Although bitcoin has yet to prove its economic case, cryptocurrencies could yet bring benefits to the financial realm, argues Manuel Ammann, professor of finance at the University of St Gallen.
Bitcoin must iron out some fundamental design flaws before it can operate as a viable alternative to fiat currencies, Ammann believes. But if would be “generally positive” if the traditional financial system can eventually be challenged by the new digital currency competitors.
Bitcoin is currently the most well-known cryptocurrency next to Ethereum, Ripple and Litecoin. Are cryptocurrencies actually "real" currencies?
Manuel Ammann: Bitcoin is not a sensible currency from an economic perspective, as the basic prerequisites are missing. For a currency to be used as a means of payment, its buying power must be kept relatively stable. Furthermore, a certain amount of flexibility is needed regarding the supply of money, as the quantity must be able to grow in line with the money requirements of the economy.
Neither of these apply to bitcoin. What’s more, transactions in bitcoin are very expensive and extremely questionable from an ecological perspective, when you think about the fact that extensive server farms are needed to validate transactions and create new bitcoins.
Is bitcoin suitable as a form of investment?
A.M.: At the moment, bitcoin is merely an object of speculation, and the bubble that has emerged will soon burst. A lot of people will be extremely disappointed. It will take a while before cryptocurrencies attain a suitable level of investment quality.
Irrespective of the most recent crash, bitcoin has increased in value very quickly.
A.M.: The fact that the quantity of bitcoins was limited to 21 million obviously contributed towards this increase in value. Credibility has also been increased due to the fact that the crypto mechanism has not been "cracked" to date. Nevertheless, you should still not forget that bitcoin is not actually "worth" anything. Behind the Swiss franc, for example, you will find assets such as gold or foreign currencies, which provide the bank notes with credibility.
But there is nothing behind bitcoin. Of course, you can also question the "value" of traditional investments. Let’s take gold, one of the oldest investments, for example, which ultimately only generates its trading value based on the investor’s belief in its ability to maintain its value.
Is there nevertheless anything positive you can say about the development of cryptocurrencies?
A.M.: Alternative currencies are generally something positive, as they provide market participants with new possibilities. When commercial currencies exist in parallel to national currencies, the competition could have a disciplinary effect on the national currencies. In the past, these have often stood out due to the fact that inflation has decreased their value.
It would therefore be beneficial, from an economic perspective, if serious commercial currencies could develop first of all, without being regulated away as soon as they achieve a certain level of importance. At the moment there is no risk that large national currencies will be pushed out of the market by private cryptocurrencies. As long as the central banks can ensure the stability of money to a reasonable extent, there will be no significant desire from the population to look for alternatives.
Are there any examples of how new technologies have had an effect on financial markets?
A.M.: Automation and digitisation have been present in the financial markets for quite some time now. Market participants hope to achieve competitive advantages through the use of new technologies. A real "arms race" is therefore taking place at the moment. Those who have the best technologies will have a certain advantage, which can result in increased income. It is exciting to observe how the companies are positioning themselves.
At the moment it is still open as to who will emerge as the winner of this technological race: will it be the traditional banks and insurance companies, which are adopting new technologies and thus defending their positions, or will it be technology companies, which are becoming increasingly active in the financial services sector?
If we do not experience monopolisation in the sector, the winner is already clear: the consumer, as they will be able to enjoy continually better, and also, cheaper financial services.
Above all in the high frequency trading sector, but also in relation to bitcoin, decisions are increasingly being made on the basis of algorithms. Is it not unsettling that machines instead of people will be the active players?
A.M.: The importance of algorithms is growing continuously, and the trend did not start with bitcoin. The flood of data is continually growing, and we need technologies to be able to process this data. However, it’s not the models that are problematic, but rather the handling of them.
The more complex they become, the more difficult it becomes to get to the bottom of things. It becomes difficult to see the presumptions on which the models are based. We therefore need to question things critically and understand the background aspects, instead of simply accepting the models. Only then will it be possible to identify and correct unfavourable effects early on.
This article first appeared on the University of St Gallen websiteexternal link