BLOG: BITCOIN IS NOT A CURRENCY—YET: A MUSING ON ITS POTENTIAL RISE OR FALL

By Nolan Weber
Senior Editor

The Digital Age has produced an enigmatic revision of a familiar institution rooted in the last technological revolution: sovereign currency. Similar to the way postal services have declined because e-mail transited information across cyberspace–the cheaper, safer and more efficient alternative–Bitcoin has emerged as genuine challenger to paper currencies for similar reasons. If you are unfamiliar with Bitcoin, Chris Cook at The Financial Times broadly described it with brevity in mind.

So, er, what is a Bitcoin?

It’s a “digital currency”. Normal currencies have banknotes, each with a registration number. Imagine that, instead of printing the notes, you just kept a list of the registration numbers of each of the notes and who owned them. People could pay one another by transferring the registration numbers online. That’s how Bitcoins work. A network of computers is keeping track of who owns a pot of 11m of these numbers. It’s the price of putting a number in your Bitcoin account that’s soaring – this week it hit $147, a more than tenfold increase in price since January.

That doesn’t sound revolutionary.

Well, Bitcoin has a few peculiar features. The oddest is that we don’t yet know who actually devised the whole system.

What do you mean?

All that we have is the founder’s pseudonym: “Satoshi Nakamoto”. It’s a Japanese name, but they could be a person or people anywhere in the world. Whoever they were, they mistrusted government enough to set up a private currency and an online bank account system outside its reach.

What’s the monetary policy for this currency?

Rather simple. The network of computers generates a fixed number of new Bitcoins a day. The system also has a cap built into it – so there can never be more than 21m of the registration numbers.

Weird.

It gets odder. The whole network is anonymised. So while there is a register saying who owns which of the numbers, it is designed to make it extremely difficult to track which real-life person owns what.

Why did someone do this?

They wanted a currency they could use online that was outside government control.

Cook was right to put “digital currency” in quotation marks. Bitcoin is not a true currency, but it is right on the cusp. It maintains many properties of a currency, but it desperately needs to be reputably stable to be classified as such. Yet, it is recognized widely enough to be considered a medium of exchange, but it has been behaving like a stock. It is used with great regularity to finance the internet black market, but its function has also been established in the mainstream as an indispensable means to preserve wealth from governmental seizure. So what is Bitcoin exactly?

No person can truly provide a truly distinct classification—for the moment. For engaged observers of the world, we are at that uncomfortable time in the life of a phenomenon where it is [possibly] making the transition from niche knowledge to mass awareness. With its principle role in the world economy in flux, niceties like exact nomenclature are hardly applicable. However, I can say with confidence that Bitcoin has the potential to become a currency in the established sense of the word, but this potentiation primarily hinges upon its ability to beat its paper-issuing competition: the governments of the world.

OK, there are unsettled issues about hacking, mass speculative short selling and long-term stability. To the critics of Bitcoin: what do you expect? It has existed for less than half a decade and, outside of F.A.Hayek’s Denationalisation of Money, the idea of a wholly decentralized, fixed-rate currency is often considered a pipe dream by established academia.

Nevertheless, reforming political economic thought is a small fraction of Bitcoin’s struggle toward monetary legitimacy. The crux of the crypto-currency’s rise rests upon its ability to provide a better service than fiat currencies. That is, its associated ease of transaction, security from seizure and relative price stability must outperform a given fiat currency.

Indeed, Bitcoin’s window of opportunity for true currency-like stability arises when instability strikes other sovereign currencies. But why not move one’s money into commodities or a more fiscally sound nation? Two words: capital controls.

The obvious case in point is Cyprus. People fled to the comfort of anonymity and exercised money’s freedom of motion in cyperspace by utilizing Bitcoin. Many people quietly moved assets into Bitcoin to not only keep their life savings from being devalued but to protect from outright seizure. Transactions are virtually untraceable and, unlike large purchases of foreign currencies and commodities, they cannot be unscrupulously taxed or seized by the decree of fiat. Transaction costs are fractions of pennies on the dollar, and transportation costs are moot in cyberspace. However, in a sense this could further complicate the future of Bitcoin. If it is simply establishes itself a specialized medium to evacuate capital from the clutches of irresponsible politicians and underhanded bankers, it remains subject to violent swings between ebb and flow.

It would have to establish itself in day-to-day transactions to counteract its becoming a niche function in the global economy. Indeed, the first Bitcoin ATM is set to be installed in Cyprus in the wake of its financial crisis. In fact, the Bitcoin ATM is having its premier press demonstration today in San Diego. Yet, this problem is small change when compared to the fact Bitcoin is without a government. Therefore, it lacks guns, badges and coercive force to aid its survival. In that respect, it can not offer a shred of competition.

Indeed, the most fundamental aspect of the nation-state is its monopoly on the legitimate use of violence. For cash strapped governments looking to exploit the wealth of their citizens to establish a specious level of financial credibility, they can simply legally qualify the use of Bitcoin as a form of money laundering. It may sound cynical at best and conspiracy theory-ish at worst, but do not put that kind of behavior past politicians. Remember, their job is to get re-elected, not ensure delayed gratification for their society by sacrificing short-term expediency for the hard choice of long-term stability. No doubt, the case can be made to outlaw Bitcoin by making an example of underground, black market websites such as The Silk Road and The Armory, which specialize in the peer-to-peer transaction using Bitcoin for drugs and weapons, respectively.

This is hardly out of the realm of possibility. While not frequently talked about, President Roosevelt ordered the confiscation of all U.S. citizen’s gold during The Great Depression. Although very different in application, we are witnessing the widespread abuse of quantitative easing—a form of strategic inflation. While the media does not conventionally mention these endeavors as capital controls, do not kid yourself: these monetary manipulations—ubiquitous among nations approaching economic depression—are utilized in an effort to feign economic stability for one election cycle longer.

However, I fail to imagine a scenario in which Bitcoin completely collapses. Without a doubt, it may diminish in value significantly, but criticisms about its capacity to simply exist are misguided. Currencies are based on confidence: how many people are using it and do they expect it to have the same value in the near future. Should my concerns about a crisis in the confidence of national currencies be misplaced and governments do not make a legal example of Bitcoin’s capacity to facilitate anynomized transactions, the crypto-currency should still survive as tool for the eccentric, libertarian, internet black market and niche computer crowd. It will always have its groupies. However, with a recent denial of service attack against The Silk Road, there may be an effort in the works to squelch this venue for monetary choice.

Slider Image by Mike Poresky

Title Image by Trader Tim

Bitcoin ATIM Image by Daniel Stuckey

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3 responses to “BLOG: BITCOIN IS NOT A CURRENCY—YET: A MUSING ON ITS POTENTIAL RISE OR FALL

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