The Bitcoin phenomenon has now reached the mainstream media where it met with a reception that ranged from sceptical to outright hostile. The recent volatility in the price of bitcoins and the issues surrounding Bitcoin-exchange Mt. Gox have led to additional negative publicity. In my view, Bitcoin as a monetary concept is potentially a work of genius, and even if Bitcoin were to fail in its present incarnation – a scenario that I cannot exclude but that I consider exceedingly unlikely – the concept itself is too powerful to be ignored or even suppressed in the long run. While scepticism towards anything so fundamentally new is maybe understandable, most of the tirades against Bitcoin as a form of money are ill-conceived, terribly confused, and frequently factually wrong. Central bankers of the world, be afraid, be very afraid!
Finding perspective
Any proper analysis has to distinguish clearly between the following layers of the Bitcoin phenomenon: 1) the concept itself, that is, the idea of a hard crypto-currency (digital currency) with no issuing authority behind it, 2) the core technology behind Bitcoin, in particular its specific algorithm and the ‘mining process’ by which bitcoins get created and by which the system is maintained, and 3) the support-infrastructure that makes up the wider Bitcoin economy. This includes the various service providers, such as organised exchanges of bitcoins and fiat currency (Mt. Gox, Bitstamp, Coinbase, and many others), bitcoin ‘wallet’ providers, payment services, etc, etc.
Before we look at recent events and recent newspaper attacks on Bitcoin, we should be clear about a few things upfront: If 1) does not hold, that is, if the underlying theoretical concept of an inelastic, nation-less, apolitical, and international medium of exchange is baseless, or, as some propose, structurally inferior to established state-fiat money, then the whole thing has no future. It would then not matter how clever the algorithm is or how smart the use of cryptographic technology. If you do not believe in 1) – and evidently many economists don’t (wrongly, in my view) – then you can forget about Bitcoin and ignore it.
If 2) does not hold, that is, if there is a terminal flaw in the specific Bitcoin algorithm, this would not by itself repudiate 1). It is then to be expected that a superior crypto-currency will sooner or later take Bitcoin’s place. That is all. The basic idea would survive.
If there are issues with 3), that is, if there are glitches and failures in the new and rapidly growing infra-structure around Bitcoin, then this neither repudiates 1), the crypto-currency concept itself, nor 2), the core Bitcoin technology, but may simply be down to specific failures by some of the service providers, and may reflect to-be-expected growing pains of a new industry. As much as I feel for those losing money/bitcoin in the Mt Gox debacle (and I could have been one of them), it is probably to be expected that a new technology will be subject to setbacks. There will probably be more losses and bankruptcies along the way. This is capitalism at work, folks. But reading the commentary in the papers it appears that, all those Sunday speeches in praise of innovation and creativity notwithstanding, people can really deal only with ‘markets’ that have already been neatly regulated into stagnation or are carefully ‘managed’ by the central bank.
Those who are lamenting the new – and yet tiny – currency’s volatility and occasional hic-ups are either naïve or malicious. Do they expect a new currency to spring up fully formed, liquid, stable, with a fully developed infrastructure overnight?
Recent events surrounding Mt Gox and stories of raids by hackers would, in my opinion, only pose a meaningful long-term challenge for Bitcoin if it could be shown that they were linked to irreparable flaws in the core Bitcoin technology itself. There were indeed some allegations that this was the case but so far they do not sound very convincing. At present it still seems reasonable to me to assume that most of Bitcoin’s recent problems are problems in layer 3) – supporting infrastructure – and that none of this has so far undermined confidence in layer 2), the core Bitcoin technology. If that is indeed the case, it is also reasonable to assume that these issues can be overcome. In fact, the stronger the concept, layer 1), the more compelling the long-term advantages and benefits of a fully decentralized, no-authority, nationless global and inelastic digital currency are, the more likely it is that any weaknesses in the present infrastructure will quickly get ironed out. One does not have to be a cryptographer to believe this. One simply has to understand how human ingenuity, rational self-interest, and competition combine to make superior decentralized systems work. Everybody who understands the power of markets, human creativity, and voluntary cooperation should have confidence in the future of digital money.
