What Problem Does Cryptocurrency Solve? Ask Any Small Business — or the Collins Family.

NY Times Columnist and Nobel Prizewinning economist Paul Krugman is a cryptocurrency skeptic. I don’t follow it closely enough to have an informed opinion, but I see nothing wrong with being skeptical of cryptocurrency. But after explaining his reasoning for skepticism, Krugman concludes with the following question:

“So that’s why I’m a crypto skeptic. Could I be wrong? Of course. But if you want to argue that I’m wrong, please answer the question, what problem does cryptocurrency solve? Don’t just try to shout down the skeptics with a mixture of technobabble and libertarian derp.”

Challenge accepted! Because while I respect Dr. Krugman and generally have similar politics, he has fallen into the classic mistake of establishment economists in this area. The current set of electronic transaction mechanisms works very well for him and most people like him — so why would anyone want to change? Other than for nefarious purposes, of course.


Short answer: The highly concentrated nature of the payment processing industry and the banking industry generally creates lots of hidden transaction costs, permits extraction of rents and imposition of onerous terms on merchants, and can be exploited by government to impose extra-legal sanctions on disapproved businesses or individuals without due process.


Even shorter answer: Cryptocurrency solves the gatekeeper problem and creates competition in electronic payment processing.


I unpack below, but it will speed things along if you first read the recent Supreme Court decision in Ohio v. Amex and this Washington Post article on how the Collins family of Kansas found their Bank of America account frozen.

Once again, I’m not predicting that cryptocurrencies will actually work out. (Remember how worked up folks were about taxing Azeroth and Second Life 10 years ago?) I’m just addressing a very narrow question of why anyone thinks cryptocurrency is useful for anything other than feeding techno-libertarian fantasies about eliminating the state or supposedly anonymous currencies for illegal transactions (BTW, anything with blockchain is going to be much less reliably anonymous than straight up cash. Just sayin’.) The current structure of the financial services industry, particularly with regard to electronic payments, creates a real need that both merchants and even some plain old citizens have.


Krugman’s Argument: Existing Electronic Payment Processing And Banking Reduces Transaction Cost While Cryptocurrencies Create Transaction Cost.


Krugman’s primary first argument is that existing fiat currency is both reasonably reliable (at least from a consumer perspective) and has consistently lowered transaction cost. To quote the relevant passage:

“Set against this history, the enthusiasm for cryptocurrencies seems very odd, because it goes exactly in the opposite of the long-run trend. Instead of near-frictionless transactions, we have high costs of doing business, because transferring a Bitcoin or other cryptocurrency unit requires providing a complete history of past transactions. Instead of money created by the click of a mouse, we have money that must be mined — created through resource-intensive computations.”

Krugman goes on to note that the high cost of creating new cryptocurrency is a necessary element to give it value. Similarly, because it would otherwise be easy to replicate digital currency, keeping track of its history of transactions is also required.


Krugman’s second argument is that even non-fiat currencies used in place of currency for transactions, like gold, have some connection to the real world that gives them an intrinsic value (Krugman calls this “tethering”). Yes, gold is valuable because it is scarce, durable, and we all agree it has value. But it also has some intrinsic value as a conducting metal for engineering purposes. Stock options, often used as a currency for service in start ups, are linked to the ultimate value of the company. Because cryptocurrencies have no tether, its entire value can disappear simply because a critical mass of people decide its no longer valuable.


Just Because You Don’t Notice Transaction Costs on Your Side of the Two-Sided Platform Doesn’t Mean They Disappear.


Actually, I think Krugman makes some good points. But he overlooks the reasons why a critical mass of people would work to overcome these problems. And this is where Krugman goes wrong. He assumes that because he is happy with the current financial system and does not personally experience significant transaction costs that therefore there are no transaction costs. This is partly driven by his unfortunate apples-to-oranges comparison of the production cost of cryptocurrency (e.g., mining for coins, scaling up blockchain) with specific consumer transaction costs.  From my perspective as a consumer, my limited experience is that bitcoin transactions resemble any other form of electronic transaction. But without the fees.


