. You actually have to read quite a bit about it to really understand it. But I think if you take away anything, hopefully this notion of suddenly digital objects can be treated like physical objects, that’s something to take away.

So we’re interested in bitcoin. The other piece is the blockchain piece. So if you take away bitcoin really is a use of a blockchain to transfer value, but then the question is: What else could these technologies be used for? And this is where one of the things that we’ve seen emerging is the hypothesis of decentralization. If you really look at bitcoin, what it is is decentralized money, currency or gold. It depends — bitcoin is sort of everything to everyone, including the IRS, who considers it property.

But what bitcoin really is is it’s a decentralized way to transfer value. So what you’re starting to see entrepreneurs look at is what else can we decentralize. What other things can we decentralize with a digital token? And one of the more interesting examples we’ve come upon is storage. So there are three projects, Storj, Sia, and Filecoin, that are looking to decentralize cloud storage. How are they going to do this? Well, right now, if you want to buy cloud storage, you go to DropBox, you go to Amazon, you go to Google Drive, and you pay them US dollars for storage on their network.

The idea with some of these other networks is twofold. One, anyone who has excess hard drive space can rent that hard drive space to the network. So if you have a gigabyte at home available on your hard drive or a terabyte in your data center, you make that available to the network. On the other side, if someone wants to buy storage on this decentralized network, they can use this utility token to buy storage on this network.

So I encourage you to look up those three projects, which leads me to the next topic that I wanted to cover quickly, which is ICOs. We believe, like many people, that there’s a lot of skepticism to be had around initial coin offerings that in many ways, they are just securities, you know, in guise. And so we have to be very cautious of initial coin offerings. And actually one of the ways that we think you can look at whether an initial coin offering is truly something beyond just a digitized security is this notion of a utility. Does it have a utility on the network above and beyond a security?

So, finally, I thought I’d close because we’re here in Washington with, you know, a bit of a regulatory point of view here. If you take my hypothesis, which you can — you feel free to reject, by the way, that this is a technology innovation, that technology innovation — the government can do I think many things to try and stop bitcoin. But I don’t think it really can ban bitcoin unless it turned off the internet. So if you accept that there is this innovation that new companies are going to be built off of, we think it’s important that there be smart regulation of this technology so as to not hinder innovation so that American companies can be the ones that build off of these innovations.

That said, there is need for, you know, a lot of careful look jurisdiction by jurisdiction and use case by use case, certainly within the ICO space, to be sure that people aren’t getting ripped off by some of these scams because the other thing about any new technology is there’s going to be scams as well. So we sort of know that but hope that, you know, the long view of this technology innovation will not be ignored.

In closing, I think you mentioned a little the mobile phone, which I thought was great, the super-computer. Another example that’s kind of brought up a lot I think in ’94 there was an article in Newsweek by a gentleman who basically said the internet is a fad. And he pointed out correctly in ’94, ’95 the internet had been around for about 10 years. There are all these bulletin boards where people go on and don’t do anything, and it’s a waste of time. Now, that — you know, I probably would have said the same thing then. This was pre-the HTTP protocol and Tim Berners-Lee’s innovation of the web. And then even when the web came out, things like Netflix were unimaginable because of bandwidth speeds.

So the point here is that this is very early days in a technical breakthrough. We don’t know what’s going to come. I certainly don’t know what bitcoin is going to be valued. But I do know and we do believe that there is this technology innovation that’s very interesting, that’s worth not quashing, and sort of allowing to flourish and see where it goes.

MR. POLLOCK: Thank you very much, Hadley.

Bert.

BERT ELY: OK. Can I have the clicker?

MR. STERN: Yes.

MR. ELY: Thank you. What I want to do is talk about both blockchain and bitcoin and try to differentiate hype from the reality to the extent that that can be done. And I’m going to start by talking about blockchain.

Blockchain is basically just a database of transactions. They’re accumulated over time in what is called a ledger. The key thing is that once a transaction is in the blockchain database, it can’t be taken out. If there’s an error, there can be a subsequent transaction to correct for the error, but you have a permanency of record that I think is very important.

Now, in a cryptocurrency context, what these transactions do is create a chain of title; that is, the history of the ownership of a particular token. And this is something, if it’s properly maintained, that can be traced all the way back to the creation of that token. Now, one of the protections that is supposedly built into blockchain is this idea of maintaining duplicate ledgers, and that’s seen as a way to maintain the — ensure the integrity of the database and that you don’t have overspending of tokens. But I’m going to argue, and I’ll talk about this further, later on, that duplicate ledgers really are not necessary or the most efficient way to ensure data integrity and to prevent the so-called double spending. And I’ll talk about that a little bit later.

The key thing is blockchain concept is not new. It’s centuries old. An early example that is — the whole recordation of property transactions. Now, it may have been on paper, in ink, and not computerized, but the concept is the same. And this is a concept that goes back to the colonial days of the United States brought over from England, where for a particular piece of property, let’s say this building, you can trace the ownership of this building all the way back to the first time there was any recordation of property ownership here in the District of Columbia.

And that is what is done in deed books through what’s called establishing the chain of title by being able to trace back to the very beginning. And this is essentially what is happening in the cryptocurrency databases. Now, the other thing that’s important — we haven’t heard this term yet, but the whole notion of permissioned blockchain, where everybody can kind of come in and participate and put their transactions into the transaction database without having to go through an intermediary.

