What taxi medallions can teach us about cryptocurrencies

What taxi medallions can teach us about cryptocurrencies
© Getty Images

Taxicab medallions have been in the news in recent weeks due to the widely publicized involvement of Michael Cohen, President TrumpDonald John Trump20 weeks out from midterms, Dems and GOP brace for surprises Sessions responds to Nazi comparisons: 'They were keeping the Jews from leaving' Kim Jong Un to visit Beijing this week MORE’s former attorney, in the New York City taxicab business. 

Much of Cohen’s wealth in recent years had been attributed to the steadily rising value of the taxicab medallions he owned, but like all cryptocurrencies, Cohen’s supposed medallion wealth was merely an illusion that is no more.

Cabs cannot operate in New York, Chicago, San Francisco or Boston unless they have a medallion, which effectively is a city permit to carry passengers for hire. 

Although not widely understood, the artificial, politically imposed limit on the number of medallions a city will issue — an artificial shortage if you will — for many years led to a steady increase in the market value of medallions as the number of taxi passengers increased.

That rising value, and the returns medallion owners expected to earn, created many distortions in the New York taxi business, including gypsy cabs and the absence of cabs in poorer neighborhoods. 

Limiting the number of taxi medallions a city would issue has a parallel in the crypto world — an artificial limit on the number of units of a particular cryptocurrency that could ever be issued. 

For example, according to the design of the bitcoin algorithm and database, supposedly developed by someone named Satoshi Nakamoto, no more than 21 million bitcoins will ever be created. 

Further, the computational effort required to “produce” each additional bitcoin steadily increases as that limit is approached, further enhancing that sense of scarcity. 

The design of the bitcoin algorithm has been seen as brilliant, but in fact it is not, for artificial scarcities do not produce sustainable value.

In each instance, there is no real value — readily available permits issued without limit have no resale value.  Cryptocurrencies that can easily be replicated under a different name have no intrinsic value, they have no claim on real-world assets, there is no “there” there.

For a while, these artificial limits worked: Values rose steadily, and the owners of these scarce items got rich. Then technology reared its ugly head, in the form of computerized ride-sharing — Uber, Lyft and their many knock-offs — and cryptocurrency “forking,” such as bitcoin begetting bitcoin cash and bitcoin gold.

According to one report, the price of a New York taxicab medallion peaked at over $1 million in 2013.  Currently, they are priced as low as $175,000, a price decline over 80 percent. Boston and Chicago taxi medallions have seen sharp price declines, too.

Comparable price drops have occurred in the crypto world. Based on data from www.coinmarketcap.com, at 1 p.m., Eastern Time, Thursday, bitcoin, the most valuable cryptocurrency, was selling for $7,529, down 63 percent from its peak price of $20,089 last Dec. 17

Bitcoin price recoveries since then have quickly petered out. For example, after hitting a low of $6,636 on April 6, bitcoin recovered to a peak of $9,965 on May 5 before beginning its current price plunge.

Other major cryptocurrencies have experienced similar price declines. After peaking at $1,433 on Jan. 13 of this year, at 1 p.m. Thursday, Ether, the second most-valuable crypto, was priced at $585, down 59 percent from its peak.

Ripple, XRP, the third most-valuable crypto, peaked at $3.84 on Jan. 4 before beginning its price plunge. At 1 p.m. Thursday, XRP was priced at $0.623, a price drop of 84 percent.

The total market value of all cryptocurrencies peaked at $595 billion on Jan. 18. Nearly four months later, that number has dropped to $333 billion, a loss in market value of $262 billion, or 44 percent. 

While many investors have only experienced paper losses on their cryptocurrency investments, the substantial crypto trading activity in recent months suggests that actual, realized losses suffered by crypto investors are in the tens of billions of dollars, if not much more.

Although there is no hard data on the extent to which crypto investors have made leveraged bets, by financing their crypto purchases with credit card advances or by refinancing their home mortgage, anecdotal reports suggest that such debt-fueled speculating has been extensive.

Many taxicab medallion purchases were financed, too. The subsequent drop in medallion prices has led to many medallion foreclosures and substantial losses to lenders. At least two credit unions have failed due to losses on their medallion loans.

Lenders to crypto investors will suffer losses, too. Often, though, they will not have realized that they had financed a cryptocurrency speculation.

There is every reason to believe cryptocurrency prices, like taxi medallion prices, will continue to decline because in a very fundamental sense, they have no real value. As I have written in previous Hill op-eds, cryptocurrencies do not function well as money, and they have been, and will continue to be, a terrible store of value. 

Worst, unlike taxi medallions, cryptocurrencies generate no income or cash flow. Consequently, the only reason to invest in a cryptocurrency is the expectation of endless price appreciation, which requires a belief that the “greater fool theory” will work indefinitely. 

That most definitely will not be the case for taxicab medallions, or for cryptocurrencies.    

Bert Ely is the principal of Ely & Company, Inc., where he monitors conditions in the banking industry, monetary policy, the payments system, and the growing federalization of credit risk.  Prior articles by Ely on banking issues and cryptocurrencies can be found here.  Follow Bert on Twitter: @BertEly