None of what happened recently – the struggle at Mt. Gox, raids by hackers, market volatility – has undermined in the slightest layer 1), the core concept. However, it is precisely the concept itself that gets many fiat money advocates all exited and agitated. In their attempts to discredit the Bitcoin concept, some writers do not shy away from even the most ludicrous and factually absurd statements. One particular example is Mark T. Williams, a finance professor at Boston University’s School of Management who has recently attacked Bitcoin in the Financial Times and in this article on Business Insider.
Money and the state: Fact and fiction
Apart from all the scare-mongering in William’s article – such as his likening Bitcoin to an alien or zombie attack on our established financial system, stressing its volatility and instability – the author makes the truly bizarre claim that history shows the importance of a close link between currency and sovereignty. Good money, according to Williams, is state-controlled money. Here are some of his statements.
“Every sovereignty uses currency.”
“Trust and faith that a sovereign is firmly standing behind its currency is critical.”
“Sovereigns understand that without consistent economic growth and stability, the standard of living for its citizens will fall, and discontentment will grow. Nation-state treasuries print currency but the vital role of currency management– needed to spur economic growth — is reserved for central bankers.”
Williams reveals a striking lack of historical perspective here. Money-printing, central banking and any form of what Williams calls “currency management” are very recent phenomena, certainly on the scale that they are practiced today. Professor Williams seems to not have heard of Zimbabwe, or of any of the other, 30-odd hyperinflations that occurred over the past 100 years, all of which, of course, in state-managed fiat money systems.
Williams stresses what a long standing concept central banking is, citing the Swedish central bank that was founded in 1668, and the Bank of England, 1694. Yet, human society has made use of indirect exchange – of trading with the help of money – for more than 2,500 years. And through most of history – up to very recently – money was gold and silver, and the supply of money thus practically outside the control of the sovereign.
The early central banks were also very different animals from what their modern namesakes have become in recent years. Their degrees of freedom were strictly limited by a gold or silver standard. In fact, the idea that they would “manage” the currency to “spur” economic growth would have sounded positively ridiculous to most central bankers in history.
Additionally, by starting their own central banks, the sovereigns did not put “trust and faith” behind their currencies – after all, their currencies were nothing but units of gold and silver, and those enjoyed the public’s trust and faith on their own merit, thank you very much – the sovereigns rather had their own self-interest at heart, a possibility that does not even seem to cross William’s mind: The Bank of England was founded specifically to lend money to the Crown against the issuance of IOUs, meaning the Bank of England was founded to monetize state-debt. The Bank of England, from its earliest days, was repeatedly given the legal privilege – given, of course, by its sovereign – to ignore (default on) its promise to repay in gold and still remain a going concern, and this occurred precisely whenever the state needed extra money, usually to finance a war.
Bitcoin is cryptographic gold
“Gold is money and nothing else.” This is what John Pierpont Morgan said back in 1913. At the time, not only was he a powerful and influential banker, his home country, the United States of America, had become one of the richest and most dynamic countries in the world, yet it had no central bank. The history of the 19th century US – even if told by historians such as Milton Friedman and Anna Schwarz who were no gold-bugs but sympathetic to central banking – illustrates that monetary systems based on a hard monetary commodity (in this case gold), the supply of which is outside government control, is no hindrance to vibrant economic growth and rising prosperity. Furthermore, economic theory can show that hard and inelastic money is not only no hindrance to growth but that it is indeed the superior foundation of a market economy. This is precisely what I try to show with Paper Money Collapse. I do not think that this was even a very contentious notion through most of the history of economics. Good money is inelastic, outside of political control, international (“nationless”, as Williams puts it), and thus the perfect basis for international cooperation across borders.
Money was gold and that meant money was not a tool of politics but an essential constraint on the power of the state.
As Democritus said “Gold is the sovereign of all sovereigns”.
It is clear that on a conceptual level, Bitcoin has much more in common with a gold and silver as monetary assets than with state fiat money. The supply of gold, silver and Bitcoin, is not under the control of any issuing authority. It is money of no authority – and this is precisely why such assets were chosen as money for thousands of years. Gold, silver and Bitcoin do not require trust and faith in a powerful and privileged institution, such as a central bank bureaucracy (here is the awestruck Williams not seeing a problem: “These financial stewards have immense power and responsibility.”) Under a gold standard you have to trust Mother Nature and the spontaneous market order that employs gold as money. Under Bitcoin you have to trust the algorithm and the spontaneous market order that employs bitcoins as money (if the public so chooses). Under the fiat money system you have to trust Ben Bernanke, Janet Yellen, and their hordes of economics PhDs and statisticians.