Well, that same thing exists with regard to property records. Anybody can walk into the local recorder of deeds and file a deed or a lien and, you know, assuming that the format is correct and so forth, it will be filed without any kind of approval by the record of deeds. Now, if it’s fraudulent, that may be contested later on, but it’s an open system. It’s permissioned blockchain. And, again, it’s been around for at least a couple of hundred years.

Now, another very important and universal form of blockchain is double-entry bookkeeping. Individual transactions are recorded in book’s original entry called journals. They’re summarized in ledgers. In fact, I would suspect that the term “ledger” that’s used in a blockchain in cryptocurrency sense comes from the use of the word “ledger” in accounting statements and in accounting systems. And then, of course, financial statements prepared for those ledgers.

The key thing is that assuming that all of these journal entries are preserved, that you can actually trace in an accounting system a particular count or the ownership of a particular asset all the way back to its origin. And so — and this becomes particularly feasible in this day and age of recording transactions with electronic technology. So my point is that the concept of blockchain is not new. It’s really well established, but not in ways that people normally think.

Now, let’s just talk about what the key characteristics of existing blockchains. First of all, they relate to the real world, to real-world assets — this building, this furniture, the chairs out there, as well as intangible assets such as intellectual property. The second thing is that a transaction history is created and easily preserved. Computer backups and duplicate records protect the loss of data, and that’s why you don’t have to worry about having duplicate ledgers because, if necessary, you can re-create a ledger through the transaction data that has been saved.

Now, other important characteristics of blockchains is, first of all, they operate within a well-established legal environment with the laws that govern how property transactions are going to be recorded — is one good example. And the other thing that’s important that it’s skipped over too easily in a lot of the cryptocurrency discussions, that you actually have to have responsible parties who can be among other things sued for defective performance, including fraud. And, as we know, fraud is a big issue these days with cryptocurrencies.

And with these existing systems, it’s relatively easy to audit and verify transactions as needed. You don’t have to have 10 or 20 or 30 people verifying the same transaction. That is wasteful. And if there are losses due to fraud or bungling such as we’ve seen in some of the crypto exchange thefts, they can be identified and often be rectified. And, importantly, you can buy insurance to protect against fraud. I’m not aware of that being possible in the cryptocurrency world.

You know, permissions can be granted to outside parties to enter transactions into the database. That’s what happens with property records. And, very, very importantly from an increasingly important data — these databases can provide information for legal compliance, which is where a lot of the regulatory thrust is coming from, is being able to identify parties to particular transactions.

Now, with regard to cryptocurrencies, my middle name is Toto, and so I wanted to take this opportunity to do some debunking of cryptocurrencies. First of all, cryptocurrencies, tokens, what have you, have no intrinsic value. Consequently, they have no economic value. What is a bitcoin really worth other than the fact that someone is foolish enough to want to pay you money to buy one if you have it?

Sure there is scarcity in bitcoin, but scarcity per se does not create economic value. In my opinion, any value or price that’s attributable to a cryptocurrency without having an intrinsic value is nothing more than artifice. It’s artificial. And I’ve drawn analogy increasingly between bitcoin and baseball cards. You know, what is a baseball card worth? Sure, it’s a collectible. It’s something to pass around or maybe someone’s willing to pay more than — pay enough that you’ll be willing to sell it. But that’s essentially what bitcoin is — in effect electronic baseball cards. Of course, baseball cards actually have some value because — in a physical sense because you can recycle them. You can’t recycle bitcoins.

Now, in terms of cryptocurrencies, I’ve got some charts here that illustrate how volatile they have been and how much turnover. And very important point, because of this volatility, the cryptocurrencies are lousy stores of value, and they consequently have little in the way of transactional utility. That is why you don’t see many transactions in bitcoin or XRP or whatever.

And one other point I’ll make before jumping into these charts is there’s been a tremendous deflation in the value of these things, and I don’t think it’s coming back.

All right. So here are charts showing the volatility against the peak daily closing price of these various cryptocurrencies. These are the three most valuable ones in terms of dollar value outstanding. And, as we you can see, they all hit various peaks. They’ve come back down, some more than other. XRP is down more than anything else. And, by the way, my own speculation is that XRP jumped up as much as it did late last year because I think it was manipulated. I think manipulation, pump-and-dump type schemes are prevalent in the cryptocurrency world, and I think that’s what happened with XRP.

The other thing is the amount of turnover. What this is a measure of is how much speculation is going on. Very little of these coins are held — from what I can tell are held for any period of time. There’s an enormous amount of speculation, and speculation can drive value up. But when the speculators lose interest or get burned, then it can plunge.

And that’s why I think that these cryptocurrencies with this high turnover really cannot be viewed as a currency. This is not the way currencies that function as such can really operate.

Now, there are other flaws. There’s a lot made of these distributed ledgers — that they’re supposed to prevent double spending and so forth — but what’s interesting is the distributed ledgers have not prevented the hacking of the cryptocurrency wallets and the losses that have been experienced. And these losses in these cases have been in hundreds of millions of dollars.

But the other thing is that distributed ledger processing, which is basically duplication is not cheap with substantial electricity and hardware cost. And I’m not going to claim that I arranged this, but there was a very, very interesting article in the Wall Street Journal just this morning. Washington State spawns bitcoin money and hotspot. And it talks and goes into some detail about the amount of real resources, particularly electricity and computer hardware, that goes into running all this duplicative effort of trying to — that is required by the mineable exchanges. I’m not a gamer, but my understanding is that gamers — computer gamers are really upset today because the bitcoin miners are buying all the gaming chips and making it harder for gamers to get the chips that they need to play their games.

