Why Goldman Sachs Got it Wrong on Bitcoin

The company says bitcoin is just a promising payments technology. It is that, and much more, says Ariel Deschapell.

AccessTimeIconApr 1, 2014 at 4:18 p.m. UTC
Updated Sep 14, 2021 at 2:08 p.m. UTC

“Bitcoin likely can’t work as a currency, but some sense that the ledger-based technology that underlies it could hold promise,” concludes a Goldman Sachs report titled 'Top of Mind'.

Bitcoin has attracted major league attention in the finance world, and most seem to share the views expressed in the report. While increased research and interest from Wall Street is good for bitcoin overall, the report misses the mark with its conclusion and underscores several systematically flawed views of the digital currency and its future role in finance.

While credit should be given to Goldman Sachs for taking a more in-depth look at cryptocurrencies, its report showcases inaccurate commentary of bitcoin's current and future hurdles, often reflecting common argumentative fallacies that have been rampant amongst analysts and pundits alike.

One-sided view

Bitcoin lies at the intersection of technology and economics, and the fallacious arguments against it span both these areas. This is really no surprise, as most economists and financial analyst don’t have extensive technological knowledge, and are prone to making errors in reasoning because of this.

Yet the technological significance of the Bitcoin protocol – in particular, its ability to transmit ownership between individuals without a third party – is hard for even the harshest critics to downplay.

Similarly, the accompanying high-speed and ultra-cheap transactions of this system are real achievements with measurable benefits.

To be fair, the GS report does conclude the block chain ledger system that underlies bitcoin indeed has real promise, not just in monetary transactions but in countless other fields. However, this is where most of the praise stops.

Wrote Dominic Wilson and Jose Usrua, two of the report's authors:

“Bitcoin currently shows more promise in terms of its payments technology than as a stable store of value.”

They have a point, given the current state of bitcoin. While volatility may be rampant, transaction fees for merchants are much lower, and money movement is much cheaper and faster.

One could argue this makes it likely that bitcoin is destined take on a role more like that of Paypal, than to replace any entrenched currency. In fact, the report even goes on to illustrate the pure potential of the efficiency of these transactional advantages by estimating that the global economy could save more than $210bn annually if bitcoin became the default means of payment and remittances.

Problem solved

Yet despite this staggering number, in regard to bitcoin's potential as a store of value, Jeffrey Currie, head of commodities research at Goldman Sachs, remarks:

“The replacement of an old commodity with a new commodity typically occurred precisely because the new commodity solved an economic problem that the old commodity could not. For example, coal replaced wood when fuel was needed for steam engines. So the question is: is there an economic problem with gold as a store of value that bitcoin solves? The short answer is no.”

Wood did not fail in itself as a store of energy, coal was simply much more efficient and suitable for growing and changing industrial demands. Similarly bitcoin – as we can clearly see from the Goldman Sachs' own report – is vastly more efficient, and able to meet the demands of a global economy in a way that a patchwork of national fiat currencies cannot, let alone chunks of gold.

The latter two require trust in third parties – including national governments – as well as clunky traditional financial infrastructure that takes days to transfer funds between owners.

To borrow Curries' analogy, if the transition from wood to coal is what allowed the industrial revolution to really take off, then the transition from national currencies to cryptocurrency is what will allow an explosion of global trade and development with little precedent.

Highs and lows

Yet detractors would rightly point out that there is still the lingering problem of volatility. A currency that suffers from frequent swings in value on a regular basis can’t, and indeed shouldn’t be adopted by the mass market as a means to move value around.

The average consumer can’t afford to gamble whether they will be able to afford basic necessities tomorrow on the value of a fluctuating currency.

This is the insurmountable problem with bitcoin cited by many economists and financial analysts, and is one of the reasons another of the report's authors, Eric Posner, remarks:

“Twenty years from now, use of the bitcoin – or other similar, perhaps improved networks – could very well be part of the process where you send money from one place to another, but an unobservable part of the process. In other words, firms that transfer money may find it in their interest to use this technology to transfer money, but it is not going to look that different to ordinary consumers. I think that is the most likely way that this plays out.”

