A physical Bitcoin-coin

Bitcoin-coin (photo by CASAACIUS)

The crypto-currency Bitcoin is still merely a speck on the global monetary landscape. It is young, experimental, and for all we know, it may ultimately fail to break into the monetary mainstream. However, on a conceptual level I am willing to call it a work of genius and arguably the most exciting development in the field of money for more than 130 years. Let’s say since the start of the Classical Gold Standard in 1879. Does this sound like hyperbole? Well, let me explain.

The Decline and Fall of Capitalist Money

The 20th century was, broadly speaking, a period of almost constant monetary decay. At around 1900 most economists, politicians and bankers would have correctly stated that global capitalism – an international market economy facilitating the free exchange of goods and services across political borders and thus allowing extensive human cooperation through trade – required an international, apolitical, and hard form of money. Such money was gold. It was the basis of the capitalist economy and it imposed strict discipline on all market participants. Crucially, that included governments and banks. Governments had to operate pretty much like private businesses. They had to balance their books, i.e. live within the means provided by taxation, and if they borrowed money in the marketplace their lenders were at full risk of default as no government could print money (gold) to repay loans or even meet interest payments on loans. Banks, of course, issued banknotes or bank-deposits that were not backed by gold but still used by the public as if they were money proper – these were and still are ‘money-derivatives’ – but again they did so at full risk of default as nobody could ‘print’ bank-reserves (gold again) to bail out the banks in case the public tired of the ‘derivatives’ and wanted to hold gold instead.

Over the course of the 20th century – or to be precise, from 1914 to 1971 – the monetary system was completely changed as a consequence of a number of entirely political maneuvers, all of them undermining the quality of money. Today, hard, international and apolitical money has everywhere been replaced with entirely elastic, national and politicized money, with money that central banks issue under a territorial monopoly at no cost and with no meaningful constraints on issuance, and that the central bankers use to ‘manage’ the ‘national’ economy (itself increasingly an out-of-date-concept), and to fund the state and grow the domestic banks (which, under the protection of a lender-of-last-and-first-resort, now issue unprecedented amounts of money derivatives).

Today the global monetary map resembles a patchwork of local, “nationalistic” paper monies, each of which is a political tool, often openly manipulated in an attempt to benefit the local export industry at the expense of foreign competitors or to ‘stimulate’ the ethereal concept of ‘aggregate demand’. Not surprisingly, the global economy is drowning in debt (increasingly public sector debt), suffers from a bloated financial sector and international trade tensions, and stumbles from one crisis to another, each one worse than its predecessor.

Bizarrely – but not entirely surprisingly – politicians, bankers and modern ‘enlightened’ economists now tell us that this unhinged financial system is to our benefit, really, just trust us.

Truth be told, the present monetary system is a hindrance to free trade, properly functioning markets and human cooperation across borders, and it might already be on its last leg. Yet a powerful but entirely misguided, consensus seems to have taken hold of public opinion, namely that ‘elastic’ money could be beneficial if money’s supply was only managed astutely by some clever monetary central planners.

I wrote Paper Money Collapse – The Folly of Elastic Money and the Coming Monetary Breakdown to challenge that consensus, to show that ‘elasticity’ of supply is always a negative for money. Elastic money is not needed. It is entirely superfluous. Moreover, elastic money is always disruptive. A monetary system based on an inherently elastic and constantly expanding supply of money is unstable and ultimately unsustainable. The reason why gold made such good money for thousands of years is precisely its essentially inelastic supply.

The word ‘Bitcoin’ does not even appear in my book. The reason is simply that I had not heard of Bitcoin by the time I handed in my final manuscript in early 2011. But when I learnt about Bitcoin soon afterwards I was immediately fascinated. Like many others, I could conceive of ‘internet money’ or ‘virtual money’. As I had explained in the book, money does not have to exist in physical form and the fact that most money today is electronic money poses no problem for the monetary theoretician. The problem with this type of money is not that it is immaterial but that its supply is completely elastic, and I simply could not see how money that was not based on a nature-given and strictly limited commodity could have an entirely inelastic supply. It was Bitcoin’s inelasticity by design that I saw immediately as one of its greatest strengths and its true genius.

My work rehabilitates the gold standard. It shows that it was a mistake to abandon gold as the basis of our financial system and replace it with entirely elastic state fiat money. When (not if) the present fiat money system finally ends we could and should return to gold. The only alternative I now see, at least on a purely conceptual level, is Bitcoin, or something like Bitcoin: Hard, apolitical immaterial, virtual money.