Now, another thing that comes up quite often, and that is actually executing transactions in the blockchain is expensive. And that may be another reason why there are relatively few cryptocurrency payment transactions. And what I find particularly interesting is that if you lose your private key, you’re out of luck. And, of course, that raises the question of who ends up owning those lost keys or those lost tokens. I haven’t heard anything about that.

Now, the other thing is that they’ve been talking about using cryptocurrencies for cross-border payments. But the problem with that is you end up with not one but two different currency exchanges, each of which has a cost. Let’s say you want to convert — you want to transfer dollars and convert into euros. Well, if you’re going to do it through a cryptocurrency, you go from dollar in the bitcoin, and then the party at the other end has to go from bitcoin back into let’s say euro or the pound. That adds transaction cost, hardly efficient.

Now, I’m just going to — we’ve already heard a little mention about this, but we have a number of comments here about — negative comments on the cryptocurrencies. Alex mentioned Roubini, and I’ve put some up here. But the most interesting one I think is from the SEC chairman talking about the cryptocurrency platforms are very easily manipulated, and I don’t think investors understand that. And I think that is part of the fraud aspect of cryptocurrencies.

Now, I’m not totally negative on blockchain. I think the question is how can it be utilized more widely. I think, first of all, it’s to break away from the idea of having distributed ledgers and instead just to have a good record of transactions with a clear chain of title that can be audited. Permission rules need to be refined and simplified so that they’re effective in preventing fraud. And that I think is part of the development challenge with blockchain.

The appropriate legal environment has to be created. And, again, that may be on an application-by-application basis. And some applications may in fact be difficult to implement in the short term and property records, even though there’s a paper-based blockchain — is difficult to electronify.

And then, finally, just to close up on blockchain and finance, money movements between banks and between banks and bank customers is a very logical application of blockchain. And my guess is that SWIFT, which is an international system for moving funds, is evaluating blockchain. But one of the keys in moving money particularly internationally is to minimize currency conversions because that’s a friction in the system. Ideally, there would be just one conversion.

The other thing that — this is perhaps the most important thing to remember — is all money movements through a blockchain must settle through a banking system because for money other than currency — that is, bank deposits — that money is some bank’s liability someplace in the world.

MR. POLLOCK: One minute.

MR. ELY: Thank you. I’m just about finished. And this ties into a proposal that we’ve seen in recent months, and that is maybe central banks need to get into the business of issuing cryptocurrency. I would say there’s absolutely no need for that whatsoever — that the banking system can handle — can basically handle movements internationally as well as domestically. The key thing is just to put in the necessary technological improvements.

And, finally, I think there are numerous other applications that will be considered. Not only will it make sense but I think this is the time of exploration, to look at blockchain can be utilized but without all of the fictions and mythology that has build up around blockchain.

With that, I think it has many interesting applications, expansion of existing applications, but blockchain is not going to be Nirvana. Cryptocurrencies are going to fade away, and we should all proceed prudently. Thank you.

MR. POLLOCK: Thanks, Bert.

Paul.

DR. KUPIEC: So let me start — before you sell all your baseball cards, last week, last Wednesday, when I start putting my slides together, this was the top story or one of the top stories on CNBC, experts say bitcoin surging to $50,000, the cryptocurrency market could easily hit $1 trillion this year, OK? This was last week. And this could a pump-and- dump kind of thing, but there could be an expert that really believes it. I don’t know. You can to go to the story.

You can see the graph down there. And this morning — well, this afternoon, before I came down, at about 3:45 p.m., bitcoin was selling at $8,196.47. It was up 10.23 percent today alone. Since last week, February 5, it’s up 28.66 percent. So the predictions of its demise may be a little early. You still might be able to make a little money off of it before — if Bert’s right, before it goes away. Trading the volatility, you could get very rich or very poor very quickly.

In the news on cryptocurrencies, I think the G20 has decided to take up the topic in their March 19–20 meeting in Buenos Aires, so that may be interesting. Something may come out of that. And in the news today, Iceland is considering a mining tax. Iceland is one of the biggest places, one of the biggest mining destinations because it’s very cold there and electricity is just about free. In fact, I know when I was growing up, and if you had the door open in the window, my mother would say, don’t hold the door open, you know, it’s cold — you know, we don’t want to heat the outside. In Iceland, when it’s cold in the winter, you open up the windows and try to heat the outside because, you know, it’s basically free. It generated — volcanic steam is the way they heat their world up there.

So will the government allow cryptocurrency to replace national currency? So there’s this segment of the cryptocurrency fan club, libertarians, who very much are against government central banks and them inflating away, the hidden inflation tax, and very much hoping we can have a private currency and something like a bitcoin or some of the other currencies might actually replace national currency.

So instead of talking about technical details of bitcoin, I’m going to talk about this question, which is I think fundamentally important about whether these things actually survive as a currency. And the first thing you should keep in mind is creating dollars and pounds and euros and yen and all the other currencies, this is a very profitable business. The profits are called seigniorage, and it’s the revenue the government gets by creating money, money creation. Today, the Federal Reserve exchanges reserves for income-producing assets, and it collects seigniorage for the government. In ancient and medieval days, you took your gold and silver to the king’s mint, and they turned it into coins. The coins were used to pay your taxes and your debts in a country, but the king kept a part of your gold and silver as a seigniorage fee, as a coining fee.

