[Lee Jong-woo's Economic Reading] The Future of Cryptocurrency Lies in the Trends of China Stock Market and Options Market

Invisible Cryptocurrency
No Value Guarantee Institution, Controversy Ensues
New Investment Targets Cause Rejection→Fervor→Volatility→Stabilization
Government Oversight Needed Until Cryptocurrency Stabilizes Amid Price Fluctuations

#During the Joseon Dynasty under King Injo, Kim Sin-guk, the Minister of Finance, strongly advocated the use of coins. The logic was that using grains and cotton as currency limited the circulation range, preventing the country from escaping poverty. He gathered people to open food stalls in front of the Ministry of Finance that only accepted coins, and taxes and the labor tribute of slaves were also collected in coins. The government tried various methods for six years but saw no effect and eventually abandoned the coin circulation policy. It took another 50 years until Sangpyeong Tongbo coins were issued and coins were used in earnest.

#The year 1992 was a historic year for the Chinese stock market. After the market was established and three years of indifference, it began to rise in May of that year, with the Shanghai Composite Index soaring 130% from 616 to 1421 in just five days. Although this was attributed to the announcement of the reform and opening-up policy, it is more accurate to view it as a rapid fluctuation process frequently observed before the market settles.

#The futures and options market first opened in South Korea in 1996. Four years later, in 2000, it became the second largest market by trading volume after the United States. Options trading, which requires mathematically complex calculations and is handled only by experts in the U.S., saw housewives in Korea jump in. After incurring losses, they left, and now there are no individual investors interested in options.

Looking at these three cases provides hints as to why endless controversies surround virtual currencies, how to interpret the recent price surges, and what the future holds for virtual currencies.

The controversy over virtual currencies arose because events occurred that were disconnected from people's experiences. Previously, mediums of exchange or stores of value had tangible forms and institutions that guaranteed their value. Virtual currencies not only lack a tangible form but also have no institution guaranteeing their value due to decentralization. Because of this, endless debates continue over how to view virtual currencies?just as people accustomed to grains and cotton in the Joseon era could not accept coins.

Virtual currencies, which started as a means of exchange, have recently established themselves as investment assets. To serve as a medium of exchange, value must be stable, but since prices can fluctuate more than 10% daily, they are unsuitable for exchange purposes. The logic of investment assets starts with gold. The price of gold is formed by adding investment value to its value as a decorative or industrial material. Before the U.S. declared in 1971 that the dollar would no longer be convertible to gold, the price of one ounce of gold was $35. Now exceeding $1700, it has risen nearly 50 times in 50 years. The use value of gold did not increase 50-fold during that time. Oil prices, based solely on use value, rose about 20 times in the same period, so the remaining increase can be seen as an increase in investment value. People agreed that gold had that much investment value, and virtual currencies are seen as having extracted only the investment value from the two values gold possesses. The logic is that if many people recognize virtual currencies, they can have value regardless of physical substance and thus become investment assets.

Even if the investment value of virtual currencies is recognized, the problem of price volatility does not disappear. This is the most frequently cited issue by those who disparage virtual currencies. On April 14, Bitcoin's price exceeded 80 million won but dropped to 57 million won on the 23rd. This 29% decline in eight days is relatively mild because it was Bitcoin; other coins experienced even more severe drops.

The rapid price fluctuations of virtual currencies arise because there is no way to evaluate their value. If it were possible to determine a reasonable price based on corporate profits like stocks or on the economy and foreign exchange supply and demand of related countries like exchange rates, a relatively rational price could be set. However, virtual currencies lack such means. It would help if there were past price experience data, but such data has not yet accumulated. The Chinese stock market, which rose to 1400 in 1992, returned to its original level within three months. After several price fluctuations, it found a reasonable price, and the current virtual currency market can be seen as undergoing a process of establishing its own price.

People's behavior is similar when a new investment target appears. At first, they reject it because they do not understand it, then become enthusiastic and create a bubble as they become familiar, and when this process ends, prices are driven down as if everything will disappear. After experiencing several sharp rises and falls, prices stabilize, and interest wanes, entering a stable phase. South Korea's options market also moved in this pattern. When interest in options peaked, the 9/11 terrorist attacks occurred, resulting in a day with 300-fold profits. Subsequently, hoping for such luck, it became a trend to buy options at unlikely strike prices at every expiration. After repeating this for one to two years, people thought it was futile and the number of investors decreased, turning the market into one unrelated to individual investors.

Bitcoin's price, which fell to 6.4 million won in March last year due to the impact of COVID-19, rose to 80 million won within a year. As a result, the number of real-name accounts at the four major virtual currency exchanges increased from 1.33 million at the end of last year to 2.5 million in February this year. Since prices rose 12-fold in one year, it is natural that all attention in the world is focused on virtual currencies. When collective intelligence about virtual currencies is formed through experience, behavior will change, and as behavior becomes rational, price volatility will decrease, and interest in virtual currencies will inevitably decline.

There is much debate over virtual currency policies. The main complaint is that the government does not recognize their substance, only obstructs when they grow, and tries to collect taxes. However, leaving them unregulated is not an option. First, efforts must be made to reduce price volatility until experience with virtual currencies accumulates. Some may say the government should not interfere with investments, but no government has ever stood by when asset prices fluctuate wildly. When price volatility intensifies, many people suffer losses, causing social problems and imposing significant costs on the entire nation. Parts of virtual currencies that can be absorbed into the institutional framework should be absorbed. At least Bitcoin must be recognized, and standards for trustworthy exchanges should be established to regulate the proliferation of exchanges. Leaving products to market functions alone at the early stage inevitably leads to accidents. It is the government's duty to monitor until the market settles.