Bitcoin is cryptographic gold

By now most readers will probably have heard of Bitcoin and have some notion of what it is. But in any case, let me give you a quick run-down. The economist Nikolay Gertchev, in a blog on the Mises Institute website, explains it quite well, although Gertchev, like many other members of the “Austro-Libertarian” movement, is somewhat reserved when it comes to embracing Bitcoin. I am surprised by the extent of scepticism in that community and believe that in general it is unfounded. But first the description:

“A bitcoin is a unit of a nonmaterial virtual currency, also called crypto-currency, by the same name. (Bitcoin is a medium of exchange that only exists in the virtual world. DS) They are stored in anonymous “electronic wallets,” described by a series of about 33 letters and numbers. Bitcoins can travel from a wallet to a wallet, by means of an online peer-to-peer network transaction. Any inter-wallet transfer is registered in the code of the bitcoin, so that the record of its entire transaction history clearly identifies its owner at any single moment, thereby preventing potential ownership conflicts. Bitcoins can be further divided into increments as small as one 100 millionth of a bitcoin. The current outstanding volume of bitcoins is above 10 million and is projected to reach 21 million in the year 2140.”

 “This brings us to the truly fascinating production process of the bitcoins. They are “mined” based on a pre-defined mathematical algorithm, and come in a bundle, currently of 25 units, as a reward for carrying out a large number of computational operations that aim at discovering the solution to what could be described as a randomized mathematical puzzle. The role of the algorithm is to ensure a declining progression of the overall stock of bitcoins, by halving the reward every four years. Thus, somewhere in the beginning of 2017, the reward bundle will consist of 12.5 units only. Also, the more bitcoins are produced, the harder are the randomized mathematical puzzles to be solved.”

Bitcoin is immaterial money yet strictly limited in its supply. Once 21 million units are in existence, probably in 2140, that’s it. No more Bitcoin can be issued. In fact, the supply of Bitcoin is more inelastic than the supply of gold. Also, the available supply of Bitcoin at any moment in time is substantially more transparent than that of gold.

If Bitcoin ever became money in its own right (how it could do so, I will discuss below), then it would be international, hard and entirely inelastic money. Like gold it also does not decay, is homogenous and (almost) perfectly divisible. Bitcoin fulfils all the requirements of good money. In the long run, gold does not have to fear fiat money, which is always suboptimal as it always is national, politicized, manipulated, unstable and inflationary money. For one thousand years, state paper monies have come and gone. Gold (and silver) stayed. Gold just has to sit still and wait for this, the latest and most audacious and arrogant, experiment with global free-floating paper money to fail, and it will come back. But now it faces, potentially, its first meaningful challenger: inelastic crypto-currency, Bitcoin.

Money of no authority

There is no central authority that issues Bitcoin and can manipulate its supply for its own gain or for any alleged ‘greater good’ of society. Positively cringe-inducing, although sometimes unintentionally funny, are the embarrassing attempts by establishment spokespeople to discredit Bitcoin on account that, unlike all that astutely managed state fiat money, Bitcoin would not constantly be losing purchasing power. In fact, just as in the case of gold, Bitcoin’s purchasing power can reasonably be expected to constantly appreciate over time.

But, so we hear the assorted ‘enlightened’ economists of the Keynesian persuasion exclaim in horror, that would mean we would all suffer from dreadful deflation, from which only an elite of highly-qualified government-appointed central bank bureaucrats and a well-oiled printing press can save us. Apart from the fact that these self-appointed money masters have neither proper economic theory nor the experience of a thousand years of financial history on the side of their destructive agenda, they obviously do not even comprehend how far their system of manipulated funny money has already discredited itself.

Inelastic money can satisfy ANY demand

As I have explained in Paper Money Collapse no society (not even a healthily growing one) needs a constantly expanding supply of money. Money is a unique economic good. Because it is the medium of exchange, money is the only good that is demanded exclusively for its exchange value, not for any use-value its substance (if it has a substance at all) may also have.

Nobody who has demand for money has demand for a certain quantity of paper notes, or a certain weight of gold, or a certain number of digits on a computer hard-drive. Money-users have demand for the exchange value that these items contain in exchange for other goods and service, i.e. qua being accepted by others as money. Demand for money is always demand for readily exercisable purchasing power.

Once a good is widely accepted as a medium of exchange (whether that good is gold, paper tickets, or sequences of digital ones and noughts), the public can, at any moment in time, hold precisely the amount of money – readily exercisable purchasing power – it wants to hold. If the demand for money goes up, the public will sell non-money goods for money or reduce money-outlays for non-money goods. As a result, the money-prices of non-money goods fall and the purchasing power of each monetary unit (whether gold, paper tickets, or digital code) will rise. This process satisfies – automatically, instantly and naturally – the higher demand for money. The public now holds more readily exercisable purchasing power in the form of money, not because a clever, über-prescient money producer has created new money units, but simply and much more straightforwardly, because the exchange-value of the existing money stock has increased.

Once a good is widely accepted as money, no further production of that good is required. In fact, as I also demonstrated in Paper Money Collapse, any attempt to flexibly inject money into the economy in order to ‘stabilize’ money’s purchasing power, or, as is declared policy today, to constantly debase it at an officially sanctioned rate, must not only fail in its primary objective (‘price level stability’) but must cause grave distortions in the wider economy. Furthermore, the steady secular deflation that is to be expected under inelastic money, such as gold or Bitcoin, is not only not economically disruptive, it is even beneficial. Just consider one aspect: as money will then have a moderate positive real return, people who have no knowledge of financial markets and investing, and who do not have the resources to hire professional advisors, can save by simply holding money. This is impossible in our fiat money economy of constant inflation and increasing monetary instability.