So the earliest national currency that I can find back was the Lydian Stater. It was around 620 to 560 B.C. There’s a picture of it up there. It was — it sounds almost like a cryptocurrency. It was made from electrum, which almost sounds like, you know, the names of these currencies they give, which was 55 percent gold, 45 percent silver, and had a little bit of copper in it. And the mythology is that it was extracted from a river where King Midas used to bathe. That’s why they had the gold and silver.

And Lydia, which was the country, was kind of — where Turkey is today — and was the trading crossroads between Greece and Asia. And a lot of trade went through there. And its currency circulated widely, and their most famous king was King Croesus. And if you were a generation before my time or, as my colleague, Desmond Lachman, says, if I had a proper education, I would know the saying “rich as Croesus.” And “rich as Croesus” refers to King Croesus of Lydia, who was very, very wealthy because he invented this idea of a national coin.

So money and the nation-state, you know, is totally intertwined. It goes way back. Regalia, the word is from medieval Latin. It means you have certain privileges, and part of your privileges of being a king was you could mint coins. By the 13th century, pretty much all the mints were under the control of a king, the sovereign. Mints were generally run as private businesses, leased from the king, and the king told them how much metal to put in the different coins and had control over the contents.

Actual data back from the 14th and 15th century from England and France shows that the fee that the king got, the seigniorage fee, varied between 2 and 60 percent. So when kings were in war with somebody and they needed a lot of money, they would do things like debase their currency. And everybody would bring their old coins back to be melted down at the mint. And the king would raise the seigniorage rate, and he’d collect a lot of gold and silver and do his own coins and pay for his armies that way. So this happened all during times back then. And they got a lot of revenue that way.

So they’ve been intertwined forever. Now, the Beatles, you may recall, told us money can’t buy you love, you know, but back in the olden days, there was a time — and if you catch it there — where you could buy your salvation. But you needed papal payola. You needed the pope’s coins. And if you go back, there’s a whole website, a museum of papal coins. And the different popes issued different currency. And you had to go to the pope’s mint, and you had to mint coins. And if you wanted to be, you know, saved from eternal damnation, you know, you had to pay the pope. You had to buy your indulgences, and you need to use his coins. So this is intertwined way back when.

Currency in the American colonies — the colonies created their own fiat currency. Back in the days when we were colonies, there wasn’t enough gold and silver or coins floating around to fund commerce in the colonies. So the various different colonies actually created different kinds of money, and North Carolina, Virginia, South Carolina, Virginia for a while, I think used tobacco leaves. And then that became difficult to pass a tobacco leaf to Bert. He couldn’t fit it in his pocket. So what you did was you put tobacco in a warehouse and you got a warehouse receipt and you traded warehouse receipts on tobacco. So you created paper currency. In other colonies, they created paper currency based on land. So if you needed some kind of money to buy something, you would go to the currency office of the colony, and you would pledge your land. And if you didn’t pay back your debt, the colony could take your land and sell it to repay the debt.

But the colonies got carried away with this and debased their currency. And there was a lot of inflation. And the British merchants at the time who were taking this paper money from the colonies got really grumpy about the fact that the colonies kept inflating their paper currency. And so the merchants in England convinced the parliament to pass the Currency Acts. There were two of them, 1751 and 1764, and it basically required the colonies to pay for anything they got from England with either British pounds or gold or silver. They didn’t want this stinking bitcoin paper money anymore because you could inflate it.

And, you know, today, if you read economic history, economic historians, they sort of say, well, the currency wasn’t — you know, that really didn’t cause the — you know, the revolution. But if you go back and you look at the quotes from the Founding Fathers, they very much say these currency acts caused us to, you know, start the revolution.

Now, whose side would you be on here? Well, the government of England was trying to protect its seigniorage rights, the rights of the money, the rights for not to be paid in debased currency. If you’re the — you know, a bitcoin fan and you think we want to replace national currencies with bitcoin, you’d be on the colonists’ side. So I’ll leave it to you to decide.

But the Founding Fathers at the time said, this is a really important reason. They went to war. As I said, the all-knowing economic historians since then, who never talked to these guys I guess, I figure wasn’t as big of a deal. Now, today, the Fed collects seigniorage for the government, and economists over time — it’s not — it’s not a very popular game now, but at times in the ’60s and ’70s, they were creating measures of how much monetary seigniorage was created.

And one of them was called extended monetary seigniorage, and there’s — they actually took this definition from Federal Reserve papers published by Federal Reserve banks. I think this one’s from the Bank of St. Louis, around 1990. And extended monetary seigniorage is the change in the money base, the monetary base plus interest earnings on private domestic assets plus interest earning on foreign exchange assets, plus or minus the revaluation gains and losses on foreign exchange assets.

Now, what I did is I took that definition, and I calculated how much seigniorage the Fed has minted or collected since 2005. That was the — I could get the records. And if you look at this is the cumulative amount of seigniorage the Fed has created, and it gets returned to the government. It’s a source of government revenue, $3.5 trillion. That’s a lot. That’s a lot of money. Do you think that the government’s going to give that up? Are they going to allow private currencies to replace their right to generate numbers like that?

Of course, during the past time, what happened, well, there were all the QE operations, which vastly expanded the monetary base, which creates huge seigniorage because the Fed gives you a reserve in the bank, which now does pay interest. But in the beginning, in the early days didn’t, and they take in interest-bearing assets from, you know, government securities, loans to reserve banks, Freddie and Fannie mortgage backs. But that’s the amount of seigniorage.

So the last thing I want to touch in whatever time I have left, and I’m not sure how much that is —

MR. POLLOCK: It’s three minutes.