Which brings me to all the transaction costs that Krugman misses, because we are dealing not just with currency but with the entire structure of electronic transactions. The easy to use credit card of which Krugman speaks is part of an extremely large and expensive two-sided market that, because it is highly concentrated, shifts the bulk of the transaction costs from consumers to merchants. This is also where the reading on Ohio v. Amex comes in. As the Court found, and as the Breyer dissent emphasized based on the district court’s findings. Credit card payment processing is a two-sided market in which three major cards — Visa, MasterCard and Amex — control nearly the entire market. As a result, these companies are able to dictate terms to merchants, since a merchant who cannot process the credit card of the customer’s choice risks losing a sale. Credit card companies therefore have every reason to make life easy and transaction cost free for high-end customers like Dr. Krugman. But shifting those transaction costs (and additional exaction of monopoly rents) to the other side of the platform does not make them disappear.


But how bad  are these costs really from a merchant’s perspective? Are they sufficiently high or otherwise onerous that merchants would consider the switching cost of moving from one system to another. As one online guide for merchants wanting to process credit cards begins: “Credit card processing fees are extensive, complicated, and somewhat overwhelming. Nevertheless, you have to pay them if you want to process credit cards through your business.” This is not generally how one describes a business with low transaction cost. The fact that the “market solution” for the massive complexity, lack of transparency, and overall expense is to create a thriving market for intermediaries who can provide small businesses with turnkey solutions (for additional fees, of course) strongly indicates that if someone could develop a product for electronic transactions that significantly simplified this process and reduced fees, that businesses would have strong reason to adopt it.


Again, I’m not saying that cryptocurrency can overcome the very real problems of creating an alternative decentralized electronic payment processing system to compete with credit cards. I’m just saying that there is an actual answer to the question “what problem does cryptocurrency solve.” From the merchant side, at least, it’s pretty clear. Functioning and widely accepted cryptocurrency would dramatically lower transaction costs, not raise them as Krugman argues. It would introduce competition into the existing electronic payment oligopoly.


Additional Costs of Gatekeeper Control. Added Expense, Complexity And The Risk of Circumventing Due Process Limitations on Government Action.


As I wrote many years ago in this speech called “Outsourcing Big Brother,” one of the under-appreciated dangers of concentration and oligopoly is the ability of government to use these companies to act in ways government can’t — either for political reasons or because constitutional protections such as due process prevent the government from acting directly. The highly concentrated and highly regulated nature of the concentrated banking and electronic payment processing market lends itself extremely well to this kind of government pressure. For example, when politicians were up in arms about Wikileaks in 2011, members of Congress prevailed on credit card companies and PayPal to act “responsibly” and stop processing donations to WikiLeaks by supporters, despite the fact that its operations were legal. When law enforcement proclaimed strong encryption that protects online speech from surveillance a bad thing, credit card companies stopped processing payments to some anonimization services.


Oh but shucks, you may reply, those are just criminals and law breakers who happen to not be breaking the law. Perhaps, but that is rather the entire point of having a law. It means that as long as people are behaving legally, the government cannot act against them simply because they find their actions inconvenient or abhorrent. Arguing that honest folk have nothing to fear from the ability of the government to act extralegally is the economic equivalent of arguing that as long as you have nothing to hide why do you need encryption or worry about the NSA?


As a historical reminder of how this can easily work, even on the local level, I refer folks to Pike v. Southern Telegram and Telegraph, 81 So.2d 254 (AL 1955) (which I describe in this blog post here). To briefly recap, Sheriff Eugene “Bull” Connor prevailed on the local telephone provider to cancel Mr. Pike’s phone service on assurances that it had nothing to do with Mr. Pike’s NAACP activities but was merely because he suspected Pike of being “a negro of questionable character.” It would be nice to imagine that the major electronic payment processing companies would stand up to a request from the Trump Administration, or some state or local authority, if asked to stop processing payments to Black Lives Matter activists or other folks the Powers That Be declare enemies of the people. But history suggests that having an alternative just in case is not a bad idea. And whereas this idea may have seemed like techno-libertarian paranoid fantasy some years ago, I find it a bit less unbelievable today.


