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Here is another economics/policy question that I was asked to address at Quora. It provides great fodder for a quick Lifeboat economics review.

The US used quantitative easing to deal with one monetary crisis, and a bailout of the automotive and banking industry to deal with another. If nations, economies or individuals begin to embrace a decentralized currency, they will inevitably shift away from government issued money. Won’t this hinder a nation’s ability to intervene in a crisis?

Answering this question goes to the very heart of the ethics and politics of cryptocurrency.

Continue reading “Does decentralized currency thwart crisis intervention?” | >

Today, economist and Nobel laureate, Paul Krugman, wrote in the New York Times, that Bitcoin is taking us back 300 years in monetary evolution. As a result, he predicts all sorts of bad things.

A significant basis for Mr. Krugman’s argument is that the US dollar has value because men with guns say it does.

Is Bitcoin erasing 300 years of monetary evolution?

Running with the metaphor that fundamental change to an economic mechanism represents ‘evolution’, I think a more accurate statement is that Bitcoin is not erasing the lessons of history. Rather, it is the current step in the evolution of money. Of course, with living species, evolution is a gradual process based on natural selection and adaptation. With Bitcoin, change is coming up in the rear view mirror at lightning speed.

The Evolution of Money

When a medium of exchange is portable, fungible, divisible, unforgeable and widely accepted, it becomes money. For at least six millennia, barter was gradually replaced by various mediums of exchange.

  • Obsidian —» Cowry shells —» Gold —» Promissory notes (backed by a Bank, employer or wealthy industry) —» Fiat (national currency)

But what backs these forms of money? What gives them value?

The first 3 currencies above were accepted as money on 5 continents. They were backed by their scarcity and unique characteristic properties (Aristotle called this intrinsic value). But even gold cannot serve as a widely used currency today. Although it is portable and scarce, it is not easily tested or subdivided in the field; it is risky to transport and difficult to track; and it is not suited to instant electronic settlement. But what about Fiat money. What backs it?

What Backs National Currencies?

Fiat has been backed by various different things throughout history. They are all compromised attempts to establish confidence and trust. They are compromised, because the fall short of one or more facets of trust.

In the list below, monetary backings in Red are what Mr. Krugman calls “men with guns”. That is, he claims that government demands give value to the dollar:

  • Value tied to gold —» Promise of redemption —» Legal tender (public must accept it for all debts) —» settlement of taxes —» The “good faith and credit” of workers

Unfortunately, the transition away from a trustworthy basis and the constant temptation of kings, dictators and politicians to print money based on credit (or nothing at all—as in the case of our fractional reserve system), has created a house of cards that few people believe is sustainable.

Bitcoin changes all this.

Finally, a crowd-sourced trust basis was invented (or discovered). It is unhackable, un-inflatable, unforgeable and immutable. Most important, it allows a government to be decoupled from its own monetary policy and supply. This is a remarkably good thing for businesses, consumers, creditors, trading partners—and especially for governments.

And Bitcoin is backed by something better than guns, gold or promises. It is provably scarce, capped in supply, completely fair, and built on a massive, crowd-sourced network of bookkeepers and auditors. It is the first currency—and quite probably the last—built on genius math and indisputable trust.

Despite the gross misunderstandings and misconceptions of early pundits, it does not interfere with a government’s ability to tax, to spend or to enforce tax collection—and it does not facilitate crime.

Bitcoin is new, but the goal of distributing trust is not as radical as you might think. It addresses a problem that economists and mathematicians have pondered since Aristotle and the ancient Greeks…

Background

Ever since the transition from real gold to government notes, bank notes and bank ledgers—economists have wondered if value can arise from a public trust that is durable, distributed and stateless. Until 2009, the answer seemed to be that this was impossible because of the double-spend problem.

But 9 years ago, something changed; and the change is dramatic. It will take an additional decade for most people to understand and appreciate this change…

In the first paragraph, I cited Mr. Krugman’s statement that the US Dollar has value because of “men with guns” (a reference to the fact that its use is legally compelled for payment of any debt and for government taxes). But this is not what gives it value. The dollar, the Euro, a Picasso painting and a fresh serving of hot french fries all derive their value from supply and demand. Bitcoin is no different. The trick is to generate viral demand and a ubiquitous infrastructure needed to achieve a robust two-sided network.

In the white paper that introduced both blockchain and Bitcoin (the first blockchain application), Satoshi taught us that a widespread and easy to access communications network (the internet and universal access to smartphones) can give rise to value that is based on a different type of trust. Instead of trust in a government, a bank, or testing the chemistry of a precious metal, value can arise from trust in a formula that is ubiquitous, redundant and constantly monitored and vetted.

All of these things have a value based on demand and the available supply. But with Bitcoin, the medium of exchange (and additionally the store and transfer of value), can be achieved by math, distributed trust and a pure, two-sided network.

So, is Bitcoin taking us backward in time, utility, safety and governance? I have never been awarded a Nobel Prize—but it seems pretty clear to me that Bitcoin is taking us forward and not backward.

Philip Raymond co-chairs CRYPSA, hosts the New York Bitcoin Event and is keynote speaker at Cryptocurrency Conferences. He sits on the New Money Systems board of Lifeboat Foundation. Book a presentation or consulting engagement.