DR. KUPIEC: Three minutes. And I won’t need — well, maybe I will. So cryptocurrencies bubble — so you might say, well, you know, if cryptocurrencies are financial assets, you know, isn’t the market efficient? Aren’t all these traders everywhere? You know, what happened to this old story that, you know, stocks and financial assets are, you know, priced a random walk? You can’t beat the market. All the information is impounded and the efficient market school.

Back when I went to — I was getting my Ph.D. back in the dark ages of the last millennium, that was what we were taught, markets were efficient, you know. Every paper that came out and every finance journal, they would find something, some stock thing that seemed like it was in a violation of the efficient market. And what you had to do to get your paper published, you had to explain why, well, if you looked at this, you know, through 3D glasses, some kind of way, and did the data this way, it really was an efficient market. We just weren’t clever — you know, the obvious conclusion that it must not be efficient is wrong. You had to come up with some kind of fancy way to show that really it was efficient, and that got you published.

But since the 1987 stock market crash, there’s been a big revision in finance thinking. In the late ’80s and early ’90s, there were noise trader models where they said people didn’t really know what they were doing but could they — they create excess volatility and they didn’t — they didn’t lose money. Lo and behold, they could create their own risk premium in the market and actually make money overtime, and it wouldn’t be driven out.

Since then, we’ve got into fancy mathematical pricing models, martingale theory. I won’t bore you with the details, but a good friend of mine, Bob Jarrow, is a very famous theorist in this time. Heath-Jarrow-Morton model, a term structure model, I Cornell. And he’s been working on theories that say, you know, bubbles are a lot more common than we think. He thinks that, you know, a lot of stocks have, you know, somewhere between 1 and 25 percent of their values are a bubble. They can go away at any time.

And when is — what’s the definition, the common English, easy-to-understand definition of a bubble? Well, a financial asset is a bubble if it’s more valuable for you to trade it before its terminal cash flows. So if you think there’s going to be some point in time where your optimal strategy is to sell it to somebody else before you hold it for its terminal cash flows, then it’s got a bubble in it. Otherwise, the buy and hold to maturity ought to be the same, ought to be the fundamental value.

Now, in bitcoins and other things, in any fiat currency, all of them are bubbles. The only reason you hold any currency, dollar bills or bitcoins, is because you think you can sell them to somebody else. You hold them forever. What do you have? You have a dollar. You have a piece of paper. There’s no terminal payoff. It pays no interest. It pays no nothing.

So in finance theories, over the years, when people worked on these theories about bubbles, every fiat currency is in fact, in financial market lingo, a bubble. So are the cryptocurrencies bubbles? Absolutely they’re bubbles. Why? The optimal strategy is to sell them to somebody else and not to hold them long term. Holding them long term, they’re valueless. So does that mean when I know they’re going to pop, what the right value is? No.

But, I mean, this whole idea that financial markets — you know, there’s a lot more bubbles in them than we used to think I think is what people are coming to in the future. And I’ll leave it at that. Thanks.

MR. POLLOCK: Thanks, Paul, and thanks to the panel for covering a really wide range of issues as we went through this. I want to give each panelist let’s say two minutes maximum just to add anything you want, react to what somebody else has said, summarize the most important point. We’ll just go down the row. Jerry, additional comments?

DR. DWYER: Yeah. There are actually a lot of different things that I could comment on. But I’ll pick on Bert.

MR. ELY: That’s why I’m here.

DR. DWYER: Yeah. That’s why he’s here. He wanted to be controversial. He was.

The question is what is the blockchain, all right? Is it just double-entry bookkeeping? No. It’s way more than that. It’s a protocol. It’s a protocol that’s agreed to across institutions to record trades and then record it in such a way that no one has the ability to go back and mess with them and change them, all right? And, you know, they don’t necessarily — there’s permissioned and non-permissioned blockchains, and bitcoin is non-permissioned. And that creates all this electricity and all these other questions, all right? So let’s leave that aside.

For permissioned blockchains, for example, the Japanese stock exchange did a couple of prototype runs actually using blockchains to record trades. See the thing is that, you know, there’s a sense in which this is trivial to most people and it’s uninteresting. But the fact is that clearing trades in stocks is expensive. It’s not cheap. Clearing internationally outside of using bitcoin across currencies is very expensive. Actually, it’s really cheap with bitcoin.

You just do two transactions, the transactions cost, I showed you, which are much less than 1 percent. So you do two of them. OK. You’re still less than 1 percent. Wells Fargo charges me $75 when I get a paper check. It doesn’t matter whether it’s $350 euros or it’s $5,000 euros. That’s a whole lot more than 1 percent, you know.

And so there are real opportunities here for lowering transactions costs partly because it standardizes the underlying databases across firms, and that actually I think is nontrivial.

MR. POLLOCK: Thank you. Hadley, another two minutes of additional comments.

MR. STERN: I guess I’ll pile on Bert too. I’m disappointed he didn’t — you know, the dollar didn’t pay off.

MR. ELY: It’s still there.

MR. STERN: I guess I took it back.

MR. POLLOCK: He didn’t offer you $2 for the ball?

MR. STERN: I think it’s important, you know, to talk a little bit about the breakthrough of the blockchain innovation. So I think there are a few things that you said that I would not only have a difference of opinion on, but I’d go so far as to say are facts.

So, one is bitcoin has never been hacked. It’s just never happened. The exchanges around bitcoin have been hacked numerous times. But I think it’s really important for people to understand that bitcoin, the protocol itself, has never been hacked.

And one other caveat before I go in here: I’m not suggesting bitcoin, you should invest in it or not invest in it or what it’s worth. I’m just talking about the technology.