For Posner and many others, the solution is as simple as stripping the 'technology' that allows bitcoin to be so frictionless and implementing it in the current financial infrastructure. UBS has recently made similar statements as well.

What they fail to grasp, however, is that Bitcoin the protocol and bitcoin the currency are inseparable. Bitcoins are units that exist only in the block chain, and aren’t tied down to any existing financial infrastructure. It is because bitcoin is separate from the traditional ways of moving money that it is so frictionless.

Cryptocurrencies aren’t going to simply improve the current financial system, they threaten to uproot it completely.

Adoption is key

The Bitcoin protocol can’t function without its own independent unit or share, this is why you can’t use the same technology to move fiat around, and also why volatility isn’t a long term problem.

Merchants are already flocking to bitcoin in exponential fashion due to its low 1% transaction costs. The savings are a no brainer. Meanwhile consumers are adopting it for everything from lowering travel expenses by eliminating the need for expensive and cumbersome currency exchanges, to greater economic and financial freedom.

While the trend is clear, “inevitability is not a strategy” points out Adam Hanft in a recent CoinDesk article, and there are things that can be done to further spur consumer adoption of bitcoin.

As the transactional usage of bitcoin continues to increase, however, taking advantage of the payment system side that Goldman Sachs has identified, the price will undoubtedly continue to stabilize. As this process continues, merchants will feel comfortable keeping some bitcoin instead of converting it immediately to fiat.

This reddit post illustrates how one business is already doing this, and paying its first invoice with bitcoin too. Once this starts happening en masse, and bitcoin begins flowing steadily around the global economy without touching exchanges, the digital currency will truly start to become a stable and independent store of value.

That’s when things will start getting interesting. When this tipping point is reached, there is no reason bitcoin shouldn’t be considered a fully fledged currency – one that is far more efficient and attractive than current fiat monies to boot.

Borrowing from bitcoin

Now can a government theoretically create its own currency using the open-source code of bitcoin? In other words, 'adapt' the technology of bitcoin as the authors of the Goldman Sachs report expect is likely? Of course, but then just like any other altcoin it would have to compete in the marketplace.

In fact Eric Posner stipulated that:

“Probably the most important reason why [bitcoin] would not be a good substitute is that we actually do want the government to control the money supply."

This, of course, is fundamental to the closed nature and centralized decision making of central banks like the Federal Reserve, and the constant annual devaluation of currencies to 'stimulate' the economy and endlessly fund expanding government debt.

What Posner doesn’t seem to grasp is that these 'selling points', if you can call them that, are irrelevant to the average individual who just wants to save costs and move money around more efficiently. Individuals want a currency for its ability to stimulate trade and store wealth, not so central authorities can test out their monetary theories on an economy.

Maintaining a monopoly

Even if this wasn’t the case, the very argument that annual inflation can stimulate the economy is nonsense. And when the conversion and exchange costs are removed from the Goldman Sachs estimates, global savings from bitcoin increase from $210bn to $326bn annually. If that isn’t an economic stimulus, then what is?

A new coin in the fiercely open and competitive cryptocurrency market based on the centralized and inflationary design of current national currencies would, simply put, be slaughtered. It would lose every time to decentralized coins with a stable and eventually static money supply when it comes to consumer choice.

With a ready and superior alternative like bitcoin available, assuming it can sustain a stable value and widespread merchant acceptance, in the long term there is ultimately no reason to keep using fiat currencies.

The monetary policies that have been all the rage in academia for decades cannot be implemented without a total monopoly of money by the governments. Can governments outlaw cryptocurrency to try and maintain its monopoly on the money supply, and thus control over monetary policy? Not likely.

That nonetheless brings us to an important question. If the only thing keeping fiat currency and monetary policy functioning is forceful use, then which is the real ponzi scheme here again?

Ariel Deschapell is a freelance opinion and news writer for CoinDesk: his opinions do not necessarily reflect those of CoinDesk.

Goldman Sachs Tower image via Songquan Deng / Shutterstock.com


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