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Bitcoin has risks, but it isn't a 'fraud'

Bitcoin has risks, but it isn't a 'fraud'
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When JPMorgan Chase CEO Jamie Dimon described the digital currency Bitcoin recently as a fraud, he was roundly criticized. Cryptocurrency aficionados, convinced that Bitcoin’s underlying blockchain technology represents the future of financial services, compared him to a buggy-whip manufacturer dismissing the automobile. Furthermore, what gave the head of a bank bailed out by the government in 2008 the right to warn about risky new investments?
 
As a business professor who studies emerging technologies, I’ve watched many similar debates. Incumbents often fail to appreciate major innovations. It’s also easy to take pot shots at established firms for moving too slowly. Yet, the reverse is also true. Successful companies and their leaders don’t get that way by ignoring the world around them, and true believers in technological disruption too easily assume that everything will change overnight.
 
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Much of what Dimon said was ill-informed. The fact that Bitcoin and other cryptocurrencies don’t have “legal support” (presumably meaning the backing of a national government) doesn’t invalidate them as investments. People accept dollar bills to pay for things because they are convinced others will do the same, not out of particular confidence in the “full faith and credit” of the United States. Conversely, instruments that do have government support — think Venezuelan bolivars or Fannie Mae-guaranteed mortgages during the financial crisis — can still blow up.

 

When Dimon asserted, "It's just not a real thing, eventually it will be closed," he seemed to misunderstand the most profound aspect of Bitcoin: No one can close it. The network is radically decentralized. Even if Bitcoin’s mysterious creator, Satoshi Nakamoto, reappeared tomorrow, he or she couldn’t pull the plug. Bitcoin could wither and die if enough of its “miners” stop verifying transactions, but even if it did, other blockchain networks would carry on. As long as there is demand for what cryptocurrencies uniquely offer, they will persist.

Bitcoin is a store of value resistant to both tampering and censorship. It’s also potentially a global transaction mechanism, which could avoid costs and interference of financial intermediaries. Other cryptocurrencies are optimized for different uses. The success of Filecoin, which just sold over $200 million worth of cryptocurrency tokens, ultimately depends on the market for its distributed storage network as an alternative to Dropbox or iCloud. Whether those tokens are “real things” is immaterial.

In ignoring the long-term value proposition of cryptocurrencies, Dimon made the mistake of fixating on Bitcoin’s surging price. Ironically, that puts him in the same boat as his harshest critics. There is smart money investing in Bitcoin, but also plenty of naive enthusiasm. Investors throwing their life savings into something they don’t understand are guilty of the same error as Dimon: reducing a potentially world-changing technology to a lottery ticket.    

A smart, seasoned banker like Dimon can see that the recent dramatic appreciation of cryptocurrencies is driven by speculation. Real adoption and value creation haven’t risen nearly as fast as prices. Liquidity is low, meaning that small transaction volumes can have big impacts. There is also anecdotal evidence of sophisticated traders or other players manipulating exchanges to drive up prices. It’s a fool’s errand to predict exactly when and how much, but Dimon is almost certainly right to expect a cryptocurrency crash.

Speculative bubbles are dangerous. Yet, they are a common feature of new technologies, going back to railroads in the 19th century and before. Often, they cause large investor losses when they pop. Over the long run, though, what matters is the technology’s real value. The carnage in 2000, when firms wildly overbuilt internet infrastructure, is a distant memory now that broadband, smartphones and streaming video make use of all that capacity and much more.

If cryptocurrencies pose a threat to financial services incumbents, it will be by restructuring markets on distributed foundations, not by creating a hot new investment category. Ironically, JPMorgan Chase understands this as well as any firm on Wall Street. It has a major commitment to blockchain technology, including involvement with the Hyperledger open source blockchain project and the Enterprise Ethereum Alliance.

Its Quorum platform offers a hybrid of decentralized infrastructure and a private network that can meet business and regulatory requirements for major financial services providers. As Jamie Dimon was throwing cold water on the most famous exemplar of blockchain technology, his employees were hard at work creating innovative solutions on the same foundations.

These are heady yet risky times for cryptocurrencies. The technology is far from mature. Separating the wheat from the chaff is difficult. The combination of hype and technical complexity makes a tempting target for thieves, scammers and snake oil salesmen. Most investors don’t appreciate what they’re getting into, or how to keep their assets secure. So there is plenty of fraud in cryptocurrency markets. That’s a serious concern, one that regulators like the Securities and Exchange Commission are actively looking at. It’s rather different, however, than Bitcoin itself being a fraud.

Jamie Dimon surely appreciates that in financial markets, risk is also opportunity. And as his company seems to recognize, for incumbents facing potentially revolutionary innovation, the riskiest approach is doing nothing.

Kevin Werbach is an associate professor of legal studies and business ethics at the Wharton School, University of Pennsylvania. He is the author of, "The Blockchain and the New Architecture of Trust," forthcoming in 2018 from MIT Press.