The other fact is that there was no notion of a blockchain before bitcoin. There was a notion of ledgers, which you went over. But the blockchain breakthrough, and I suggest anyone read Satoshi Nakamoto’s white paper. There were three concepts of computer science that were combined to create the first blockchain that were mixed together in a way that’s never been done before. One was cryptography, one was distributed computing, and the third was consensus algorithms. So I wouldn’t conflate a — because blockchain, bitcoin has a ledger with the fact that it’s existed for years. From a computer science standpoint, it simply hasn’t.

So, you know, the other things I’ll say, again, not knowing what bitcoin is worth or not, is it does appear that the dominant use case is this notion of digital gold, these digital tokens. And what many people find very intriguing about bitcoin but is very scary about bitcoin is no one owns the network, so bitcoin, a lot of these projects are open-source projects. There is no annual meeting of bitcoin. It literally does not exist. It’s computer software that’s run that has a series of code.

So, again, I think it’s important to say what a blockchain is and what it isn’t. And, again, to emphasize this innovation breakthrough only happened very recently in history. And we’re really at the beginning of it. It’s very hard to debunk something and say it’s not worth something if you’re not clear on what exactly it is.

MR. POLLOCK: OK. Thanks. Bert.

MR. ELY: OK. Thank you. Several points. First of all, I think one of the real negative impacts of cryptocurrencies is I think it’s detracting and taking attention away from a lot of potential opportunities to develop blockchain in various ways in which they haven’t been utilized before. Someone mentioned clearing stock trades. So I think that that is one of the real I’d say unfortunate aspects of cryptocurrencies is that it is taking probably a lot of development effort in resources and talent away from developing various blockchain applications that people are talking about.

I think the second thing is I think resource consumption is what’s going to be a killer for cryptocurrencies because of the tremendous amount of — not only electricity, but human talent as well as computer hardware that is needed. I think what will compound or accelerate this is that the only way you can pay for these processing cost is if there’s a continual appreciation of whatever the cryptocurrency is that is being mined. And when you get into a period of sustained price depreciation, then mining becomes a losing proposition for the miners.

And what we may find at some point in time is that a lot of mining activity will dry up and the cryptocurrencies with it because of a lack of sufficient appreciation. Things can’t keep going up forever. Even the prices of baseball cards come down sometime, and I think that that’s what is going to happen. And that will actually be a positive apart from the fact that people — a lot of people that have lost billions upon billions of dollars gambling on bitcoin or cryptocurrency price appreciation. I think that when we get a sustained period of price decline that the cryptocurrency speculations will shrink dramatically, and as I said before, I think that will free up human and economic resources to focus on developing genuine blockchain applications.

MR. POLLOCK: Thank you.

Paul.

DR. KUPIEC: Yeah. I think the blockchain is important. I think right now it is not so useful, but the next generations of uses for the blockchain — smart contracts — have a lot of potential. But I think, however, you could do things — smart contracts, which are the next generation blockchain are things that do more than just transfer a coin from one wallet to another wallet. They might look at other data and exercise an option. They might record land values, like Bert said. They might do a lot of things.

You have to somehow put some money in the system to get the internet miners to record it on the blockchain, to record this transaction on the blockchain. I don’t think it necessarily has to be done with a virtual currency. I think you could do smart contracts on the blockchain with national currencies. And I strongly suspect that the governments will protect their right of, you know, minting currencies. I think they would make a lot of money out of it. I don’t think they’re going to give that up easily.

So I think there’s a future for the technology. I definitely do. I’m no expert on smart contracts. That’s why I brought all these smart people here that know more about that. But I think it’s the wave of the future, and I don’t think — I think a lot of these initial coin offerings right now really look pretty dubious. They’re not really functioning.

They’re a — well, if you crowdsource and buy my tokens now, and I raise $20 million, then I’m going to get a bunch of folks together who are my friends and we’re going to build this software that does this smart stuff that you can use those tokens later on to trade. These are what a lot of these token things are right now that are being disputed as securities. And you’ve got no guarantee of anything, and most of them are trying to get around securities laws. They’re trying to do it through crowdsourcing funding rules. And these things, you know, I don’t think are going to fly.

So I think there’s a future for the technology. Maybe Hadley is going to tell me I understand this all wrong. I don’t know. But that’s what I think from what I read so far. Thanks.

MR. POLLOCK: Thank you, Paul, and thank you all. Now we’re going to come to your questions, ladies and gentlemen. May I remind you, for the question period, we have microphones. You need to wait until the microphone gets to you and then tell us your name and your affiliation and your question.

If when you feel the microphone in your hand and hear the sound of your own voice echoing in it, you become inspired to give a lecture instead of asking a question — (laughs) — before very long, I will remind you that it’s time to ask the question. I know time is fairly short, but we’re going to have a reception, and the panelists will be here. And you’ll have a chance to pursue questions then as well.

I have a first question, way in the back here, then I’ll come up to you.

Q: My name is Ryan Cook. I’m a recent graduate of George Mason University. So my question is with the bitcoin market growing, do you think it presents some sort of systematic or systemic risk to other asset classes, real estate, precious metals, equities? And do you think that bitcoin has any sort of correlation to equity and currency markets?

MR. POLLOCK: OK. Any member of the panel, systemic risk in bitcoin, correlation? OK. We’ll get Paul, and then we’ll come to you, Hadley.

DR. KUPIEC: Yeah. I don’t think it has a systemic risk, but I would remark that bitcoin started falling before the stock market. So it’s a leading indicator of the stock market. Don’t quote me on that, but yeah. (Laughter.)