Truly international

As Bitcoin has no issuing authority it has no country of residence or origin. It is truly global money. It can be used for payment anywhere in the world without going through banking systems or foreign-exchange markets. It is undeniable that the multitude of local paper monies poses a considerable hindrance to free trade and thus the rise of living standards in large parts of the world as this system necessarily introduces an element of partial barter into international trade relations. Today’s massive foreign-exchange markets are nothing but a make-shift, a crutch to deal with the suboptimal and politically motivated arrangement of various local currencies. This market ties up capital (both financial and human) without adding any real wealth to society.

If Bitcoin were to get widely accepted – and that is still a big if – it could become a great platform for connecting potentially any two counterparties in the world in direct financial transactions. It is the ultimate disintermediator: no banks needed.

At this point it might be objected that it only connects people who have access to the internet or smartphones but this is obviously a rapidly shrinking barrier. On my travels in Africa last year, I found that internet access was usually more ubiquitous than bank branches. And by the way, Kenya and Tanzania already have M-Pesa, the world’s most developed mobile payment system that uses the mobile phone network to facilitate money transfers. These countries could easily make the transition to smartphone-based payment systems without ever making the detour through clunky bank branch networks.

On the issue of tying down capital, Bitcoin wins hands-down against any other financial system, including a gold standard. Bitcoin does not require any physical storage, which naturally is always expensive. Bitcoin is monetary raw material and payment system in one. (Although, fascinatingly, the free market has already created physical Bitcoins.)

Money requires trust. We presently do not live under a gold standard but, as Jim Grant has observed so astutely, a PhD-standard, a system of flexible, state-sponsored money, managed by people like Ben Bernanke and his team at the Fed, who enjoy the privilege of implementing policies based on their own faulty monetary theories and hair-raising interpretations of economic history, while a cheap-money-addicted class of speculators plays them like a fiddle and laughs all the way to the bank. The appeal of gold has always been that it does not require the public to put trust in a ‘money elite’ but that it only has to trust gold’s creator: mother nature. With Bitcoin you only have to trust the algorithm, and as this is open software, there cannot even be a hidden agenda. Bitcoin, just like a proper gold standard, is hard, capitalist money with no politics, no Federal Open Market Committee meetings, no monetary policy, no central banking bureaucracy. It is free market money.

Common objections to Bitcoin

Given its free market and ultra-hard-currency credentials, the scepticism towards Bitcoin in parts of the Austro-Libertarian community is somewhat surprising. I think some of the objections are easily refuted. There is, first of all, the idea that Bitcoin could have many imitators, which would undermine its uniqueness and reduce its attractiveness. If Bitcoin itself cannot be inflated, what about the concept of crypto-currencies, could it be inflated by too many different currencies on offer?

This argument strikes me as weak. By all accounts Bitcoin’s design and cryptographic robustness are an exceptional accomplishment. It is not as if any hacker of medium talent could pull off something similar tomorrow. But even if he could, the argument completely underestimates first-mover advantage in the area of goods and services with substantial network effects. How many people have launched a second Facebook or a second Twitter since these inventions kicked-off the social media craze, although technologically, these inventions are much simpler than crypto-currency? – Nobody. The network effects of these goods are immense. Once they have a certain acceptance it is hard, if not impossible, for late-comers to break in. These goods and services have value for their users predominantly because others use them too, and the more people use them, the more valuable they get. There is no good for which this is truer than money – the general medium of exchange. Customized money is an oxymoron. Consequently, once a form of money is accepted, it is very difficult to take business away from it.

This feature of money is obviously a problem for Bitcoin in its fight against established state paper monies but is equally a big plus when it comes to keeping potential new entrants into the crypto-currency arena at bay. Bitcoin now dominates the market for crypto-currencies (it pretty much IS the market for crypto-currencies, in my view) and I believe that only the discovery of major flaws in Bitcoin – none seem to have surfaced in its four-year life up to now, and every day they are less likely to appear -, or if some vastly superior crypto-currency came along but I am hard-pressed to see in which aspect it could outperform Bitcoin. But just launching another crypto-currency – a Bitcoin clone – is certainly not going to put a dent into Bitcoin.

Menger and Mises would love Bitcoin

Many ‘Austrians’ get thrown off by Menger’s theory of the origin of money and Mises’ so-called ‘regression theorem’, and somewhat rashly conclude that Bitcoin can never achieve money-status because it did not originate from a non-money commodity. Mises was correct when he stated that something could only become money if it had previously, that is, before it was used by somebody as a medium of exchange in its own right for the first time, established some value in trade. For if that had not been the case, how could the first person to employ the commodity as money have any point of reference by which to assess its value and determined its exchange value for the first monetary transaction? However, this theorem, which remains unrefuted in my view, does not apply to Bitcoin. Bitcoin can simply piggyback on established forms of money that already have exchange-value and derive its original value from them before it does, over time, establish its own value.

