On June 9th this year, the hip-hop star and businessman Shawn “JAY-Z” Carter announced that he was starting The Bitcoin Academy to educate the residents of the Brooklyn, New York public housing complex where he grew up about cryptocurrency. The average household income for residents in New York City public housing is reported to be about $25,000. Investing in cryptocurrency is a terrible idea for low-income households—and it is not a good idea for most other people either. On June 9th, Bitcoin had lost nearly 60 percent of its value from its peak seven months earlier.
A recent survey finds that Black people are more likely than white people to be invested in cryptocurrencies, and that Black people are more likely to incorrectly believe that cryptocurrencies are regulated by the government and are safe. Sadly, the Nobel Prize-winning economist Paul Krugman is correct to call cryptocurrencies the “new subprime.” The predatory selling of subprime mortgages stripped massive amounts of wealth from Black communities. Cryptocurrencies are a shiny new way to lose money.
Cryptocurrencies are complex, but their fatal flaws can be easily understood. The following discussion reveals some (there are more) of the reasons why Black people–and really all people—should not be invested in cryptocurrencies.
Cryptocurrencies Are Not Practical Currencies, Part 1
Technically, cryptocurrencies may be currencies, but practically they are not. They should not be used for day-to-day exchanges as one does with fiat or government-backed currencies.
Cryptocurrencies are extremely volatile. Imagine that you are a business owner. You have done $100,000 in sales, and put that money in the bank for future use. Six months later, you want to use the money to restock your inventory and pay bills, but you discover that you only have $40,000. This could happen if you were paid in cryptocurrency instead of dollars. As mentioned above, the value of Bitcoin fell by about this much in a similar period. Your business was profitable when you had earned $100,000, but with only $40,000, you are operating at a steep loss. This volatility is one of the reasons why it would be a mistake to try to conduct day-to-day business using cryptocurrencies instead of US dollars.
Cryptocurrencies Are Not Practical Currencies, Part 2
The global economy has fewer than 200 fiat currencies. Cryptocurrencies are not bound by any government. They are supposed to be global currencies. So, one would expect that a world economy run on cryptocurrencies would have fewer currencies than the number of fiat currencies. Instead, there are more than 12,000 cryptocurrencies, and about 1,000 cryptocurrencies are being added every month.
It is a fair bet that at some point most of these 12,000-plus cryptocurrencies will be worthless since they have no useful purpose to people generally. It is a bad idea to try to do business in a cryptocurrency minted yesterday, which will likely be gone at some unpredictable time in the not-too-distant future.
Cryptocurrencies Are Bad Investments
Cryptocurrencies are not really currencies but investments. However, they are not like other investments. They are really bad investments. For example, if someone invests in stocks from IBM, that person essentially owns a portion of the company. There are metrics that individuals can use to assess the value of a company and, thereby, the value of a company’s stock. Once it is determined that the company is solid with a good business plan, then it can be considered a good investment. The value of even a good stock like IBM’s can be fairly volatile, but it is not likely to fall as far and as fast as a cryptocurrency.
IBM makes and supports computing technologies that are very valuable in the world today. Even if IBM were eventually driven out of business by competitors, this would likely take several years. IBM is a huge company that has lasted for about a century. There is a good chance it will be around into the foreseeable future.
Unlike companies like IBM, cryptocurrencies do not make and sell a product or provide a service. The value of a cryptocurrency depends on the amount of hype or irrational exuberance there is attached to the cryptocurrency. For example, Dogecoin was literally a joke idea. Individuals then decided to make it into a real cryptocurrency. Elon Musk hyped Dogecoin, and people purchased it and increased its value. Eventually, the hype died down, and the value of Dogecoin crashed. It lost about 90 percent of its value from its peak in May last year.
Dogecoin is not used for everyday purchases and is not based on a company that sells a product or provides a service. Its value rises based on the amount of hot air from the hype under it, and crashes when that air cools.
The Later Investors in Cryptocurrencies Make the Earlier Investors Rich
When people might bid up the stock of Apple, they are betting that the company’s products will generate increased profits in the future. With cryptocurrencies, there is no company producing profits. The value of a cryptocurrency increases purely as a function of more investors buying the cryptocurrency. This means that when people buy a cryptocurrency, they are simply betting that many other people will also buy the cryptocurrency.
Since the way to make money off a cryptocurrency is to get other people to buy it, then it becomes important to have an aggressive marketing effort that keeps the actual mechanism of wealth generation obscure. This is why there are so many celebrities being paid to market cryptocurrency. The only way to make money is to get other people to buy the cryptocurrency.
Therefore, the real money that cryptocurrency investors can actually use is made from selling the cryptocurrency when its value is high. This means that later investors are essentially transferring their wealth to the earlier investors when the earlier investors cash out. The irrational exuberance around cryptocurrencies allows the first investors to make a lot of money very quickly. The late investors, those individuals who buy the cryptocurrency when its value is high and it is about to crash, can lose a lot of money very quickly.
A factor in the rise of cryptocurrencies is the extreme inequality in US society and the fact that it is harder for average people to get ahead. It is in this context that get-rich-quick schemes are appealing to many people. Get-rich-quick schemes, however, are always a scam. Ultimately, it is better for people to invest in the slow and hard work of un-rigging the economy and enacting policies that make society more equitable.
This first appeared on CEPR.