Chapter XIII of my book, "Politics for the New Dark Age: Staying Positive Amidst Disorder" defines an economic bubble like this:
"Bubbles are deviations from the long-term trend in the value of particular assets where their rate of return exceeds the underlying productivity growth of the capital."
From a policy perspective, bubbles are undesirable and difficult to manage, but they're also a useful diagnostic tool: the presence of a bubble indicates that an economy is unbalanced, and that there's an excess of either supply or demand for capital or labour going unused.
Crypto-currencies are currently experiencing a bubble. Take a look at the price chart for bitcoin, the founder and standard-bearer of this new type of digital currency:
That's a more than 17-fold increase of value of bitcoin assets in a year, creating a total market valued at about US$280 billion. Other digital currencies are performing similarly. Ethereum, the third most significant cryptocurrency by both value and volume traded increased by more than ninety fold. Perhaps better capturing the irrational exuberance of the bubble, companies are doubling or quadrupling their share value overnight by adding 'blockchain' to their company name, and new currencies are being created and attracting venture capital at an staggering rate. More annoyingly, semi-informed elites are kvetching non-stop about way blockchain technology is going to save the world: honest-to-god, I attended a public lecture recently on how blockchains could be employed to monitor human rights abuses.
We've seen this scale of bubble before: the best fit is the .com bubble of the late-1990s, during which tech companies posted similarly insane gains before crashing back to earth. I'm not saying the value of bitcoin has always been illusionary (all currencies are illusions, one way or another). Bitcoin has been around for a while now and found genuine niche uses in online (and black-market) transactions. It has developed a reputation as a meaningful unit of exchange, and attracted financial infrastructure investments to improve the efficiency of its operations. In the same way that the .com bubble didn't mean the internet was a failed technology, a cryptocurrency bubble doesn't mean that bitcoin and its peers are useless: merely that their current valuations grossly exceed the underlying productivity of the asset class.
Why now?
Let's be clear. The value of cryptocurrencies isn't miraculously increasing because blockchain is the future of money. Cryptocurrencies cannot repace fiat money because they operate on the same principle as gold or other precious materials: they are resource-constrained prestige assets privileged by some consumers but unsuitable as a universal medium of exchange. Why are cryptocurrencies resource constrained? Well, the fact that bitcoin mining currently consumes more electricity than the Republic of Ireland gives a clue. While digital currencies themselves may be unlimited, the computing power required to cryptographically process blockchains consumes a scarce common good (electricity) and produces waste (heat and carbon dioxide). When the prices of these inputs and outputs are taken into consideration, cryptocurrencies will face natural limits to growth, much as the value of gold is constrained by the accessiblity of the mineral in the Earth's crust. Fiat money is not limited in the same way: assuming trust in public institutions, it's a more efficient solution for creating an unlimited medium of exchange.
So why is the cryptocurrency bubble happening now? Let's take the productivity of bitcoin as a given and look at why more capital might be flowing into the market. First, most digital currencies have in-built inflationary drivers: there is a mathematical limit of 21 million bitcoins that will ever be created, and even currencies that are unlimited in the same way exponentially slow the creation of new units of currency over time. In other words, the longer cryptocurrencies exist, the more stable and predictable the supply of coins becomes. Secondly, several events in 2016/17 significantly improved the regulatory certainty of the major digital currencies. Ethereum famously split into multiple versions in 2016 as a result of attacks on its value, whereas the bitcoin market changed some of its internal rules in 2017 without splitting. A stable asset pool with regulatory certainty is a good de facto target for market speculators.
But the core reason for the timing of the cryptocurrency bubble is that there is just too much capital sloshing around the financial system right now without anything productive to invest in. The same factors that are pushing the US stock market higher are creating, at miniature scale, the digital currency bubble. That is: obscence rates of corporate profit, the promise of debt-funded tax cuts by irresponsible conservative governments, stagnant wage growth and rampant inequality. Supply-side economics when there is a glut of capital supply does not work. Capital availability does not make capitalists invest in low-productivity, low-return activities: it increases their tolerance of high-risk, high-reward assets. In other words, it drives speculation and bubbles. Whereas the Bush tax cuts were invested in speculation driving up the price of housing and food (which was bad enough), the Trump cuts are being invested in bitcoin, share-buy-backs and an increasing concentration of corporate monopolies.
Three Futures
Overall, I'm not very concerned by the cryptocurrency bubble. It's a warning sign that things are seriously wrong elsewhere in the economy, but not a problem for public policy-makers per se. Unlike housing, food and superannuation, cryptocurrencies are not (yet) essential to the provision of essential public goods and services, and so there's little reason for governments to be concerned about their prices (by analogy: why bother controlling the price of expensive art?). To that end, I see the cryptocurrency bubble ending one of three ways:
1) In the first (and most likely) scenario, the market for cryptocurrencies crashes without significant consequence for the broader economy. Lots of people take a haircut, and a bunch of financial instrastructure investment is effectively wasted, but cryptocurrencies continue to be used and develop at their underlying growth rate - as happened to tech companies after the .com bubble. The bitcoin crash may come about either on its own, or as a consequence of a broader systemic financial crisis: either way, no one will really take notice except the speculators who were playing the bitcoin game.
2) The second scenario is that the bitcoin bubble crashes and creates negative feedback for the real economy because of the overexposure of key financial institutions (including pension funds and banks) to cryptocurrency risk. This is far less likely. US$280 billion may seem like a large asset pool, but it's a drop in the ocean in terms of global financial markets. While I have little faith in the market's ability to handle systemic risk, I'm marginally more confident that institutional investors will be warier of cryptocurrencies than they were of mortgage swaps.
3) The third, and least likely scenario in my mind, is that there is in fact a positive feedback between the cryptocurrency market and the broader financial world. In this scenario, amidst a broader systemic market crash, in which the faith of investors and consumers in national currencies is shaken, trust and confidence in crypocurrencies actually leads to their increased use in market transactions, such that cryptocurrencies ultimately help stabilise the real economy. Think of people hoarding gold during the Great Depression to get an idea of how this would look. I refer to this as a the "Mr Robot" scenario (spoilers for season 3), and it's the preferred vision of the techno-libertarians who have the most faith in bitcoin. It's an extremely unlikely outcome for the forseeable future, but an interesting possibility nonetheless.