Bitcoin’s Troubles Go Far Beyond Elon Musk

All speculative market manias produce signature characters. From the Yale economist Irving Fisher, who, in October, 1929, pronounced that stock prices had reached “what looks like a permanently high plateau,” to Charles Prince, the chief executive of Citigroup, who, in July, 2007, remarked, “As long as the music is playing, you’ve got to get up and dance,” these individuals are forever tied to the bubbles they got caught up in. When the story of bitcoin is written, there will be many crypto boosters to choose from, such as the Winklevoss twins; the hedge-fund manager Paul Tudor Jones; and Cathie Wood, a pioneer of funds devoted to investing in disruptive companies. Right now, though, the individual most clearly associated with bitcoin’s travails is Elon Musk, the C.E.O. of Tesla and SpaceX.

As the Wall Street Journal reported over the weekend, Musk “has become Bitcoin’s biggest influencer, like it or not.” In January, he added “#bitcoin” to his Twitter profile; the following month, Tesla announced that it had bought 1.5 billion dollars’ worth of bitcoin and would accept payment for its electronic vehicles in the digital currency. A couple of weeks ago, however, Tesla reversed course on accepting bitcoin, a decision that Musk attributed to concerns about its environmental impact. (According to some estimates, the electronic mining of new bitcoin consumes more energy than do midsize countries like Argentina and the Netherlands.) After peaking at nearly sixty-five thousand dollars apiece, in April, bitcoin value was already dropping before Tesla’s reversal. Many crypto speculators blamed Musk for adding to the downward pressure, which, at one juncture last week, led to panic selling. Early Monday afternoon, bitcoin was trading at about thirty-seven thousand five hundred dollars.

It makes an entertaining narrative to focus on Musk, but the issues facing the crypto market go well beyond one individual. Briefly stated, the bitcoin boom faces two existential threats: a tightening of monetary policy by the Federal Reserve, and a legal crackdown by the Chinese and other governments intent on protecting their own currencies. The prospect of a Fed shift could cause the price of bitcoin to fall a lot farther. The spectre of concerted government action to restrict the trading and use of bitcoin is potentially even more perilous: it brings into question the long-term viability of the digital currency.

To see the impact that the Fed has had on the value of bitcoin, you just need to look at the currency’s price chart for the past year or so. In mid-March of last year, a single bitcoin was worth less than six thousand dollars. Then the Fed announced a massive stimulus to support the economy during the coronavirus pandemic. After the Fed move, the prices of virtually all risky financial assets began to rise, and bitcoin was one of the biggest beneficiaries of this trend. By the start of this year, it was trading above thirty thousand dollars. In classic bubble fashion, its rise became self-sustaining, as investors—professionals as well as amateurs—jumped in to capitalize. Another factor was the abstract nature of bitcoin. Since it doesn’t yield any cash flows, bitcoin’s value as an investment asset is essentially arbitrary. Like a work of art, it is worth what people believe it’s worth—a fact that Marion Laboure, an analyst at Deutsche Bank, highlighted in a March, 2021, research report. She called this “the Tinkerbell Effect.”

To be sure, some bitcoin boosters claim that the currency is the new gold: an asset that, although of limited intrinsic utility, does provide a valuable hedge against a fall in the stock market and other financial assets. Recently, however, bitcoin acted more like a risky meme stock, falling sharply as bond yields rose and investors fretted about a change in Fed policy to head off the threat of inflation. Last week’s rout coincided with the news that some Fed policymakers want to start discussing a plan for tightening the central bank’s money spigot, which has remained fully open even as the economy has rebounded. As bitcoin plunged last week, the price of actual gold rose.

Even now, long-term holders of bitcoin are sitting on large profits, and some optimists insist that the value will rebound and reach new highs as more and more institutional investors accept crypto as a legitimate asset class. Last week, Wood, the bitcoin proponent who heads Ark Investment Management, reiterated an earlier claim that the price could reach five hundred thousand dollars. She also predicted that “Elon will come back and be part of that ecosystem.” Musk, for his part, tweeted emojis of a diamond and a pair of hands, apparently indicating that Tesla doesn’t intend to liquidate its bitcoin investments. (On social-media platforms, some people use these “diamond hands” emojis to signal their intention to hold on to a stock.)

Given the nature of speculative markets and the widespread interest in the blockchain technology that underpins bitcoin and other digital currencies, it’s unwise to make firm predictions. But, on top of dealing with the possibility of a reversal in U.S. monetary policy, crypto bulls are facing the possibility of other countries following China’s lead and cracking down on bitcoin—the rise of which could present a competitive threat to government-issued currencies—such as the renminbi, the euro, and even the dollar—which are also called fiat currencies. If bitcoin or another peer-to-peer digital currency did achieve widespread acceptance as a means of payment, this would be a profound global economic development. Commercial banks could be circumvented. Financial regulations could be evaded. Governments could lose control over monetary policy and the ability to track money transfers for tax and crime-fighting purposes.

Early last week, three state-run Chinese financial agencies warned Chinese banks not to provide their customers with any services relating to bitcoin and other virtual currencies, including trading, storage, or acceptance as a means of payment. Later in the week, the State Council, China’s cabinet, issued a statement that said, “We should crack down on bitcoin mining and trading activities and prevent individual risks from being passed to the whole society.” Since the bitcoin-mining system relies heavily on power provided by Chinese power plants, this was no idle threat. And China has accompanied its moves against bitcoin by taking steps to roll out its own digital currency, which will initially circulate alongside cash.

The United States and other Western countries haven’t yet gone as far as China has, but their governments aren’t standing idle, either. Earlier this year, Janet Yellen, the Treasury Secretary, described bitcoin (correctly) as an “extremely inefficient way of conducting transactions,” and pointed out (equally correctly) that it is used “often for illicit finance.” (A couple of weeks ago, when Colonial Pipeline, the company that runs a main fuel-supply line on the Eastern Seaboard, agreed to pay hackers a ransom of $4.4 million, it paid in bitcoin.) Officials at the Treasury and the Fed are examining the possibility of the U.S. government following China’s example and issuing its own digital currency. “Our focus is on ensuring a safe and efficient payment system that provides broad benefits to American households and businesses while also embracing innovation,” Jerome Powell, the Fed chairman, said, last week.

Powell’s statement was studiously bland. It represented another straw in the wind, though. In India, where investing in bitcoin has become popular, there have been reports that the government is preparing to ban people from owning the digital currency. Ray Dalio, the founder of Bridgewater Associates, the world’s biggest hedge fund, has suggested that, under certain circumstances, even the U.S. government could outlaw bitcoin, to protect its monopoly on the supply of money. At this stage, such a development doesn’t seem likely. Still, the ultimate outcome is uncertain—a fact that Musk acknowledged over the weekend. In yet another tweet, he wrote, “The true battle is between fiat & crypto. On balance, I support the latter.” That pledge of allegiance came as no surprise. But, if investors have learned anything over the past few decades, it is that fighting the feds can be costly.