Bitcoin has theory and history on its side

Bitcoin-coins

Money of no authority (source: CASASCIUS)

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 does neither repudiate 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.

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Comments

  1. Barry Sheridan says

    Welcome back Detlev, your targeted commentary has been much missed. It is appropriate that amongst your first words are those examining the bitcoin phenomenon. It will be interesting to see what happens should it begin to challenge the hegemony of state money. Regards

  2. says

    yes the bit con’s are back
    it’s a good concept like esperanto and neolatin…or fortran IV

    gold and silver …and bit coin’s i have a bit coin in the last radiography?

    bit coin iodine makes centers of nucleation in cloud’s?

  3. Simon Learner says

    Hello Detlev, great to see you back once again. I just wanted to mention that the problem bitcoin and all the other crypto-currencies surely have is the potential to become too successful – and since there is no way The State and their Central Banks will allow their money-making privilege to be taken away from them, they will never supplant Sovereign-money.

  4. Ariel Deschapell says

    Welcome back Detlev! I’d be lying if I said I didn’t check into this website almost every other week in the hope of an update. I checked back in today to actually reference you in one of my own articles.

    While I’ve always been interested in economics your book introduced me to the Austrian School, and your blog inspired me to pursue my own writing career. In fact your original comprehensive analysis is what first convinced me of Bitcoin’s inevitable success, and I have since been highly involved in the space.

    I’m proud to say I recently had my first ever article published on coindesk.com, the premier Bitcoin news source, and in large part owe it to both your ideas and example.

    Cheers to an exciting future!

    Link: http://detlevschlichter.com/2014/02/bitcoin-has-theory-and-history-on-its-side/

  5. says

    The weird thing for me is that there are even a lot of people in the libertarian camp that can’t wait to see Bitcoin fail, like Gary North or Peter Schiff. Bitcoin to me remains a great idea. And if paper moneys really going to collapse it might become very important, like we see in Argentina right now.

  6. Robert Halstead says

    Welcome back, Detlev. It occurred to me, when reading articles about the end of Mt.Gox causing the end of bitcoin, that this sort of event would indeed cause the end of the fiat financial system if it happened to a major institution of the “too big to fail” variety. People are confusing their model of the financial system with free market systems.

    A setback like this is more likely to strengthen a decentralised system, and the disappearance of weak or unlucky parts makes the remaining whole evolve into something better. Like you say, it would take a more fundamental weakness to end bitcoin.

    PS. a small typo; in paragraph 8 you wrote “exited and agitated”. I think you meant “excited”.

  7. Darren Hopkinson says

    Detlev, great to see you blogging again, and your thorough dismantling of Mark Williams’ FUD on bitcoin is a very apt way to mark your return. Welcome back!

  8. Steven Law says

    Great article! And I concur completely.

    Only one thing: the term “gold standard” is an equivocation the way it was employed within the article. This is quite common really, so it’s no huge deal. I just want to clarify this matter a bit.

    There are quasi-gold standards, or what I call arbitrary political Gold “standards”, where the sovereign state artificially affixes a currency/note quantity to the redemption of specific weights of gold. Or silver, under bi-metal “standards” as set by compulsory states. A “redemption value” so to speak. But these mechanisms still act in undermining voluntary market economy.

    Precious metals “standards” as promulgated through fiat are still quite perverse and deleterious to market economy. These standards still lend central power over the purchasing power of these market monies to a sovereign nation state.

    To be clear, under state managed gold standards, the state affixes a price through legislation, and it is still compulsory and not through voluntary market economy. This is still quite a powerful authority and can still command compulsory obligations of a people that otherwise would not exist. Mainly war and redistribution schemes.

    I own a gold ring with a 1/10th Gold Eagle embedded within it not as an announcement of my hope of any return of the so-called “gold standard” as commanded by rulers, but as a reminder of the broken promises illustrative of a political caste’s inability or desire in maintaining a restriction upon themselves.

    Still, this is a great article. I’m just being anal about the “Gold Standard” thing.

    Thank you for this work.

  9. daniloux libertarian says

    dear detlev, even if the bitcoin “idea” is a great one i think that the main flaw is that is backed by nothing else but the confidence in it. if bitcoin would be backed by something which has an historical subjective value (“intrinsinc”) , than bitcoin would be great. peter schiff, in london real video , talks about the project of europacific bank that is working for “backing” current accounts with gold. this is a great biycoin idea!. don’t you think it is?

  10. Smack MacDougal says

    The tirade written by Detlev Schlichter and published here is ill-conceived, terribly confused, and wholly factually wrong.

    Bitcoin is not money. Though Bitcoin has currency (bearer negotiability), it’s a rather weak currency as perhaps at most 2,000 retailers on earth accept Bitcoin compared to hundreds of millions that do not. At last check, a scant 57,809 transactions went down in Bitcoin, most likely trades in purchases and sales of heroin, cocaine, meth and pot through the USPS and Canada Post.