The same has, in fact, happened in the case of paper money. The paper notes that are used as money today did not start their ascent to widely used and generally accepted monetary assets from humble beginnings as commodities – that is, as mere paper – but started out as paper-claims on physical gold. Gold was money and the paper tickets simply a technology to transfer ownership of gold. When the first banknote was used it did not derive its exchange value from its paper content but from the fact that it could be exchanged for a fixed amount of gold. That was the necessary reference point – in accordance with Mises’ regression theorem. Paper money started as payment technology and as the public got used to paying with paper rather than with gold coins and gold bars, the underlying gold content could be reduced over time and ultimately the link to gold completely severed. What gives value to these paper tickets today? – The fact that the public still accepts these paper tickets in exchange for goods and services. That is all. And in fact, it is all that is needed. Any form of money –even gold, which still retains some functionality as industrial commodity or consumption good (jewellery), although that functionality is now irrelevant for its role as monetary asset – any form of money derives its money-value from the trading public and the public’s willingness to exchange the monetary asset for goods and services.

And herein lies in fact Bitcoin’s biggest challenge. However, this challenge is not of a conceptual nature. The concept of Bitcoin as money is, as I have tried to show above, extremely compelling. But Bitcoin has to offer something to the average money-user that state paper money cannot offer. Just as the banknote bestowed an instant and discernible benefit to each money-user relative to heavy gold coins, that allowed it to become a widely used medium of exchange in its own right and ultimately even operate without any link to gold, so Bitcoin has to set itself apart from fiat money and overcome fiat money’s powerful network advantage. The fact that fiat money is suboptimal in terms of its inflation characteristics and its disruptive effects on the broader economy is not something that bothers the average money user at the moment he desires to engage in monetary transactions, and do so as conveniently, securely and easily as possible. The state paper money system today offers easily useable ‘computer money’ and the broader public is still happy to use it. Why switch to Bitcoin?

Will Bitcoin get accepted by the wider public?

It is my impression that the community of Bitcoin users, although apparently growing strongly, is still largely composed of those who are fascinated by the technology as such and who want to be part of something new, and those who like it for ‘ideological’ reasons, i.e. those who detest state paper money or dislike the banking system. Thus, there is apparently still a big contingent of computer ‘nerds’, hackers, crypto-anarchists, anti-government libertarians and Occupy-Wall-Street-types among its user base (which is not to say that there are not many who do not fall into any of these categories). How could Bitcoin attract a broader base of money-consumers beyond these groups?

One powerful aspect is cost. Bitcoin transactions are free, so Bitcoin could become – or maybe it is already – the Skype of payment systems. Another attraction could simply be the usually reasonable, and with some effort potentially considerable, anonymity and untraceability that Bitcoin offers. This seems to be a hotly debated topic. On the one hand, Bitcoin is incredibly transparent. All transactions are literally in the open domain. However, each ‘user’ is only identified by his ‘address’ and the number of addresses is practically unlimited. One could use a new address for each transaction. This may not mean instant untraceability from ‘the authorities’ but then again, certain techniques and add-ons, some of which are still being developed, have the potential to increase anonymity and untraceability even further. Additionally, it is possible to acquire Bitcoin for cash – rather than via the established and already regulated exchanges – and thus anonymously.

This means Bitcoin could be used, as is a frequent charge against it already, for illegal transactions involving drugs and guns. But people do not have to be drug or arms dealers, or even ordinary tax cheats, to appreciate a certain degree of financial privacy. As bank secrecy laws disappear everywhere and as almost all governments are waging a ‘war on cash’, by which any transaction that involves more than just petty cash is to be moved to electronic systems within the state’s fiat money network, so that ‘the authorities’ achieve full ‘transparency’ as to what the citizenry is up to at any moment, there could well be a widespread demand for ‘outside’ electronic payment systems offering privacy. For example, a range of ‘activities’ exist engaging in which may not be, or not yet be, illegal but considered a major potential embarrassment to the parties involved if made public (gambling, pornography, escort services), so that many people would not want to have payment for them on their permanent records. This potential development is not lacking in irony: Our modern information society with its trends towards the ‘transparent citizen’ and unlimited data storage holds many threats to a free society, privacy and individual liberty. It would be fitting if countermoves to these trends emanated from the same technology.

An additional boost to Bitcoin may come straight from the crumbling state paper money infrastructure itself. The cases of Iceland and in particular Cyprus have driven home the point that ‘money in the bank’ is far from safe, and even if your deposits have survived the bank collapse and the ‘bail-in’, you may not get them out of the country any time soon as capital controls are likely be imposed. As the overstretched paper money economy staggers towards its inevitable demise, more of these instances will occur providing an additional opening for Bitcoin. To the best of my knowledge, Bitcoins cannot be confiscated and Bitcoin accounts cannot be frozen Additionally, you store Bitcoin yourself rather than put them into a fractional-reserve bank that would conveniently use them as ‘reserves’ for its own ‘money derivative’ production.