Hey, give me the algorithm any day!
Money of no authority
But Professor Williams does seem unable to even grasp the possibility of money without an issuing and controlling central authority: “Under the Bitcoin model, those who create the software protocol and mine virtual currencies would become the new central bankers, controlling a monetary base.” This is simply nonsense. It is factually incorrect. Bitcoin – just like a proper gold standard – does not allow for discretionary manipulation of the monetary base. There was no ‘monetary policy’ under a gold standard, and there is no ‘monetary policy’ in the Bitcoin economy. That is precisely the strength of these concepts, and this is why they will ultimately succeed, and replace fiat money.
Williams would, of course, be correct if he stated that sovereigns had always tried to control money and manipulate it for their own ends. And that history is a legacy of failure.
The first paper money systems date back to 11th century China. All of those ended in inflation and currency disaster. Only the Ming Dynasty survived an experiment with paper money – by voluntarily ending it and returning to hard commodity money.
The first experiments with full paper money systems in the West date back to the 17th century, and all of those failed, too. The outcome – through all of history – has always been the same: either the paper money system collapsed in hyperinflation, or, before that happened, the system was returned to hard commodity money. We presently live with the most ambitious experiment with unconstrained fiat money ever, as the entire world is now on a paper standard – or, as James Grant put it, a PhD-standard – and money production has been made entirely flexible everywhere. This, however does not reflect a “longstanding bond between sovereign and its currency”, as Williams believes, but is a very recent phenomenon, dating precisely to the 15th of August 1971, when President Nixon closed the gold window, ended Bretton Woods, and defaulted on the obligation to exchange dollars for gold at a fixed price.
The new system – or non-system – has brought us persistent inflation and budget deficits, ever more bizarre asset bubbles, bloated and unstable banking systems, rising mountains of debt that will never be repaid, stagnating real incomes and rising income disparities. This system is now in its endgame.
But maybe Williams is right with one thing: “If not controlled and tightly regulated, Bitcoin — a decentralized, untraceable, highly volatile and nationless currency — has the potential to undermine this longstanding bond between sovereign and its currency.”
Three cheers to that.
This article was previously published at DetlevSchlichter.com.
Gold and silver (and other commodities) have many uses – for example industrial uses.
Bit”coin” (it is not actually “coin” at all) has no nonmonetary uses – none what-so-ever.
Nor is Bit”coin” a fiat money – for “fiat” (as in “by fiat” – command, order) implies legal tender laws and tax demands (the vile Paul Krugman’s “men with guns”) – and Bit”Coin” has none of these things.
So BC is neither a commodity money nor a fiat money – it is neither. It is not money.
As for private currencies – they have indeed existed.
For example the notes issued by various banks in past centuries – these notes claimed to represent gold or silver, often the banks that issued them did not actually have the gold or silver the notes said they had, but at least the CLAIM was made (Bit”Coin” is a claim on no commodity – none).
Better was the system of minting of private coins (real coins) by private mints in the American West – these coins (both gold and silver) were of full weight and the purity they claimed to be (the process of competition made sure of that).
This was a real private money system and it worked – till the Congress banned it in the 1850s.
Today electronic transfer of the ownership of gold or silver (or any other commodity) is not difficult.
Therefore a commodity money does NOT mean the end of credit cards (and so on).
There is no need for “crypto” money, when people can have real money.
With Mt. Gox dissappearing, bit coins vanishing, and the ‘price’ in fiat for bit coins not exactly stable, more like a yoyo, how anyone could describe crypto currencies as money or ‘cryptographic gold’ is beyond me. To claim crypto currencies are superior to fiat is ridiculous. The only possible instance I would ever consider crypto currencies would be to transfer funds out of the country. Mt. Gox was obviously controlled by one man. Bitcoin was supposedly created by one man. NSA and others all track every electronic communication. The notion that no one controls bit coin, that it’s free from human mischief has just been proven wrong, no? With all due respect to Mr. Schlichter, I’m afraid Mr. Morgan was right : “Gold (and silver) is money, everything else is credit” Trading fiat for precious metals makes a lot of sense for many reasons, trading fiat for bit coin, why would anyone do that? Finally, just the notion that one can ‘mine’ bit coins with uber computing power is a hoot – this is supposed to be an improvement over bankers creating money from nothing? The world’s monetary system of fiat currencies is failing. Going back to gold and silver money liberates every human being and destroys the power of banks to own and control the earth. Bitcoin is a bankers wet dream of continuing world domination and enslavement of humanity.
