Susan Athey is a senior fellow at the Stanford Institute for Economics Policy Research, specializing in auction-based marketplaces and the economics of the Internet. She is also an advisor at Ripple Labs and serves as Microsoft’s Chief Economist.
Athey brought an independent academic perspective to discussions at CoinSummit San Francisco last week, using her expertise and research to assess the technology’s potential on many fronts.
CoinDesk spoke to Athey about what gives bitcoin intrinsic value, the novelty of the Bitcoin protocol, possible scenarios for bitcoin’s future, and the currency’s value as an investment.
CoinDesk: When we saw your name and credentials listed on the agenda, we thought maybe this is the responsible grownup who is going to tell us how crazy bitcoin is and how it won’t work. But it seems like after examining bitcoin with a skeptical academic eye, you are not dismissing it. When you first looked into bitcoin were you sceptical?
Susan Athey: I was introduced to bitcoin by some early aficionados. The first things I read when I got home were about bubbles. I pulled out my books about asset bubbles and tulips, and I worried that it was a Ponzi scheme in the sense that a lot of rich people were investing in it and telling their rich friends to invest in it, and so the price was going up as rich people were putting their money into it.
Also, the arguments in favour of it by some of the early adopters didn’t resonate with me: the idea that we needed it because something terrible was going to happen to the US dollar. In steady state as a store of value there may be better financial instruments.
Right now the price is growing, so it’s a good investment because the upside offsets the risk. But if it were in steady state and no longer growing, there may be better ways to protect your money than bitcoin in the United States.
What fascinated me and captured my imagination was the technology itself, understanding what the ledger meant, what it accomplished, and why a native currency was essential to the overall technology.
Let me unpack that a little bit. When we start thinking about the actual technology, the block chain, the ledger and the security around the ledger, that’s clearly a powerful thing. We have lots of other expensive and cumbersome institutions to establish that things of value have moved in ownership from one person to another. The block chain doing that in a decentralized, frictionless way – a pure way – is a powerful innovation.
But then the first question you ask is, ‘Why did you need to invent a new currency? Was that a gimmick? Something that you added on, a marketing tool to sell this thing that was really just a ledger?’ Then I realized that bitcoin itself is sort of fundamental to the ledger.
Let me explain that. I could have entries in a ledger that describe ownership of dollar bills. I could, in principal, use a security protocol: If I owned a ledger entry I could send a message to move a dollar to someone else. But that would just be a message. It would be a promise. We haven’t invented the technology to beam dollar bills and have them appear on your keyboard.
The SWIFT (Society for Worldwide Interbank Financial Telecommunication) international system is a system of messages that tells people where money has moved, and then underneath it, the money actually moves through clearinghouse systems. Being able to send messages is very powerful, but it’s not as powerful as actually being able to send value.
The bitcoin is the only thing where the complete definition of ownership is the entry on the ledger. It has to be a native and new currency because the definition of the object is the ledger entry. That doesn’t correspond to a dollar or a piece of gold or something else. It is what it is. The entry on a ledger of a bitcoin is a fundamental unit whose value can be moved electronically through the security protocol.
Does the value of the technology mean that it’s not a bubble or a Ponzi scheme?
It’s a technology that can be used in a variety of ways. We’re perfectly capable of coming up with Ponzi schemes in the old economy. I couldn’t say that you couldn’t put a Ponzi scheme on top of bitcoin. But the technology has use and so, to me, the thing that gives bitcoin its fundamental value is its use.
The ability to move value electronically without counter parties and without IOUs and promises is very useful. If people use it, it will have value. That’s what makes me think that it does have intrinsic value.
One way to think about the transaction volume and the intrinsic value is that, at any moment in time, there’s a fixed number of bitcoins, and suppose you want to run half a billion dollars-worth of transactions through the system in a day.
There’s a fixed number of bitcoins, and a dollar value of transactions that needs to be supported on them, and each bitcoin can only be used once in a day, then the market cap of the bitcoins would have to rise to support the dollar value of transactions. There’s a market price for access to the bitcoins.
You have examined the relationship between transaction volume and price. So are you saying that the volume that you saw justifies the price?
Yes. That’s not a complete theory of price, because if the volume is driven by speculation, it’s possible that the volume could support the price, but it’s still possible that the price could fall, and the volume could fall.
I’m just saying that ‘the volume justifies the price’ isn’t a complete theory of what the future price should be. It’s more of a high level impressionistic view of the market that the prices and the transaction volume have moved together in a way that makes sense.