What are Bitcoins worth?

I agree with Jon Matonis that nobody can give a reasonable answer but that the outcome is probably binary: Either Bitcoin ultimately fails and the individual Bitcoins end up worthless. Or Bitcoin takes off and Bitcoins are worth hundreds of thousands of paper dollars, paper yen, paper euros, or paper pounds. Maybe more. Those who buy Bitcoin as a speculative investment should consider it an option on the future success of the crypto-currency. At time of writing, Bitcoins are trading at $127 and £83 at Bitcoin-exchange Mt. Gox.

On a personal note, my biggest ‘liquid’ asset continues to be physical gold. As I explained on numerous occasions, I consider gold to be the essential self-defense asset in the ongoing paper money crisis. Gold is not being used presently by the wider public as a medium of exchange either but its two-thousand-plus year history as global money means that it retains monetary asset status and that its historic function as a liquid and lasting store of value – a function that fiat money cannot fulfil – remains unrivalled. By comparison, the brand-new crypto-currency Bitcoin has to first earn its stripes as a monetary asset by proving itself as a ‘common’ medium of exchange. That is why I view Bitcoin very differently from gold, although the attraction of both has its origin in the demise of entirely elastic, politicized state fiat money. I will certainly continue to follow the Bitcoin revolution with interest and sympathy.

In the meantime, the debasement of paper money continues.

 

 

 

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41 Responses to Could Bitcoin be the money of the future?

  1. David Goldstone says:

    Dear Detlev

    This is a pellucid and penetrating analysis of BTC which is both informed and avoids so many of the errors that one sees made by critics of BTC (including, regretably, some Austrians and other libertarians).

    Your analysis is particuarly welcome given your personal committment to gold. I have noticed a considerable antipathy on the part of gold bugs to BTC (usually for bad reasons) and so it is very refreshing to read an intelligent and open-minded analysis on the subject from somebody who is also a believer in the virtues of monetary gold.

    I do have one question, which is perhaps at this time more theoretical than practical. It is this. If we assume that BTC at some point in the future replaces fiat on a large scale, where does that leave gold? Do you see gold and BTC in the long run as competing or complimentary?

    My own view tends towards the latter (hence I hold both), but I can see an argument that if BTC becomes near universal then the need to hold gold as a monetary asset and store of value might diminish.

    Best regards

    David

    p.s. Your example Facebook as a case of first mover advantage is actually a salutory lesson in the speculative nature of any BTC investment. One must not forget the fate of Myspace or Wordperfect….

    • Thanks, David. If BTC (or something like BTC) becomes widely used and replaces fiat money then it could be complementary to gold for some time but not forever. ‘Complementary’ monies or competing monies are suboptimal arrangements. Ultimately, one form of money wins, and that could indeed be BTC, or inelastic, unmanipulated digital money. Conceptually and in the long run, gold faces its first true challenger in a few thousand years.

      • BTC Books says:

        Here I must disagree:

        “Conceptually and in the long run, gold faces its first true challenger in a few thousand years.”

        There’s already a mission being pushed to grab an asteroid and re-orbit it around the Moon. In a hundred years, we’ll be mining the Asteroid and Kuiper Belts with robotic spacecraft – not for gold specifically, but rather for those things that have value to space exploration and habitation. However there’s plenty of all the PMs in our Solar System: enough to utterly destroy the scarcity component of each and every one of them. And they will not be ignored just because their value will diminish sharply. Gold, platinum, & etc.. still have uses. Just not as money. Mark my words:

        Don’t bet on gold longer-term than that…

  2. Maximian says:

    Your example Facebook as a case of first mover advantage is actually a salutory lesson in the speculative nature of any BTC investment. One must not forget the fate of Myspace or Wordperfect….

    There’s a key difference between Facebook and Bitcoin: the former is a proprietary application with a tightly controlled walled garden for third-party apps, whereas the latter is an open technology platform.

    As we’ve seen with HTTP (the web) and SMTP (e-mail), if an open technology platform becomes broadly adopted and built upon with layers of supporting technologies, it becomes integrated into the fabric of the Internet and is almost impossible to supplant. Bitcoin isn’t quite there yet, but I think it has a reasonable chance.