    Banking systems of various countries use cash and not money. Cash isn’t money, though cash appears to do some of the work of money, e.g., extinguish debt. Cash is evidence of deposit and nothing more than deposits in perpetual circulation.

    Money is coined metal by weight and fineness so said the Romans. It’s their word — moneta — and their concept.

    The Romans found money to be universally accepted in the Roman world. The Romans discovered others would also accept money in trade for property (right of ownership).

    Bitcoin never can be money because 1) it’s not metal 2) it doesn’t trade by weight and fineness for goods.

    The mining metaphor was unneeded, thoroughly. And thus it can be argued the supply of Bitcoin is regulated by the algorithm, which makes Satoshi the ultimate issuing authority.

    Thus, for those who understand, truly, money, banking, credit, cash, and Bitcoin, Bitcoin has much more in common with central banking that it does with open minting, free banking and money.

    Enjoy a superior read on Bitcoin, here: FROM BITCOIN TO SHITCOIN IN ONLY A FEW DAYS.

    • Adriano says

      “… never can be money because 1) it’s not metal 2) it doesn’t trade by weight and fineness for goods.”
      REALLY? :D :D :D :D :D :D :D :D :D :D :D :D :D :D :D :D :D :D
      can’t stop laughing!

      “Thus, for those who understand, truly, money, banking, credit, cash, and Bitcoin…”
      Those experts like you I suppose… :D :D :D

      Yep! Sure Detlev has no knowledge of monetary history.
      Neither had this fool who, as Detlev correctly pointed out, was not exactly a gold bug (not an Austrian either):

      https://www.youtube.com/watch?v=6MnQJFEVY7s

      Thanks Smack for entertaining us!

      THANKS DETLEV FOR BEING BACK!!!

    • Ariel Deschapell says

      You claim Detlev’s article is “factually wrong” when you apparently fail to do any actual research yourself. You state that perhaps 2000 retailers accept it, when the figure is actually more than 35,000 based on the 2 largest payment processors for it alone.

      Further Bitcoin is not “regulated” by anyone, and even Satoshi no longer has the power to change the algorithm that limits it’s supply. It is as gold as gold in it’s fixed quantity, and comes with a built in near instantaneous payment system unlike gold.

      Seeing these wholly factual errors and fallacious arguments hardly compels me to clink on “your superior read”.

      • Smack MacDougal says

        Merely saying so doesn’t make it so. Anyone can pipe up and make the silly claim that no research has been done.

        The total sum of bitcoins is fixed, regulated. Had you done any research you would have discovered this as so. You were given a link to make it all too easy. Alas, you failed to take the steps needed.

        “There is a finite number of coins which can get mined and that number is 21 million. Bitcoins get produced on a schedule of 25 bitcoins about every ten minutes. In 2017, that schedule changes to 12.5 bitcoins every ten minutes. In turn, that shall get halved ever four years until 127 years from now, in 2140, when the final bitcoin shall be generated, assuming that bitcoins acceptance survives that long.”

  11. Olivier Francoeur says

    Gold is an Element.The most Stable Element we know of.

    Which part of the above do you have problems understanding?

    Sorry, but BTC it not the Philosopher’s Stone;
    It will not turn electrons and Silicon into Gold.

  12. Jetstar says

    I am going to crowd fund some money to pay for:

    andreas antonopoulos
    detlev
    jon matonis
    max keiser
    rickard falkvinge
    simon dixon (at Bank to the Future)
    and vitalik buterin

    to sit around a table with brian rose of london real (youtube fame) for a 2.5 hour discussion.

    how much is needed to convince all to come to the table-

    $30,000 – $4,000 each?

    That seems fair…

  13. says

    First of all I would like to say I too am glad Detlev has decided to resume blogging. Welcome back! On the subject of Bitcoin, I nearly bought some a while back but just could not bring myself to get involved. I just couldn’t see anything there. Bitcoins only really exist in the imaginations of those “buying” them and if everyone believes then fine but as soon as confidence goes then it is over. In this respect it is more like FIAT currency to me. I also did not like some of the individuals pumping Bitcoin and it had all the hallmarks of a pyramid scheme. My internal alarm bell rang and I decided to stick with physical gold. Iam glad I did, and I still have no intention of ever buying Bitcoin. I do however accept that a second or third generation virtual currency may succeed, I will believe it when I see it, but It would be arrogant to say “impossible”.

Trackbacks

  1. [...] Now before all you crypto lovers start having a go let us err on the side of caution and ensure that we are each developing a diverse investment portfolio. Crypto-currencies have never been tried out in our documented history so to proverbially go ‘balls deep and all in’ on one investment is not just foolish it’s reckless. Nothing in life is guaranteed other than that we will one day leave this reality. Courtesy of Detlev Schlichter of DetlevSchlichter.com [...]

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