In steady state, when speculation is no longer the primary driver of volume, then it would be possible to relate the transaction volume to the price in a more defensible way.
A lot of the volume is related to speculation. What you might like to do is look at the parts of the ecosystem that are really being used for commerce. That transaction volume is the thing that will matter if you’re at a steady state. If it gets to a steady state size, then people are no longer coming into it because they think it’s going to grow. And then the value is determined more by the transactions on the system.
I have a very simple theory of what the price should look like in steady state. That theory, when applied to what happens today, doesn’t do badly in matching up with the data, but we’re not in steady state right now, so the theory is incomplete.
I have heard people warn that, one day, this value is going to evaporate and nobody is going to want bitcoins anymore.
It could happen. Let me give some of the scenarios where it would happen. One might be that there’s a security flaw found, or some sort of attack occurs that undermines the trust in bitcoin.
Given where we are today, I would imagine that in that scenario we would migrate onto an alternative coin. This is one reason why I think it’s good for the bitcoin ecosystem to have a number of other coins out there, because if something catastrophic happened to bitcoin, I think we could move in a pretty orderly fashion to another alt-currency, and while certainly there would be some redistribution of wealth in that transition process, the overall investments in the ecosystem would be maintained.
The venture capitalists are backing a number of firms in the virtual currency space. Most of them could pivot to another virtual currency with relatively little effort. In terms in the application layer, yes, it’s specific to bitcoin, but if it needed to, it could pivot.
Now, we understand the security properties of bitcoin very well. There would be a period of uncertainty with that new protocol and that testing process could lead to migration to a third alt-currency.
So if something catastrophic happened to the Bitcoin protocol, there would be disruption and there might be a period of uncertainty as we figured out what would be the best alternative, and maybe a rebirth of bitcoin once they had fixed whatever the problem was.
So, if people think everybody else is leaving bitcoin, everybody will get out of bitcoin, and the price will fall. There are many other types of businesses and investments that have that property.
For example, a marketplace that needs buyers and sellers. If the buyers and sellers all started migrating to another platform, you could see that. Think about a social network. We saw people using MySpace, and then they migrated to Facebook. We see many types of platforms and institutions and firms where the utility of the platform is based on other users using it.
That doesn’t mean you can’t value a Facebook, just because things are only useful when other people are using them. The risk profile of a bitcoin investment is less like a really safe store of value.
I actually look at it more like the risk profile of, say, a marketplace startup that has an initial user base. If the users stay and they interact with each other and it grows, it will have a lot of value. If the users pick another platform for whatever reason, then you won’t have any value. If you were buying stock or taking a venture position in this kind of a startup, you would realize there’s some probability of it going to zero and there’s some probability it’s going to grow big.
That’s the way that I look at bitcoin: there’s some probability that people shift to another platform for whatever reason; if they don’t, it grows and it has intrinsic value based on the transaction volume.
You consult with world governments on economic issues. Have you discussed bitcoin with national or international economic authorities? Are there widely divergent views around the world in regard to whether bitcoin is going to be important, whether they fear it, are ignoring it, and so on? What is the vibe you are getting?
One thing that’s kind of interesting is that the individual people from the various branches of government who have gotten interested in it, like almost everyone who takes a look at this, become fascinated by it.
This is just really interesting and challenging and intellectually fun. It’s fun because it’s hard. To think through all the implications of this new technology and to think through all the ways that various regulations could have good and bad consequences is a challenging problem. So one vibe that I get is that they, like the rest of the community, find it really intellectually engaging and challenging.
A message that I have found to be resonating is that it is very important that the environment in the US is friendly enough that the ecosystem stays here, because there are a lot of resources in the US to support that, and a lot of those resources will also encourage that development to favour more legitimate uses and safe uses. If it becomes illegal then it develops more in [unwanted] directions. It is in the US national interest to have this ecosystem develop here.
And you think that people in authority in the US understand that?
I think they do. Now, understanding that and being able to act on it in a timely and clear way are different things. No individual regulator can solve the whole problem, and banking regulation is an extremely challenging and complex area. But as it sinks in that this protocol and technology is here to stay, and that it needs to be dealt with, then the attention turns to dealing with it right.
At a fundamental level, you can certainly throw tacks in the road. You can make it difficult to buy things. Like the latest tax ruling makes it challenging for people to comply with tax law; they need to do a lot more accounting if they’re using bitcoin for small transactions.
For bitcoin investors, the tax ruling is actually helpful, because it provided clarity. If you’re just buying and selling, the tax ruling was quite simple. For someone who had a stash and was spending them on small purchases, you will probably need accounting software to file your taxes properly.