MR. ELY: And if I could add to that, I actually posed the question to a member of the administration at a recent luncheon. If some kind of crisis developed in the cryptocurrency markets if the federal government might come to the rescue in some fashion, the way it has when there have been banking crises, and I was assured this is on the record so I’m not speaking out of school that the federal government would not come to the rescue, which was good news. So I think if there is any kind of crisis, and I actually kind of hope that one does come along in the cryptocurrency world, that it won’t affect the real world.

MR. POLLOCK: Hadley.

MR. STERN: I think the market cap right now is very small so I think the market cap of gold is something like $7 trillion. So gold, which is also — many people call bitcoin digital gold because gold also doesn’t really have much utility except human beings agree that it’s worth something. So I don’t think there’s much danger that the size of the — you know, the amount is pretty small.

MR. POLLOCK: As a founder of nonlinear dynamics, we want your view on this as well. Any systemic risk in these digital currencies?

DR. DWYER: No. I don’t see any at all. I mean, it’s a relatively small valued asset. I mean, at least — the way people normally do these kinds of regressions, it’s uncorrelated with stocks and a lot of other things. And so its relationship with a lot of other — it’s idiosyncratic. It’s just got its own little thing going on, you know.

MR. STERN: I think the other thing that makes it idiosyncratic is the fact that it’s global and it’s 24/7. So, you know, if I want to buy Samsung stock in the US, I mean, it’s very difficult, right? So that’s the other piece that this isn’t just a US phenomenon. It’s a global phenomenon.

MR. POLLOCK: OK. Bring up the microphone to this gentleman up here please. He’s waiting, up in about the second row here. Ryan, thank you. You’ve got the microphone coming on your other side.

Let me just add one more thought on systemic risk. If the grand dreams, however, of cryptocurrencies come true and they get much bigger and have a chance of challenging national currencies, then we could perhaps imagine a systemic pricing problem with them. Yes.

MR. STERN: There are some bitcoin maximalists who track the price of the US dollar against bitcoin as an example.

MR. POLLOCK: Sure. Every exchange rate can be viewed as —

MR. STERN: It’s the movement away from the US dollar to bitcoin.

MR. POLLOCK: Yeah.

DR. DWYER: The inverse price.

MR. STERN: Yeah.

MR. POLLOCK: Yes, right here please.

Q: Yes. My name is Hormaz Gudrege. I’m a student at Stanford University, currently interning at the Nuclear Threat Initiative. And my question is: Are there likely to be any applications of artificial intelligence technology to the field of cryptocurrency?

MR. POLLOCK: I think maybe, Hadley, that one would come in your space.

MR. STERN: Yeah. That’s another area of interesting inquiry. So there’s this notion of machine-to-machine payments. And so if you — you know, you take what I said first about this digital token that can suddenly be exchanged, suddenly some interesting things can happen, like your fridge could pay the grocery store, your car could pay the grid, and it’s not done through sort of the US dollar, but it’s done through these micropayments.

There’s some interesting companies in the solar space that actually have created a utility token for solar. There’s a company called Power out of Australia that is creating shared solar panels for buildings and condominiums. And they’re using blockchain technology as a way to create a market for people to trade. So it’s absolutely an interesting use case of machine learning.

MR. POLLOCK: Interesting question. Thanks. You need to give your microphone back. And, Bert, will you comment, and I’ll look for another — OK. You’ll be next.

MR. ELY: Yeah. Just very quickly on that point. I think that it’s going to be hard to replace the dollar or the euro, the national currencies for actually making payments because that is the common dominator of economic systems and payment systems. And so I think we will continue to have national currency-centric payment systems and systems for transferring value.

MR. POLLOCK: OK, Bert.

DR. KUPIEC: Bert, at one time, the Lydian Stater was the currency everybody used.

MR. ELY: OK. But that was — that was a long, long, long, long time ago.

MR. POLLOCK: Right here please.

MR. ELY: The gold standard didn’t last either.

Q: Hi. How’s it going? My name is Salmaan Qadir. I work at CFPB. I wanted to ask a question. You brought up smart contracts. I will admit my knowledge on it is pretty limited, but from the few articles I might have read on it they seem to be neither smart nor contracts, like glorified lines of codes, if/then statements. So I’m wondering what the actual innovation is there.

MR. POLLOCK: Thanks. Anybody want to take that, smart contracts?

MR. STERN: Yeah. So this goes to — it’s very early, you’re right. They are a series if/then statements. But their innovation is those if/then statements are tied to this immutable ledger that then processes the transactions. Now, the problem with that is you have things like the Dow hack, where if there’s a mistake in the smart contract, you can lose, you know, tens of millions of dollars. And there’s a lot of controversy around smart contracts. There’s this whole question of can code really be law.

And so this is, again, why it’s so early and why there’s no real production example of a blockchain that’s the backend of a business. So you hear a lot about blockchain for financial services. And one of these issues is could code really be law. So there’s a lot of interesting writing being done, and Cardozo Law School has some articles on that.

MR. ELY: If I can add something to that. You know, a contract is an agreement between two or more parties. And contracts are developed under common law, statutory law. You still have a legal instrument. Now, it may be in computer code, have various options in it. But it’s still fundamentally a legal contract that if nothing else could be put down on paper if necessary. There are enforcement issues that will come up, undoubtedly lawsuits.