Aloholjim – I guess that D. Schlchter could come back at you by saying that Bit”coin” is hard to expand (unlike Central Bank money). Assuming all this computer stuff is as sound as the BC salesmen (i.e. the people who are trying to talk up the value of the BC they own) say it is.
Other than that your points can not really be countered.
Hmmm. I note above this wonderful line: “The first paper money systems date back to 11th century China. All of those ended in inflation and currency disaster. Only the Ming Dynasty survived an experiment with paper money – by voluntarily ending it and returning to hard commodity money.” This appears to favor something other than a commodity which only exists as electrical current flowing through somebody’s computer. So do I. Some years back I paid scant attention to my retirement funds as they withered and died on the vines until I was only able to salvage roughly 50% of my future plans. Something similar was just done unto many Indian investors. This was done by a basic misunderstanding of what Bitcoin truly is. Wealth is not lost, it is simply transferred or exchanged. If I had been so foolish as to invest in just one Bitcoin last Friday afternoon it would have cost me $556.99 (http://bitcoinexchangerate.org/c/USD). If I had made such a swell deal, the seller would have almost $557 in real folding money and I would have had some digitized electronic current. If Mt. Gox had been the broker and its electricity shut off, I would now have nothing but a fleeting memory of what better use of that $557 (which the seller may still have in his wallet) I could have had if instead I had used it to buy a bottle of 25 year old Glenfiddich. No thank you. Been there and done that. Now unless a commodity has sufficient heft to put a dent in the thick skull of a government economist or politician, I ain’t interested. Now I am convinced that Bitcoins are but a manifestation of carbon credits and similarly intended as a ruse to transfer wealth from the less equal animals to the dire wolves who prey upon us. {http://profit.ndtv.com/news/nation/article-indians-lose-crores-in-bitcoins-as-japan-exchange-collapses-381933}
My original post having disappeared into the ether like a Mt. Gox account, I revised it and am giving it a second go:
Hmmm. I read above this wonderful passage: “The first paper money systems date back to 11th century China. All of those ended in inflation and currency disaster. Only the Ming Dynasty survived an experiment with paper money – by voluntarily ending it and returning to hard commodity money.” This appears to favor something other than a medium of exchange which only exists as electrical current flowing through somebody else’s computer. So do I. Some years back I paid scant attention to my retirement funds as they withered and died on the vines until I was only able to salvage roughly 50% of my future plans. Something similar was just done unto many Indian investors. (Read “Indians lose crores in bitcoins as Japan exchange collapses” from Press Trust of India | Updated On: March 02, 2014 16:12 (IST) )This was done by a basic misunderstanding of what Bitcoin truly is – a binary pattern of on/off electric currents. Barring wanton destruction such as breaking a window or flying a plane into a building wealth is not lost, it is simply transferred or exchanged. If I had been so foolish as to invest in just one Bitcoin last Friday afternoon it would have cost me $556.99 (bitcoinexchangerate.org/c/USD). If I had made such a swell deal, the seller would have almost $557 in real folding money and I would have had some digitized electronic current. If Mt. Gox had been the broker and its electricity shut off, I would now have nothing but a fleeting thought of what better use of that $557 (which the seller may still have in his wallet) I could have had if instead I had used it to buy a bottle of 25 year old Glenfiddich. No thank you. Been there and done that. Now unless an imaginary currency is backed by something with sufficient heft to shatter Bastiat’s window, I ain’t interested. I am convinced that Bitcoins are but a manifestation of fiat currency, carbon credits and other digitized pieces of paper and similarly intended as a ruse to transfer wealth from the less equal animals to the dire wolves which prey upon us.
Don’t show me the bitcoin. Show me your oldest single malt.
To commenter Paul Marks and to the author of this article especially, the fact that the ultimate number of Bitcoins is finite does nothing to support Bitcoin value. Why not? Gold is limited in supply, right? Just like Bitcoin, right?