The Collins Family Would Probably Prefer Bitcoin to Bank of America.


The government doesn’t have to act in an extralegal way to take advantage of the highly concentrated, centralized banking and electronic payment system. Over the years, particularly after 9/11, we have passed a lot of laws requiring banks to “know their customer” and pass on that information to the federal government. no one can deny this has been of enormous assistance to law enforcement in tracing and stoping lots of really awful behavior from terrorism to human trafficking. But it also drives up cost and occasionally whacks perfectly innocent people on the head through false positives.


Which brings me back to  this Washington Post piece about Josh Collins and his wife Jessica Salazar Collins. Bank of America sent a letter to Josh Collins asking for all sorts of information required under various “know your customer” laws (although why they did not already have this info is unclear). Critically, the thing the letter said they really wanted confirmed was whether Josh was a citizen of the United States. Being wise to the numerous scams trying to trick you out of your personal information, and following the general rule of thumb that the bank has your social security number and will use it to prove its identity to you so be wary of banks or the IRS or whoever claiming they want you to confirm your Social by giving them more than the last 4 digits, they ignored the letter. A few weeks later, without warning, BoA froze their accounts.


Haha. Funny story, right? Not since Tuttle was transcribed as Buttle has their been such a comical mix up. One would think that this sort of thing is sufficiently rare that the idea of building a market to meet the demand for people who “dislike gatekeeper control of banks and wouldn’t mind an a liquid alternative rather than gold or jewelry” would not be large enough to support cryptocurrency. And on its own it’s probably not. But if you are are an “at risk” population because of your religion, ethnicity or LGBTQ status, you might want to hedge with a currency that can’t be suddenly frozen or easily monitored. Just as we saw a surge in people downloading the encryption app Signal after Trump’s election, the idea of encryption for your currency is not as whacky as it used to be.




To repeat once again, I am myself a cryptocurrency skeptic. I’m not trying to debate whether cryptocurrency is worth it. There are a lot of other potential ways to address the concentration problem and high transaction costs on the merchant side. We could, for example, *gasp* regulate the financial industry as we did in 2009 to prevent payment processors from abusing their market power or position as critical intermediaries.


My two sole points are these. First, there actually are some specific problems that cryptocurrencies potentially solve. This isn’t simply techno-libertarian fools gold or a high-tech version of goldbuggery. It may not ultimately work for a wide variety of reasons, but that wasn’t the question asked. The question was why would anyone think it was worth trying to do at all.


My second point is a little more subtle. People tend not to notice real problems that don’t obviously and directly impact them. Krugman believes there are low transaction costs associated with current financial system and electronic payment processing system because he doesn’t encounter them in his own life. About 5 minutes of web searching would turn up a wealth of literature — including a Supreme Court case a month ago — demonstrating this is totally not the case. But why bother to do the research in the first place unless you have some reason to believe there might be an issue?


This is not a blindness unique to Krugman. It is one of the biggest problems of public policy. A good deal of my job as an advocate is collecting and presenting evidence to folks in D.C. about how things work in the real world. For example, despite the increasingly desperate demand by people who don’t have broadband for some sort of government intervention to bring it to them, it’s damn hard to convince people who (a) have access to high-speed broadband; and, (b) who can afford it that this is a hot political issue. After all, they have broadband, so how is it possible that lots of people who really want broadband can’t get access to it or afford it? Must be that everyone who wants broadband has it.


Which is the real reason I’ve spent so much time on this issue. (Hey, it’s not like Paul Krugman is likely to read this blog — but if you, Dr. Krugman, please leave a reply in the comments!) As Horace notedaliquando bonus dormitat Homerus D’oh! (“Sometime worthy Homer nods [angry grunt]”). Even a Nobel Prize winning economist can forget that a two-sided platform can shift transaction costs from the consumer side to the merchant side. We need to keep in mind here in Policyland that not everyone experiences life the same way we do, and policy needs to reflect their needs as well as our own.


Stay tuned . . .


  1. Thanks for the information it clarifies my crypto confusion.

  2. Funny story, right? Not since Tuttle was transcribed as Buttle has their been such a comical mix up

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