Speculators worldwide have gone gaga over Bitcoin, the progenitor of numerous cryptocurrencies that has rocketed in price over recent years. From a value near zero when launched in 2009, Bitcoin has traded briefly at over $40,000 per coin in what has quickly exploded to become a trillion-dollar global cryptocurrency market. Several prominent and even institutional investors have joined the craze.
Normally, prudent pension trustees would steer clear of such high flyers as unduly speculative, but what if their cost as founders was zero? What if states, acting together shrewdly, were to pop up their own cryptocurrency to compete with Bitcoin and its crypto-copycats? Public finance and pension professionals might give a serious look at whether there could be a hidden treasure for taxpayers in the scenario presented below — a "straw man" proposal intended to generate exploratory professional and policy discussions.
There's nothing new about public-sector involvement with cryptocurrency. In 2018, for example, Governing reported on Berkeley, Calif.'s plan to issue bonds using the blockchain technology that underlies cryptocurrency. Consultants at Deloitte published a paper on state-sponsored cryptocurrencies. Ohio experimented briefly with Bitcoin for tax payments. And two Virginia public pension funds have invested in a blockchain venture empowered to own crypto.
Before getting into the larger picture of how states and pension funds might profit from cryptocurrencies, though, a primer on the subject: Central banks globally have been monetizing national debt — creating new money out of thin air — by expanding reserve bank credit at big banks that ultimately gets loaned out in the real economy. The crypto crowd is betting that this inflates the dollar value of the finite supply of bitcoins that was baked into its exotic algorithm by its pseudonymous founder. The blockchain technology that creates a permanent ledger of ownership and transfer of each bitcoin is now an article of faith among those who exchange their dollars for this new electronic money. TV ads exhort investors to trade out of hard assets like gold and fine art to buy into crypto. Who needs to hoard gold when you can carry a fortune in bitcoin in your phone?
So what could possibly go wrong? For one thing, Bitcoin's soaring price chart evokes a familiar pattern in investment bubbles. It's informative to skim the classic book on bubbles, Extraordinary Popular Delusions and the Madness of Crowds, written by Scottish journalist Charles McKay in 1841. It describes the South Sea Company and Mississippi Company bubbles of the early 1700s and the Dutch tulip mania of 1637; in the latter, a single tulip bulb was auctioned for the price of a house before the crazed speculators collectively realized that they were just flowers with no investment value. All of these speculative frenzies ended badly for the suckers who bought on the way to the top.
What today's speculators overlook is that Bitcoin is just one of many cryptocurrencies that can be "minted." And the hotter this market becomes, the more that copycats will be incentivized to create the next crop of crypto. As an asset class, the supply of blockchain currencies is unlimited.
But cryptocurrency's advocates — crypto bulls — consider this an unfair objection: The value of Picassos and Rembrandts, they point out, is not impaired by the fact that other artists have come along. They swear by a scarcity factor that rewards holders of a finite supply of a specific brand. What has worked for fine art for centuries, they say, will work for crypto just as well: Over time, the value of a given Picasso or a bitcoin must escalate because they cannot be replicated, and Bitcoin's price will be undergirded by the expansion of the central-bank money supply as governments persistently run budget deficits.
Which brings us to the public sector's opportunity to "manufacture" its own crypto. There is nothing, except a lack of innovation, collaboration, technical savvy, good legal work and skillful marketing, that precludes our 50 states from creating their own cryptocurrency. For fun, let's call them "Madisons." An interstate compact, with an independent trustee to protect owners' interests and a legally enforceable contract supported by a blockchain ledger of the Madisons' ownership, would be every bit as secure for purchasers as the magical, mystical algorithm that Bitcoin enthusiasts consider unbreakable. Each state could contractually convey its entire finite allotment of digital Madisons to their respective pension funds at zero initial value and then let the market price float higher, chasing Bitcoin.
Unlike insolvent nation-state sponsors that have every incentive to unilaterally devalue and manipulate their own cryptocurrencies, the magic of an American interstate crypto compact is that, if well written, the contractual obligations — of each state to others, to the trustee, and to future owners — would be legally enforceable and irrevocable. Additional issuance of Madisons or related substitutes can be contractually prohibited, making these the most scarce of the popular cryptocurrencies. A secure and patented anti-money-laundering blockchain portal could catapult Madisons to become the preferred tax payment cryptocurrency of governments worldwide, at all levels.
The total supply might be set at, say, one Madison for every 20 residents of the founding states. That would make them rarer than bitcoins, forever. Any foot-dragging states that sign on later would incur a mathematical reapportionment of their allotment, precluding windfalls for fence-sitters and benefiting the earlier adopters. As with the "float" in a stock exchange IPO, such digital coins could be dribbled into the market each year by the public pension funds, making Madisons even more scarce and profitable to pioneering institutional investors than Bitcoin while making the pension funds' reserves more valuable over time. Profits from sales by the pension funds should be used first to defray pre-existing unfunded liabilities, then employer costs.
Even with speculative-bubble selloffs and competing cryptocurrencies, Madisons should legitimately keep some scarcity value against the dollar, giving the pension funds a windfall asset to carry at zero cost on their books. Using the long-term price that JP Morgan projects for Bitcoins alone, it's not inconceivable that the Madisons' hypothetical share of market someday might equal the unfunded liabilities of all public pension plans, even if the actual proceeds gleaned by the funds fall far below that hypothetical ceiling.
Obviously there are hurdles: First would be legal issues, including the constitutional rights of the federal government versus the states to print money as legal tender. But Bitcoin is not legal tender — required by law to be accepted as payment — so the grounds for constitutional arguments are squishy. Second, to be commercially successful, such a state consortium would need a skilled marketing agent to control and promote placement on crypto platforms. And third, getting even 10, let alone 50, states to take the idea seriously and then agree on anything like this would be a harder challenge than herding cats in a barn full of mice.
Nobody should consider the minting of Madisons a "Hail Mary" panacea for funding underwater pension funds, but it's plausible that the funds could be natural depositories to warehouse, remarket and profit from such a novel cryptocurrency. And every element of this straw man is technologically achievable. Meanwhile, Bitcoin bulls, don't ever say you were never warned.
Nothing herein should be construed as investment advice to buy, sell or hold a specific security or financial instrument. Disclosure: The author does not own cryptocurrencies.
Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.