But you fail to see that there is no rational limit to the number of crypto currencies which can exist. See how many crypto currencies exist already? Anybody can develop and release their own crypto currency, meaning they have no more intrinsic value than one of the trillions of Word Documents stored on hard drives around the world and in the cloud.
Gold, on the other hand, is a product of nature. There are other metals, such as silver and copper, which have been used as money but they have different properties than gold and — most importantly — the number of alternative metals is strictly limited. Try developing a new precious metal not yet on the periodic table and let me know how it works out for you.
Bitcoin is just another Tulip mania.
Mr Thompson and Callum – quite so.
The key question with anything that claims to be money is the following…..
“Can I save this stuff for my old age?”
If anyone thinks the answer to that question is “yes” in the case of Bit”coin”……..
Well I have nice bridge to sell you.
Speaking as a former employee of a precious metals dealer that’s just opened an affiliated bitcoin exchange, there seems to be a real split between techie-minded libertarians and more conservative-minded, historically aware people (such as myself, and I’d guess Paul and some of the other commentators above).
The techies are all starry-eyed about bitcoin, but don’t know any history, so think that warnings about government hostility to their enterprise is just paranoia. They’re very clever people, but can be blind to really obvious things – like the fact that bitcoin has no value independent of its role as a medium of exchange. Again, I think this is because they don’t tend to think about what money is, and haven’t thought about economics as much as people who are coming at this issue from a liberal-arts background.
James – sadly I hear that for a BC lady in Singapore reality just caught up with the fantasy.
I do not want to hurt these young people – I want to warn them.
Even now it is not too late – they are young (I wish I was) they can walk from all this, and start again.
Even bankruptcy is not the end – if one is young.
There is no need for them to die.
Callum;
Money is money because it is a medium of exchange, store of value, and unit of account.
But to be those three things, it just has to enjoy the confidence of both parties to a trade. What mechanism prevents this?
The algorithmic process by which coins are ‘mined’ requires computers to do real work (it can’t be faked) and the amount of work required to mine one bitcoin doubles at a regular interval (which escapes me at present) meaning it can’t be just conjured…
So as long as people believe in it and use it, it’s money. If you wanna wallet the size of a rucksack, enjoy your gold and silver.
Matthew:
It should be safe to assume anybody hanging out at the Cobden Centre already knows the textbook definition of money, but thanks for your effort.
Your point about carrying gold and silver around in a rucksack is irrelevant. That problem was solved eons ago. After all, paper notes were once warehouse receipts for gold held in a centralized vault. Nowadays there are plenty of digital methods for buying, selling, and transferring title to precious metals online.
Bitcoin is great as a medium of exchange and just as good as any enumerable object as a unit of account. The problem with Bitcoin in its present form is that it is rather dubious as a store of value.
There’s nothing backing up Bitcoin at the moment. With fiat currency, at least you have the backing of the state’s ability to harness the productivity of its subjects through present and future taxation. With Bitcoin, there’s just nothing there.
Ever wonder why Bitcoin’s value fluctuates so violently from day to day? You need to look at the store of value problem to see why. Presently the market is not very confident in Bitcoin as a store of value, and that lack of confidence leads to extreme volatility.
Now, if someone developed a gold-backed cryptocurrency, that would be a different matter entirely. Such a development would destroy banking as we know it and reshape the financial systems of the world.
I’d welcome such a development. But Bitcoin in its present form will not be the catalyst for this transition.
Still think I’m wrong? Bookmark this post and come back in 5 years to tell me so.
Great article Detlev
I think our next generation who are growing up in an internet age will prove the outcome of these arguments eventually. If the fiat system can sustain itself on it’s last legs for a few more years it could allow for Bitcoin to become so widespread that it will make for a very easy transition if the market so chooses. The fallout of the fiat collapse is the worrying part. Both the Bitcoin protocol(with currency unit of measure = bitcoin) and Gold (unit of measure – fiat units per ounce) can be argued are forms of sound money.
Let the market choose. My fiat investment is split 80/20, i.e. 80% Bitcoin, 20% gold. But I am relatively young. Others might rather opt for the inverse ratio.
Thx for good arguments posted. Bitcoin is more than just another form of money. It is an idea. A hidden possibility of escaping the current paradigm as we know it. Undoubtedly triggering robust and required dialog. If only more people join the movement, we can escape central banking tyranny together.
Just another Bitcoiner.