Those kinds of things can certainly be tacks in the road. Lack of clarity in banking relationships is a huge hurdle in the road. But at a fundamental level, you can’t really outlaw a ledger. This is a piece of computer software that has lots of different uses. You can regulate how fiat currency goes in and out of it, but you can’t really stop it from being used.
Some of its uses don’t relate directly to currency at all, some of the multi-signature applications where you have multiple people signing a transaction, keeping things in escrow, title, applications where you’re using this as a way to send a public message that has a timestamp that verifies it. Companies could build their own internal ledger. They could just fork the Bitcoin protocol, they don’t need to move any money in and out of banks, they just use this ledger to manage their internal books, if they move money across divisions within the firm.
There are lots of these applications out there, and many of them don’t really require the approval of regulators. Once you recognize that the technology’s out of the bag, it can’t be stopped, it has lots of interesting applications, it only makes sense to put a framework around it that makes it possible for it to work.
Are you working on research papers or projects related to bitcoin?
I’ve been working on analyzing the block chain and trying to describe the evolution of the block chain over time, what kinds of transactions are occurring, trying to document the flows of funds …
It’s a pretty challenging exercise to do well because of the idiosyncrasies of the way the block chain records information: the fact that there’s not one wallet number to one individual or entity on the block chain, and they don’t have any identifying information.
At an individual level you have a fair bit of noise in understanding what’s going on, on the level of a single block chain transaction. But you can still look at aggregate patterns. I’m doing research in this area.
It’s a bit time-consuming to get it right, but interesting patterns emerge from understanding the block chain. It’s only going to become more interesting as companies like BitPay expand their reach and allow more and more people to do transactions.
If actual people buying and selling things is only a few per cent of what’s going on, it’s a little bit less interesting to analyze, but that’s changing. I think that real commerce is in the double digits on the block chain, and it’s growing. People finding utility from the block chain, from an economic perspective, is much more interesting to study. I’m doing research and also in parallel waiting for the community to evolve to the point that it’s more interesting economically.
Is this a popular topic that graduate students want to sign on to research?
There’s a lot of interest. [However] there are not very many people yet who have mastered the technology required to study it well. My guess would be that within a year you’ll see an explosion of analyses.
Based on my own experience, there’s a pretty big startup cost to sort through all the institutional details, to really convince yourself that you’ve understood the informational content of the block chain. Think about some of the things that change over time.
People use anonymization techniques in order to disguise themselves. Use of that and the way that works changes over time. The identities of the exchanges and the way they interact with the block chain change over time. Some services do a lot of stuff off the block chain, while other services do a lot of things on the block chain.
It’s a moving target and a complex target to understand what’s on the block chain, what’s off the block chain. There’s a barrier to entry with this research, but I think people will surmount that barrier.
Have you purchased any bitcoins yourself?
To study any market you need to be a participant in the market, to understand the user experience and wrap your head around it. So I’ve been in and out of bitcoin, but at a low level. I’ve tried to try out different exchanges, and as new firms come on I’ve tried to experiment with them and see how they work.
If I was in the position of doing a lot of more risky investments, I think it totally makes sense that a lot of the wealthier investors have taken a position here. It’s got a very interesting growth profile.
One thing I would say about investing in it: most Americans should be holding US dollars and index funds. That’s the tried and true way to hold money. But for people who are looking for the kind of risk profile that’s associated with new ventures, which is some probability of zero and some probability of growth, an interesting thing about investing in bitcoin is that it democratizes access to an investment of that profile.
You as an individual are not offered a share of a venture capital fund. You can’t buy that. You have to be a large investor, and even if you’re a large investor, you still have to be invited to participate. So it’s interesting that not only has bitcoin democratized access to moving money, but also, at the moment, buying bitcoin is like taking a stake in a startup. That’s a risky bet, but it’s got high growth potential.
Instead of investing in five bitcoin startups, you can buy just bitcoin, and that’s probably going to go with the bitcoin startups. The one caveat to that is that many of the bitcoin startups could pivot if the Bitcoin protocol blew up. The bitcoin itself could go down.
One of the things about investing in bitcoin is that you wouldn’t want to be caught unawares if something started shifting, if another protocol started gaining traction.
So there are some issues with holding bitcoin, but it’s an opportunity if you wanted to take a very risky position in your portfolio, high risk/high return. It’s a much more liquid way to get that investment profile than many other investments that have the same risk/return profile.
This interview has been edited for length and clarity.