The answer may be counter-intuitive: Not only can Bitcoin be widely adopted under a supply cap, its trust and integrity are a direct result of a provably limited supply. As a result, it will flourish because it is capped.

Everyone Can Own and Trade a Limited Commodity, IF…

…if it is both measurable and divisible. Bitcoin has a capped supply just as gold has a capped supply. Although both assets will be mined for some time into the future, there is only so much that will ever be uncovered. Thereafter, the total pie cannot grow.

But the transaction units will continue to grow as needed, because the pie is divisible into very, very tiny units:

There will eventually be 21 million BTC and each coin is divisible into 108 units. This yields (21 million * 100 million), or 21 trillion exchangeable units. And, it can be divided further by consensus.

As Bitcoin is adopted—whether as a simple payment instrument, an investment asset or even as national currencies around the world—each unit of the limited supply simply rises in value. If thought of as a currency, with a value established by supply & demand, it leads to a deflationary economy.

But, Isn’t Deflation Bad for the Economy?

It’s common to associate deflation with economic ills. One need only glance back at the the last century to conclude that deflation coincides with wars, joblessness, recession and a crippling concentration of wealth. Perhaps, just as bad, the tools used to pull a nation out of deflation often force governments to cherry pick beneficiaries of stimulus spending.

But it is important to note that deflation plays no role in causing these things. On the contrary, it is an effect rather than a cause… In fact, when a supply cap is introduced as a designed control input for monetary policy, all sorts of good things follow. I address these in various answers at Quora. Dig in:

Philip Raymond co-chairs Cryptocurrency Standards Association. He was host and producer of The Bitcoin Event in New York. In his spare time, he edits A Wild Duck

I was asked this at Quora.com, where I answer questions under the pen name, ‘Ellery’. But the query deserves a companion question, and so I approached the reply by answering two questions.

You might have asked “Why was Bitcoin designed to have a cap?” But, instead, you asked “Why is the cap set at 21 million bitcoins”. Let’s explore both questions starting with the choice of a circulation cap…

Why set the cap at 21 million BTC?

The choice of a cap number is arbitrary and in fact, it could be 1 or it could be 1 hundred trillion. It makes no difference at all and it has no effect on the economy—even if Bitcoin were to be adopted as a currency all over the world. If it were set to 1 BTC, we would simply discuss nano-BTC instead of 1 BTC for amounts of about $650.

In fact, we already do this today. For many purposes, people are concerned with very small payments. And to best discuss these payments, we have the Satoshi. There are 100,000 Satoshi to each bitcoin (BTC).

What is important, is that the total number of bitcoin (regardless of how many units there are) can be divided into very tiny fractions. That way, the total worldwide supply can be divided into smaller and smaller slivers as market adoption gains traction. Everyone needs to earn, save, spend or pay with a piece of the pie. All users need to know is what fraction of the pie do I control? and not how many ounces, pounds, Kg, or tons is the pie. That is just a number.

Incidentally, the same could be said of gold (it can be shaved very thin), but gold is not quite like computer bits. It has industrial and cosmetic value, and this intrinsic demand for gold (beyond it’s role as a pure monetary instrument) has an effect on supply and demand along with the influence of investment, circulation, savings and reserve.

Why is there a cap at all?

At the beginning of this answer, I suggested another question: Why is Bitcoin capped at all? After all, the monetary supply in every country grows. Even gold production is likely to continue for centuries to come. Why not Bitcoin?

Satoshi designed Bitcoin to eventually become a deflationary currency. I believe that he/she recognized inflation is an insipid tax that constitutes an involuntary redistribution of earned wealth. With a firm cap on the total number of units that exist, governments can still tax, spend and even enforce tax collection. They can go about business building bridges, waging war and providing assistance to the needy. But without a printing press in the hands of transient politicians, they can only spend money with the consent of their constituents and residents.

Of course, they could borrow money by issuing bonds. But with a capped currency, each creditor would earnestly believe in the will and ability of the country to repay its debts.

In effect, monetary policy is restricted to the business of the governed, but the money itself is not coined by a domestic treasury. It is the province of something that is far more certain than a human institution. It arises from pure math. It is open and transparent. In effect, everyone is an auditor. That’s because the bookkeeping is crowd sourced.

For prescient legislators and national treasurers, Bitcoin presents far more of an opportunity than a threat. It is good for both government, business and consumers, because it forces everyone to be open and honest. Ultimately, it builds trust in government, because no one can cook the books, water down wealth, or print their way out of debt.

What about recession. Isn’t it a result of deflation?

Deflation doesn’t lead to recession. Rather, it sometimes accompanies a recession. Recession is caused by an uncertain job market, war, a massive supply chain interruption or political upheaval. In one way or another, it boils down to a lack of confidence sparked by one of the economy’s core foundations: consumers, investors, business or creditors.

Bitcoin as currency removes a major impediment to confidence. By creating a system that cannot be rigged, it fosters trust in government along with an open and transparent treasury.

Philip Raymond co-chairs CRYPSA and was MC at The Bitcoin Event in New York. He writes for Quora, LinkedIN, Wild Duck and Lifeboat Foundation, where he sits on the New Money Systems Board.