At the outset let’s be clear on the relation between Bitcoin and blockchain technology. Blockchain technology is one of the most important economic innovations in decades. It has the potential to revolutionize transacting and record keeping. Its developers, if we ever find out who they are, should be at the top of the list for the Nobel Prize in economics.
Bitcoin applies the block chain technology to a crytocurrency. For more details on the economics of Bitcoin, I recommend the blog of my colleague Aswath Damodaran.
The massive price increase in Bitcoin has generated a great deal of attention and controversy. In my view, Bitcoin is the most sophisticated chain letter in history. As Prof. Damodaran notes, Bitcoin is not an asset because it provides no cash flow and is not a commodity because it provides no useful service. It is at best a poor substitute for national currencies. But despite these deficiencies, it is an ideal vehicle for the development of a speculative bubble because the risk of transacting has been removed. I am definitely in the camp that Bitcoin is a modern day tulip and is headed to a collapse similar the that which occurred in Holland in the 16th century.
How does the Fed fit in? In my view, the nearly decade long experiment in negative real short-term interest rates and quantitative easing has led to an almost pathological search for investment return. And nowhere is that pathology more clear than in Bitcoin. I cannot get a haircut these days without my barber asking me about Bitcoin. He says he bought at $3,000 and has more than doubled his money. I hope he sells soon or he may have to cut a lot of hair.