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On Thursday, June 10, Antoinette Schoar joined Markus’ Academy for a lecture. Schoar is the Stewart C. Myers-Horn Family Professor of Finance and Entrepreneurship at MIT.

Watch the full presentation below and download the presentation slides. You can also watch all Markus’ Academy webinars on the Princeton BCF YouTube channel.

Executive Summary

  • The Blockchain Trilemma means that you can have two of the three desired features: self sufficiency, resource efficiency, and no rent extraction. Self sufficiency means that there is no need to rely on an outside verification system. Resource efficiency does not occur in proof of work blockchain, as it takes a tremendous amount of energy and has some environmental damage. Centralized ledgers typically involve some rent extraction. For example some monopolistic record keeper enjoys some future profits. To maintain these rents he has to keep records honestly. Bitcoin is extremely energy inefficient. Every transaction uses energy.

  • Bitcoin is currently based on permissionless “proof of work” blockchain protocol. Allows for pseudo-anonymous transactions. Bitcoin flows can be traced across addresses, but the owners of the addresses are unknown. People can however be identified when they exchange their bitcoins for Dollars, Euros etc on exchanges that require KYC standards, but not all exchanges impose these standards. If Bitcoin is widely adopted, so that one can buy various goods and services, it will become possible to bypass exchanges and with it points of verification (KYC=Know Your Customers).  Despite the increased participation of many small retail investors in the Bitcoin ecosystem, the rer is still very concentrated ownership of Bitcoin among a very small set of large holders (or “hodlers”).

  • Bitcoin mining is done in pools. Pools provide coinsurance for their members, with the majority of the pools registered in China. This means that the mining pools are important, but the highly concentrated nature of the pool is worrying because if regulators start restricting mining capacity, the whole system would be at a greater risk. On average, it takes less than 100 miners to get to 50% of the mining capacity, showing the weakness in the system and that it is not simply concentrated pools, but also concentrated miners.

  • Although Bitcoin has a large market capitalization, there is still high volatility. This suggests that it would not be as safe as people would hope, which is why Bitcoin is still seen as largely speculative.

  • Several worries in adoption for regulators. The loss of seigniorage would shift the benefit from the public to a few early adopters. The replacement of government backed currencies with Bitcoin would transfer seigniorage benefits to parties that do not provide public goods. There is also systemic risk: entrusting control of widely-used value to unknown entities can create large disruptions and systemic risk. Malevolent private or state actors could gain control and inflict large losses to the general public and FIs. It would also facilitate tax evasion because transactions cannot be traced as well.

  • But not all cryptocurrencies are equal. Regulators have to weigh the cost of and benefits of different cryptocurrencies. There are currently large lobbying efforts to allow regulated financial institutions like pension funds, mutual funds, publicly traded firms, and government entities to speculate in Bitcoin. The differences between currencies also means the treatment of cryptocurrencies should be different, which is why stable coins (if well regulated) could provide significant benefits to the payment system.

  • The El Salvador situation (where the president announced that BTC would become legal tender) could be occurring for a variety of reasons. One possible reason for this decision is that the government looks to boost the economy by allowing the illegal transactions to occur in El Salvador or giving people who want to evade taxes a place to do so, in a bit of a “race to the bottom.” This might attract resources to El Salvador, but the worry for other economies is that certain individuals and groups would take advantage. It also can have negative implications for El Salvador if it becomes difficult to tax citizens.  El Salvador may be giving up seigniorage, but perhaps it is not as bad as it would be for another country with a stronger currency.