  3. [...] http://detlevschlichter.com/2013/04/could-bitcoin-be-the-money-of-the-future/Related posts:The Financial Case for Borrowing Money TodayPaying Lip Service to LibertyThe Politics of Fear in America: A Nation at War with ItselfDetlev Schlichter: “Watching your money disappear” – Speech to senior representatives of the UK pens…The Death of PrivacyAnthony Gregory: The Bellicosity of a Democrat’s Second Term 16 Ways to Cut Defense Spending“The Government is US?” Not Unless We’re CitigroupGary North: How Come We're So Rich?There Will Be No Economic Recovery. Prepare Yourself Accordingly.Cyprus and the Unraveling of Fractional-Reserve BankingThe State: Crown Jewel of Human Social OrganizationJohn Browne Explains the Great GameBill Bonner: Tough luck for investors!How to Be a YouTube Star and Beat Justin Timberlake in the Charts This entry was posted in Essays and tagged Bitcoin, Economics, Money, Technology by admin. Bookmark the permalink. [...]

  4. Andy says:

    Detlev – many thanks for your article on Bitcoin, which was very informative and enlightening.

  5. Peter Šurda says:

    Dear Detlev,

    I wonder if you might consider reading my master’s thesis about Bitcoin from Austrian perspective, which you can find by googling or on my blog. I quote your work several times.

    Cheers,
    Peter

      • Adriano says:

        Detlev,

        you and Peter should do something together!

        Peter,

        I had a look to your blog:

        “But Bitcoin can do much more than become money. … With its ultra low transaction costs, it can make money substitutes redundant (and, obviously, without money substitutes there is no credit expansion and without credit expansion there is no business cycle). Again with its transaction costs and abstract base, anyone can make a payment to anyone, anytime, anyplace. Nothing that has existed so far in the history can do that. And even if we disregard it as a hypothetical, we just need to remember that gold already failed, because it was reduced from money to a secondary medium of exchange. This was only possible because money substitutes emerged. If nothing else, Bitcoin shows that money substitutes are merely an empirical quirk and not an inherent feature of monetary systems, and for that alone is it should change the landscape of the Austrian literature forever, and open a wide spectrum of possibilities for research and our understanding of money.”

        That’s a very BRILLIANT insight!

        I do not agree that the gold standard “failed”. I think it was killed by governments. BUT this was exactly because governments exploited the “vulnerability” of gold to be “substituted” (i.e. fractional reserve banking and cycles of inflation-deflations).

        Interestingly, even Milton Friedman many times stated that he had nothing to oppose to a “true to God” gold standard. It was the “fractional” aspect that accompanied the gold standard that made him oppose the gold standard (though I do not agree with this vision).
        This characteristic of Bitcoin to make potentially redundant any money substitutes is perhaps the most fascinating aspect of it.

  6. karol zimmer says:

    thank you for the informed post. thank you for making me think harder of bitcoin, too. yet, I prefer your book to your latest post.
    Two reasons for this:
    1. You would most likely agree, but I feel this needs to be stated in plain language: As an Austrian, I do not doubt bitcoin, because I think people “ought to be using gold”. And that is how I understood your book, too.
    If bitcoin (or gold) is our legal tender, the economy would function much more efficiently. Yet, legal tender in itself is anti-market and sub-optimal. Be it gold, fiat money or bitcoin. The openess for competition of monies is essential. If an accepted money loses some of its benefits, or society discoveres yet better money, the old one should be vulnerable to get void. Unless it can improve and outperform. btw I believe that is what is behind Hayek´s call for competing monies. Not a believe that more monies would be more optimal (as you seemed to state in your book).
    If society chooses bitcoin, Austrians would be all happy to switch. Well, at least I would. :-)
    But, why I do not? Why am I not running my bitcoin digging on my laptop?

    2. One of the reasons may be that I am not a fashionista. :-)
    The other reason may be I am ill informed. But as I understand bitcoin is electronic, network, inelastic money. And all these adjectives seem to be worse than those of gold:
    electronic: with bitcoin, your possession depends on hardware, software and power cord. possession of gold depends on… possession of gold.

    network: you have money if you tune in. that makes untraceable, free transferability pretty limited. U can pack up your bitcoin and move it to another computer. But you cannot fly-it-away to hide it from your wife. Nor from Mr. Taxman. Not without a trace. It is nice that taxmen do not go after you. But it may be just a matter of time. It would also be difficult to bury your bitcoins in your garden. Or under mattress. And recover them a few years later.

    and finally, the inelasticity: its inelasticity is a creation of a man. Not a discovery by society of some (nature- or lord-given) feature confirmed by experience of society. It is largely untested by society. Will it be inelastic when finally authorities start to care? And all hackers? To make a cheap point: if a man can be trusted with creation of good electronic money, what´s the fuss with FED?

    I believe bitcoins seems successful because current legal money is a nightmare. Any will do. And, once you give bitcoin a thought, it is great to be a gold digger and earn some for free. As for marketing, this is ingenious. But of the known alternatives, gold seems to be a winner for me.

  7. DmitryK says:

    Thanks to the author for a good analysis and explanation.
    I think the main drawback of Bitcoins – is algorithm.
    Any algorithm can be changed explicitly or covertly.
    Risk of changes in the algorithm in the future – this is the main drawback Bitcoins against gold.

    If the intelligence agencies would be given such an order, they will solve this problem very quickly. Author Bitcoins itself will change the algorithm as he was told.
    After that, he will jump out of the window. Or happen to him some a tragic accident.

