Chartalism suggests that cryptocurrencies are worthless speculative investment vehicles.
The use of blockchain technology in sectors such as healthcare and logistics to protect patients’ sensitive health records and identify issues in supply changes undoubtedly has merit. In finance, there is a debate as to whether a tokenised form of the blockchain, cryptocurrency, has fundamental value. Cryptocurrencies cannot be valued on a cash-flow basis as their properties contrast with bonds and equities, although it is important to consider that cryptocurrencies have had market value since their founding (e.g., Bitcoin in 2009 and Ethereum in 2015).
Chartalism can be used to value cryptocurrencies by assessing their uses in markets and in satisfying tax liabilities. Goods, services and financial assets are exchanged for monetary tokens; chartalism suggests the token used for transactions is based on state acceptance. Alternative valuation methods underpinned by econometric models can explain past and future cryptocurrency price trajectories. These models differ from chartalism by treating cryptocurrency as an investment rather than money.
Cryptography
Cryptography is used in the blockchain’s underlying technology and is needed to understand alternative cryptocurrency appraisal techniques based on the cost of mining and derived demand for secure payments. Cryptography has led to encryption which regulates data access through ‘keys’. Blockchain protocols are the intellectual property supporting a cryptocurrency defined by the creator. Users of the blockchain interact with the protocol and have public and private keys. A transaction is signed using a private key which prevents forgeries and the public key validates a transaction to confirm the owner of the cryptocurrency.
A set of transactions form a block and once validated, are added to a chain of previous transactions to create a ledger. Miners of the cryptocurrency have a profit motive to validate new blocks by finding the solution to a mathematical problem defined by the protocol. Miners work to find an input of a function output, namely the output of the SHA-256 or Scrypt cryptographic hash function, which are functions that are impossible to reverse engineer. In the case of Bitcoin, there is a block reward received by the first miner who solves the input and a transaction fee paid by the individual transferring Bitcoins. There is a limit to how many transactions will fit in a block creating a market for block space where supply and demand interact to determine transaction fees. Note that without the miners, there would be no supply of the cryptocurrency.
The blockchain forces proof of work to verify transactions. The ‘trusted’ ledger is the one backed by the most computational work. Statistically, no single blockchain user can solve the solution to the cryptographic hash function consecutively thus ensuring that no user will disagree with any ledger entry.
A Chartalist View on Cryptocurrency
Chartalism reasons that money is endogenous and a medium of exchange by law that supports a population's social and financial activities. Formerly, various tokens were used to minimise barter transaction costs and as an accounting unit for debt settlement. Tokens are any physical or digital asset; the token used in the developed world is fiat money. Under chartalism, governments supply money through government spending and induce money demand by requiring taxes. Recent interpretations of chartalism include neo-chartalism which is interrelated with modern monetary theory (MMT). MMT asserts economies can never default by financing state deficits by creating more domestic currency all while only being constrained by inflation.
A chartalist view assigns a zero value to cryptocurrency because it is unable to settle financial obligations. Like regular currencies, cryptocurrencies have zero intrinsic value and are traded for currencies a government accepts to pay taxes. Chartalists may see a greater need for cryptocurrency regulation if fraud, money laundering and other illegal activities threaten the tax-driven society.
Government interactions with cryptocurrencies have materially increased since the COVID-19 pandemic. Cryptocurrencies have been treated much like traditional investment assets rather than money. In February 2022, the US Department of Justice seized $3.6 billion in Bitcoin via forfeiture when two were arrested for hacking the cryptocurrency exchange Bitfinex. The distribution of the cryptocurrency back to the victims is near-impossible as they were compensated by Bitfinex when the hacking occurred. In theory, this Bitcoin could be sold or distributed by the government. Second, central banks are exploring digital currencies (CBDCs) that will have similar security features as used in cryptography. If governments use a digital currency, cryptocurrency may be a close decentralised alternative that could give it some value. Governments will never distribute cryptocurrency as legal tender because this would centralise the currency.
Alternative Valuation Methods
Bubble theories present cryptocurrencies as speculative investments using mathematics rather than a theory of money to prove a zero or marginal cost price. Further ideas on why cryptocurrencies should exceed their marginal cost price are outlined to form a ‘value range’ for a cryptocurrency.
Empirical findings show that the boom in cryptocurrency prices is a financial bubble, indirectly agreeing with chartalist conclusions. Bubbles are either formed by self-fulfilling rational expectations, rational mispricing or irrational mass hysteria unrelated to the asset value. A cryptocurrency bubble is modelled using an intrinsic rate of return and risk which are both a function of a hazard rate; hazard rates show there is a non-zero probability that a fixed percentage of the asset's value will be erased in each period. A critical model assumption is that financial instruments exhibit exponential price behaviour in the long run. Price action associated with the bubble and the exponential behaviour is separated to validate whether cryptocurrencies are experiencing a bubble. Throughout a bubble’s lifespan, investors are compensated with excess returns for an increased risk of the bubble popping, accompanied by a decrease in market volatility from reduced expected price risk. Academic studies have concluded that Bitcoin’s price action in 2013 and 2017 represented a bubble. After the bubble pops, asset and intrinsic value converge to zero in the model.