So I think the whole notion of the so-called smart contract is really greatly overblown. It just is kind of a way to automate the application of a written contract in a particular situation such as with mortgages. But I think that the notion that somehow a smart contract is different than other contracts is just fallacious.

Q: My name is Bonnie Watchel. I’m an investor. Bert, two questions for you. First, just to make clear, I assume that everything you said about bitcoin and baseball cards could also be said of gold, and a lot of people do question whether it makes any sense to invest in gold.

And while you’re at it, when you’re answering that, I’m a beginner in this. I’m sure others are also. Could you explain this concept of a bitcoin miner? What is that? Just a software developer? Can anybody do that? I really am at a loss as to who that is and what it means.

DR. KUPIEC: I’ll take the bitcoin miner quickly. So what you have to do is solve a big cryptography problem. You find numbers that solve a problem. Anybody with a computer can try to do it. In fact, my neighbor — my neighbor’s son, he was in high school. And when bitcoin started trading, he was building computers. He’s a geek. He’s a nerd. He would describe himself that way. He built computers in his basement and to see how good they were, he solved bitcoin. And he had about five or six of them except he threw out those computers so he’s lost them all. (Laughter.) But in the early days, you solved this mathematical problem and in the process of solving the problem, you take a block of transactions and you basically verify that they’ve happened.

So anybody anywhere can do this, but it’s gotten very complicated. People try to do it fast because there’s a reward. You get bitcoins if you solve the problem and so people, you know, pool together big computer power so the mining — the big mining firms are in places like China, in Northern China, where electricity is really cheap and it’s cold. Because a lot of computers together generate a lot of heat so you want cold air. Iceland is a big mining place. So these mining farms are big computer farms and people, you know, build specialized computers to try solve each blockchain and make bitcoin as they go along.

MR. ELY: Bonnie, let me just address —

MR. POLLOCK: Bonnie, that’s your first good question. Now we’re going to come to your second good question. And that’s the one we’re going to end on. What’s the difference after all in the value of gold, paper dollars?

MR. STERN: I admit. I am not a gold buff. But gold does have some real-world value, not just as jewelry but also there are a number of industrial applications for gold. I think most gold — I think gold mining is an incredibly wasteful process at this time because almost all gold just ends up sitting in a vault someplace. But it is probably relatively more valuable than bitcoin or cryptocurrency mining bits. There’s absolutely no intrinsic value or no alternative use for these cryptocurrencies. So I don’t want to make an argument for gold mining is good. To me it’s just less bad than cryptocurrency mining.

And, again, I refer people to this very interesting article in The Wall Street Journal this morning about bitcoin mining and how resource intensive it is.

MR. POLLOCK: Hadley, yes. I was going to call on you.

MR. STERN: So just very quickly, I think it is very similar to gold so it’s a good question of why one is not worth the other. There is a very good book out there that has a bit of an insulting title, “Bitcoin for the Befuddled.” I have no relationship with the author, but if anyone is serious about wanting to learn about the technology, it’s actually not that hard of a read either. I encourage you to pick it up, and you’ll come away understanding how mining fits into it. But bitcoin was designed in many ways off of in some ways like gold, this notion of a limited supply that gets harder to mine over time and there’s less of a supply. There’s a limited supply of bitcoin. There’s been only 15 million mined.

MR. ELY: But I think that that’s actually somewhat misleading because what you have is you get the fractionalization of bitcoin. And I believe most people who now own bitcoin actually own a piece of a bitcoin. So it’s kind of like a stock split, and you can keep dividing and dividing and dividing —

MR. STERN: Just like gold. You can shave the gold bar.

MR. ELY: That’s right. No. That is true, but I think that the limit — this artificial limit isn’t much of a constraint because you can keep dividing it and keep the price, if you will, of an individual transactions at a relatively tolerable level.

DR. KUPIEC: Before we close, it’s worse than that. You can take the blockchain and create new cryptocurrencies —

MR. POLLOCK: Without limit.

DR. KUPIEC: Because nobody controls how many new bitcoins there can be. There’s —

MR. STERN: But there’s a limited supply of bitcoin.

MR. POLLOCK: How many new cryptocurrencies —

DR. KUPIEC: Bitcoin, yeah. Yeah.

MR. POLLOCK: — there can be.

DR. KUPIEC: You’ve got Ether, and you’ve got all of them.

DR. DWYER: You can make bitcoin cash if you want, but it’s not bitcoin.

MR. STERN: It’s not bitcoin.

MR. ELY: You know, it doesn’t make any difference what you call it.

DR. DWYER: And that’s what’s important. It’s an equilibrium where these things have value.

MR. POLLOCK: That’s good. We’re losing control up here. (Laughter.) That is to say I am.

DR. DWYER: Well, what he’s saying is wrong.

MR. ELY: But true.

MR. POLLOCK: I want to ask one more question, and then we’ll adjourn. How about bitcoins and those paper dollars, Hadley, that you were showing out there? How would we contrast those?

MR. STERN: I think we contrast them: One is physical, and one is digital. I think gold is a better analogy to bitcoin. But I think the key thing here — whether bitcoin exists 100 years from now is sort of not the point. The point is whether as human beings anyone does something really interesting with this technical breakthrough and creates new products, services, and companies that were unimaginable. Just like when Tim Berners-Lee wrote the HTTP spec, he never would have imagined the World Wide Web. And that’s an answer that’s going to take a while to come.

MR. POLLOCK: OK. Good. That’s a good comment to end on. Ladies and gentlemen, thank you for being with us. Please join us at the reception. And let’s show our appreciation for a very interesting panel. (Applause.)

(END)