    But gold does not have any algorithm. Government and security forces have no power over the author of gold. Because the author of gold – is God.

    • Srinivas says:

      Nice point. What is the guarantee that the algorithm is immutable. It is after all something developed by a human being. Nevertheless it could be a good competitor to gold, for some time.

      Thank you Detlev for a very interesting post.

    • Nico Metten says:

      The software is open source. Lots of hackers are controlling the code, so no one can just change it, without this being noticed. And you can always get the original software from somewhere, even if the government were to bring out its own version.

  8. jm says:

    Obviously Bitcoins are a great conversation piece- particularly the ability to move money cryptically across borders without being “tracked” – in this sense its better than gold which can be confiscated at borders (think Cyprus), or where black market currency rates differ from official rates (Argentina). A few points I’d like to note however in your completely incomplete analysis in my opinion…

    1) First of all, as you rightly point out, the amount of bitcoins “minted” are set by an algorithm- the algo cannot change and herein lies the problem. The total value of all bitcoins minted so far give or take (because the market is more volatile than yahoo stock circa 2000) is about $2billion – so the concept is nice but in a multitrillion dollar global economy its a drop in the bucket.. so you say, change the algorithm and mint more bitcoins to make the market bigger – or develop another virtual currency??? well now you basically make bitcoins like any fiat currency- printed at a whims notice, devaluing current holders.
    2) Bitcoin sites like MtGox require your ss# to open an account but the “anonymity” is what interests people. Does anyone think for one second governments who need a tax base (and surely need to broaden it in the future) will allow virtual currencies to be used unregulated for transactional purposes!!!! I believe the odds are nearly 100% that in the near future governments will demand user info on the Bitcoin market to ensure they can track things.
    3) A medium of exchange (money) gets its bearings by its inherent stability. When you and I transact- say I sell you bananas and you promise to pay me in dollars within 30 days at a set price, I need to know that the medium of exchange (dollars) is somewhat stable in terms of purchasing power. Take a look at this chart and tell me if you would buy or sell anything on credit based on the value of this chart 30 days from now…https://coinbase.com/charts . “Money” simply doesn’t quintuple in value over a week and then lose 70% of its value the following week.

    Bitcoin to me is a brilliant idea with the same characteristics of wall street supply/demand dynamics- restrict supply and you get bubble like action. The broader point seems to be there is a revolt against governments and fiat printing. I’ll stick with whats worked for centuries- hint- its yellow.

    • Adriano says:

      ““Money” simply doesn’t quintuple in value over a week and then lose 70% of its value the following week.”

      Try to convince those in Cyprus with deposits over 100000 euro…

    • David Goldstone says:

      1) “change the algorithm and mint more bitcoins to make the market bigger”

      I don’t believe this is possible, but in any case increasing the nominal supply of a currency does not increase the demand for it.

      2) “Bitcoin sites like MtGox require your ss# to open an account”

      These are not “bitcoin sites”. They are just exchanges. There are other ways to get bitcoins if you don’t want to use an exchange.

      3) “A medium of exchange (money) gets its bearings by its inherent stability”

      Ultimately what matters is not stability in purchasing power. What matters is that economic calculation is not disrupted by changes in the money supply. Bitcoin achieves this better than any other currency including, even gold (which is quite saying something!)

      • Jm says:

        David
        Exactly my point- increasing supply of course LOWERS -not increases demand. Which is why bitcoin founders are brilliant – they created a bubble by limiting supply . Similar to any hot Internet ipo which sells 10 pct of the float to get the stock up before insiders can sell. So my point is make it bigger and it’s like any fiat currency which can be altered at a whim. As to your point that bitcoin has stability in purchasing power?? Are u kidding me??? Again a bitcoin quintupled in value in a week and then plummeted by 70 pct!! As to mt gox asking for ss #, first of all it is the primary way people can obtain bitcoins but it honestly becomes a moot point whether or not you can obtain bit coins elsewhere when the mt gox website got hacked and most people have to search alternative websites just to get accurate pricing over the last week let alone buy bit coins. I don’t know about you but as much as I distrust the banks at least you know where to go to transact!

  9. Nico Metten says:

    The more I think about bitcoin, the more I realise that this might be the strongest weapon against statism there is. People who start using bitcoin will have an advantage over those who don’t. And once it establishes itself as a commonly used currency the welfare state is basically finished. And the more people are using it, the less volatile it gets. But it won’t happen over night. As the comments here show, and as my own thought process proves to me, it will take time for people to understand this new concept. Trust needs to be earned.

    • Tomer says:

      I wonder what is to stop a state from passing a law that all bitcoin transactions are subject to a 15% value added tax and that all employees of companies paid in bitcoins must have 45% of the bitcoin amount deducted at source and that corporations must pay 38% of all of their profits, including that earned in bitcoins. Law-abiding corporations and citizens do exactly this right now and that is not because the money is fiat, but because they accept the premise that governments can pass and enforce such laws.