Modified financial bubble arguments show that the price of the cryptocurrency will tend towards its marginal cost. Miners have a ‘hash rate’ associated with ‘hash power’, the power needed to find solutions to the cryptographic hash functions, which comes at some cost to the miner. A non-zero marginal cost implies a non-zero price in a competitive market. If the marginal cost exceeds the marginal product (or price), miners would reallocate the computational power to mine other coins or elsewhere. Perfect capital mobility and similar rewards to miners across cryptocurrencies (e.g., an amount of the cryptocurrency mined) means that opportunities for excess returns are short-lived. Research has shown that mining effort Granger causes cryptocurrencies to have a price, not vice versa. A fall in energy costs combined with blockchain efficiency improvements (such as Ethereum’s recent ‘Merge’) may erode marginal cost and its fundamental value.
Properties of cryptography suggest that prices should exceed marginal cost. The law of one price says the cost of an asset will have the same price in different markets. If current credit card providers or foreign currency exchanges charge high transaction fees relative to cryptocurrency, the cryptocurrency must increase in value to reflect the differential between the transaction fees, otherwise, there is an arbitrage opportunity. Due to technological advancement, transaction costs on currency exchanges will likely equal the price of cryptocurrency transaction costs in the long run. Further, the intangible cryptocurrency protocol has value if individuals are willing to pay a premium to transact on a secure, permissionless, decentralised payment network as a matter of preference (there is a derived demand for cryptocurrency). The magnitude in which price would be above marginal cost is unforecastable.
A market sizing model puts an upper bound on cryptocurrency value. The approach uses functionalism to value cryptocurrency by its ability to store value and act as a medium of exchange in e-commerce and monetary transfers. The model assumes a fraction of payments will use cryptocurrency and that Bitcoin has a similar reputation to safe-haven assets. The model also suggests cryptocurrency market capitalisation is determined by the enterprise value of firms that facilitate monetary transfers.
Discussion
Chartalism is correct when cryptocurrency is considered as a form of money because no government accepts cryptocurrency for taxes. Any asset where a gain is realised is subject to capital gains tax. Germany views cryptocurrencies, specifically Bitcoin, as private money which officially makes Bitcoins a unit of account. Akin to German real estate, cryptocurrencies are only subject to capital gain if profits are realised within a year. However, only euros are ever collected by the government, not Bitcoins, so the idea of taxing cryptocurrencies is no different to taxing any other asset.
The theory of chartalism is flawed in the means by which money is created and trusted. First, pre-colonial tribes saw no need for government and shells as tokens to settle debt so there was no centralisation within this system; but this argument is now flawed as economies have increased in complexity with institutions and have inequalities. Secondly, chartalism emphasises governmental control of the money supply; modern-day central bank independence is understated. Central banks control the money supply implying that money is not tax-driven, particularly in a zero-tax environment. Therefore, as the chartalist view has less validity when discussing the modern monetary system so its conclusions on cryptocurrency could be wrong too.
Despite arriving at similar conclusions on value, the cryptocurrency bubble argument is unlinked to chartalism. In the past, financial innovations have been subject to financial bubbles and their prices have been fuelled by governments and central bank rhetoric and policy (the dot-com bubble in 2001 and the CDO housing bubble in 2008), cryptocurrency may be next. Under the marginal cost bubble model, miners must be active in perpetuity to have value. Bitcoin is scarce and its protocol means only 21 million units will ever exist and no mining will occur after around 2140. Miners may lose interest in cryptocurrencies and reallocate their computational power towards blockchain in other industries. Furthermore, cryptocurrency funds are now spread over underdeveloped coins so investors are at a greater risk of ‘rug pull’ scams.
Added value or arbitrage arguments may cause some market noise around the marginal cost; the price may diverge above the marginal cost when seen as a better alternative for security or transaction cost reasons. Access to the decentralised secure payment and settlement service could be a preferable option, the token provides connectivity. The ‘upper bound’ market sizing model is erroneous, cryptocurrency is dormant in 70% of wallets, so is poor as a medium of exchange. Secondly, if Bitcoin had zero value, the money transfer firm would still have some enterprise value. Further, it is ludicrous to compare Bitcoin with silver or gold because of the industrial uses of these commodities that cryptocurrencies do not have. The model may be more reliable if its assumptions changed given that money transfer firms such as Coinbase and PayPal have seen correlations with cryptocurrency prices since providing the coins in its service range.
In conclusion, the theory of chartalism is a poor choice to explain the value of cryptocurrency because it misrepresents money issuance within an economy and provides no mathematical proof of its value. Cryptocurrency is used in payments as a currency but is not money, thus behaving like investment assets in a financial bubble. The marginal cost is a lower bound on price after the cryptocurrency bubble eventually bursts but will decrease through energy efficiency advancements and decreasing supply growth and mining interest. Consequently, cryptocurrencies will have zero value in the long run. Noise may be observed in the price from arbitrage opportunities or irrational decision-making.
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