Should-Read: John Cochrane: The Grumpy Economist: Bitcoin and Bubbles

Should-Read: Ima gonna archive this to jeer at in the future! Yes. BitCoin is a bubble. It is a mania of irrational crowds. It is not a financial market that is serving as a rational social calculating mechanism. It is not a market in which prices are being set by rational von Neumann optimizing agents. It is not even a market with short-selling constraints in which rational speculators are exploiting a non-rational herd: John Cochrane: The Grumpy Economist: Bitcoin and Bubbles: “So, what’s up with Bitcoin? Is it a ‘bubble?’ A mania of irrational crowds?…

…It strikes me as a fairly pure instance of a regularly occurring phenomenon in financial markets…. The convenience yield… it facilitates tax evasion, and allows for illegal voluntary transactions such as drugs and bribes…. On top of this “fundamental” demand, we can add a “speculative” demand…. You can make so much money in a volatile market over a week, if you get on the right side of volatility…. In sum, what’s going on with Bitcoin seems to me like a perfectly “normal” phenomenon. Intersect a convenience yield and speculative demand with a temporarily limited supply, plus temporarily limited supply of substitutes, and limits on short-selling, and you get a price surge…. Other theories, such as madness of crowds, do not explain that correlation…

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A longer excerpt: John Cochrane: The Grumpy Economist: Bitcoin and Bubbles: “So, what’s up with Bitcoin? Is it a ‘bubble?’ A mania of irrational crowds?…

…It strikes me as a fairly pure instance of a regularly occurring phenomenon in financial markets, one that encompasses some “excess valuations”…. Let’s think about “convenience yield.” Why might someone be willing to hold bitcoins even though… we know pretty much for sure that within our lifetimes bitcoin will become worthless?…. Some of the convenience yield… is that it facilitates tax evasion, and allows for illegal voluntary transactions such as drugs and bribes. We can debate if that’s good or bad…. This is the obvious “convenience yield” of bitcoin…. It’s great for laundering money. And it’s great for avoiding capital controls…. There is a perfectly rational demand for bitcoin as it is an excellent way to avoid both the beneficial and destructive attempts of governments to control economic activity and to grab wealth….

On top of this “fundamental” demand, we can add a “speculative” demand…. High prices come with volatile prices…. Someone speculating on bitcoin over a week cares little about its fundamental value…. You can make so much money in a volatile market over a week, if you get on the right side of volatility. Now to support a high price, you need restricted supply as well as demand. There are only so many bitcoins….

In sum, what’s going on with Bitcoin seems to me like a perfectly “normal” phenomenon. Intersect a convenience yield and speculative demand with a temporarily limited supply, plus temporarily limited supply of substitutes, and limits on short-selling, and you get a price surge. It helps if there is a lot of asymmetric information or opinion to spur trading…. This view says that price surges only happen with restricted supply, and accompany price volatility, large trading volume, and short holding periods. That’s a nice testable link, which seems to hold for bitcoin. And other theories, such as madness of crowds, no not explain that correlation…