      As much as I wish for minimal government, I do not think bitcoin cures us of statism, which is a philosophical and not a technological problem.

      That said, I do understand that taxation is finite and explicit, whereas a lot of the money printing actions of central banks is rather covert and widely misunderstood by the public. So in that sense it may be that the size of government, if bitcoin were a currency, could be curtailed to only that which they are able to get away with through taxation and legitimate borrowing.

      To get to the position where individuals would shun fiat currency that the government legislates as legal tender would however be a dramatic shift in people’s perspective toward government. Bitcoin adoption would be one effect of such a mind-shift, but I do not see how it can be the cause of it.

      • Nico Metten says:

        Governments can certainly still enforce taxes on locals, but what they cannot do is print bitcoins. Once people accept bitcoins and prefer it to paper money, because it is more stable, they will have a hard time outlawing it. And if it is legal, people might insist to be paid in bitcoins. At that point the state looses its ability to grow by printing money. Without this ability, the state is forced to shrink dramatically.

        Also, bitcoin raises the competition between states, as it is very easy to pay someone abroad and bring your savings abroad.

  10. Konrad Graf says:

    Nice treatment here. I have examined Bitcoin in terms of Misesian monetary theory and found a great deal that was of interest. My general sense is that some of the self-identified “Misesian” Bitcoin skeptics you reference have tended to err with some combination of not understanding Bitcoin well enough and not understanding Misesian theory itself well enough to apply it to an entirely novel development, basically committing some of the same errors of objectification based on outward appearances against which Mises himself warned in the strongest of terms already in his Theory of Money and Credit. My work on this (which aims to take a mainly constructive rather than critical approach) is collected under the Bitcoin Theory tab of my website.

  11. dingo says:

    seems like Bitcoin relies upon both working Internet and electrical power grid…both or either could be easily disrupted by a regime or government etc

    • David Goldstone says:

      True at the extremes, though if global power and communications are lost or destroyed through governmment action (nuclear war?) then I suspect we would have more things to worry about than the fate of bitcoin!

  12. Ed says:

    I am an IT architect for a large software firm and I have been programming for over a dozen years. So I understand both private and open source programming. The premise of bitcon is very promissing I love the idea that it is not controlled by the Fed yet!

    1. It is an open market which can be cornered by anyone who holds enough shares.

    2. It can be controlled by any group who has enough voting power to change base code someone decides what changes should be accepted into the collective.

    3. It can be hacked maybe not now but in the future hackers always have the upper hand.

    4. Now there are new bitcon millionaires then future billionaires then maybe trillionares creating a new controlling class if the current one doesn’t decide to take control.

    5. Code is always changeable and not static so the premis today can change tomorrow.

    6. How do we really know that those stated to create the system were actually the ones that did? How do we know that the limit stated is actually the limit? How many of its users have actually read all of the code and tested it in a sandbox environment to know that it does what is claimed?

    It is probably the future but I would like to see even more competing applications than just bitcon currency out there that creating even more opportunity and more challenge against control over these digital currencies from governments and those that develop the systems.

    It seems that the forces that have held the dollar in power (public belief of value) rather than actual intrinsic value is driving the value of bitcon today. What happens after their first major computer glitch and people loose millions I hate to see how that belief will hold up.

    Maybe I am too pessimistic but sometimes change is hard only the future will tell.

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  16. walter says:

    Dear S.,
    the article is very interesting, but i have a question: do you think that in a remote future Bitcoin could be used as widely accepted way of payment in international trade in sostitution of national currency, aren’t you? There are not negative aspect of this choice? This point of view is incompatible with the Optimal Currency Area theory?

  17. TVardalos says:

    A terrific discussion here. With respect to governments I think it should be noted that although most tend to agree that Bitcoin serves two main purposes, as a currency and as a form of payment, it may well in time serve as an important means to an end. That being to separate state and money. History has shown that by controlling national currencies the state has maintained and expanded its power over people to the point where the people are now the servants of the state. The original intention of democratic governance was that the state be the servant of the people. The point to point protocol could illuminate our way to new and properly functioning democracies, even without borders.

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  23. There are several bitcoin knock-offs already. Litecoin and feathercoin, to name but two.

    This is a good thing. In a free market, choice is king. We make a false assumption that efficiency is gained by having a central single monopoly over a resource – and money is also a type of resource. Even though one will predominate, having alternatives maintains honesty and integrity.

    • If there are already “clones” of Bitcoin today, there will be many more such clones by the year 2140, and then, where goes the idea of a completely inelastic currency? Each of the currencies might be inelastic, but the number of clones would be elastic. I can see no other solution to this than that the government steps in and declares Bitcoin the only legal tender and outlaws all other currencies. And that is hardly what we want.

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  25. dingo says:

    Competitive currencies will be weeded out by the natural forces of capitalism…no need for government to institute a monopoly…in fact no need for government at all.

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