Bitcoin Blues


Enthusiasts expect bitcoin to become a new privatized money, perhaps even replacing government money. The system will keep track of cash balances and transactions in such a way as to prevent fraudulent double-spending of the same units. Operating without any centralized recordkeeping (as by a bank or government), it will enhance financial privacy. It will employ an advanced technology called blockchain. As the Federal Reserve Bank of St. Louis Review (first quarter 2018) said, to really understand bitcoin and its many imitators requires combined knowledge of cryptography, computer science, and economics.

I lack this knowledge. Some points, though, are clear enough. A workable monetary system requires a unit of account and a medium of exchange. Prices, values, debts, claims, and cash balances are expressed, and accounting is conducted in the unit. The medium is something routinely used for receiving and making payments; in the United States it is currency and bank accounts denominated in dollars. Each transactor needs to hold some of the medium of exchange because receipts and expenditures are uncertain in exact timing and amount and are not closely synchronized.

The bitcoin unit goes undefined by anything and lacks redeemablity.

A suitable unit of account has an at least roughly stable value, which may be achieved in either of two ways. First, the unit may be defined by a quantity of some good or basket of goods, with the definition kept operational by two-way convertibility between money and the defining good or basket. Under the gold standard the US dollar was defined as the value of 1.5046 grams of pure gold. Under such a system the money supply adjusts almost automatically to the defined value. Alternatively, the value of the unit may be managed by central control of the money supply. The price level then adjusts to rough proportionality with the money supply, as explained by the quantity theory of money.

The bitcoin unit goes undefined by anything and lacks redeemablity. Its quantity grows in a strange way called “mining.” As a reward for taking part in the system’s decentralized record-keeping and especially for solving increasingly difficult mathematical problems, miners obtain new bitcoins. Their final amount is limited to 21 million. Who knows what happens then? Meanwhile, bitcoin-mining destroys real wealth by consuming vast amounts of electricity to operate huge computers.

Wild fluctuations in bitcoin’s undefined value rule out its use as unit of account and so, almost completely, as medium of exchange. Who wants to hold amounts of such an unstable asset for receiving and making payments? The occasional business firm “accepting” bitcoin promptly sells it for standard money rather than adding it to its transactions cash balance. A video by a Wall Street Journal reporter shows the great effort and extra costs of buying a pizza with bitcoin in New York City.

The final amount of bitcoins is limited to 21 million. Who knows what happens then?

Why, then, does anyone hold bitcoin? Some libertarians hold it to express disgust with government money and a hope for some kind of private and privacy-preserving alternative. (But other and academically respectable proposals for privatized money are available.) Some enthusiasts buy it as an investment or speculation. (Saying so in no way denies that speculation generally serves sound economic functions and that the distinction between it and investment is fuzzy.)

Prudence recommends that anyone considering an investment should ask how the desired gain might come as a share of real wealth — desired goods and services — created by his own and others’ investment. Even a gambling casino creates wealth in the perhaps questionable form of hopes, excitement, and entertainment. Gain on an investment or speculation with no prospect of creating wealth must come as a transfer from losers.

Meanwhile, bitcoin-mining destroys real wealth by consuming vast amounts of electricity to operate huge computers.

How, then, might promoting bitcoin create wealth? The advantages of a sound nongovernmental monetary system could count as wealth, but as a “public good” in the technical sense of something whose benefits cannot be withheld from people not paying for it — such as national defense or policing. Furthermore, competition from bitcoin’s surviving imitators would dilute any profits. More optimistically, experience with bitcoin might spur profitable improvements in its blockchain technology, which is already being extended beyond monetary uses.

Bitcoin might even evolve, after all, into a workable privatized money, quite in contrast with our current system. But how? Ayn Rand would dismissively reply: “Somehow.”

A final comment may be unfair, but I cannot resist making it. Excitement over bitcoin reminds me of the dotcom boom of the 1990s and even more so of the British South Seas bubble of 1720. For little more reason than that stocks kept going up, speculators drove prices still higher — until the crash came. Meanwhile, stock in dubious new enterprises sold readily. Charles Mackay (Extraordinary Popular Delusions and the Madness of Crowds, 1848) writes of one promoter who disappeared with the proceeds of successfully issuing stock in something described as “A company for carrying on an undertaking of great advantage, but nobody to know what it is.”

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Several current phenomena puzzle me. Maybe some of Liberty’s readers have answers. I’ll save one puzzle about politics until the end of this Reflection.

  • BP, notorious for spilling oil in the Gulf, has been filling TV screens with ads about its concern for the region’s prosperity. According to these ads, it has installed “cutting edge” technology and a “state-of-the-art” monitoring system operating “twenty-four/seven.” How can BP and its advertising agency believe that its public image benefits from the insincerity suggested by three clichés in ten or fifteen seconds in an ad often repeated in a few minutes?
  • In its ads Kroger, the grocery chain, offers reduced prices if one buys at least a specific number of specified items or spends at least a specific amount on them. To take advantage of the deal, the customer has to count which of them he really wants or is willing to stock up on and how much, in dollar terms, he wants them. This additional little complication to life often makes me omit buying the one or few specified items that I do want; I don’t want to yield to the price discrimination. Sometimes I even shop at another supermarket. My reaction may be irrational in the most narrowly economic sense, but I think it is human. I wonder how common such reactions are and whether Kroger takes them into account.
  • Charities often send out personalized return-address stickers, presumably to put recipients on a guilt trip if they do not contribute. Almost without exception these stickers put a title before the name — in my case “Professor,” “Prof.,” “Dr.,” or “Mr.” Don’t these fund-raisers realize that it is bad form (except perhaps for a physician) to refer to oneself with a title? The name alone is better.
  • Expressing my next puzzle might seem to be a complaint about other people. It is not; I am genuinely curious. Why do so many people want almost continuous contact with one another, as by cellphone, texting, Facebook, Twitter, and other social media? Myself, I do not want to send or receive hourly or daily bulletins about the trivia of everyday life, not even to or from close friends. I understand that the social media are useful in coordinating revolutions, but what accounts for their popularity in the United States?
  • Whatever became of the half-dollar? Why is the quarter the largest denomination of coin routinely circulating in the United States?
  • Why does bitcoin, the digital currency, receive the respect it does in the popular press? A full-fledged currency must maintain a reasonably stable and predictable value, at least over the time between a holder’s receiving it and paying it out in transactions. Bitcoin’s value, however, has been monstrously unstable, ranging from $13.50 in January 2013 to $782 in mid-November, then falling back. How could people confidently use such a currency for pricing and regular transactions, let alone for long-term or even short-term loans? A sound money derives a determinate value either by linkage to some commodity like gold or by regulation of its quantity with some attention for the demand to hold it. Bitcoin, however, is created in a decentralized and capricious way as the reward for solving difficult mathematical problems requiring much expensive computer time; the problems become more and more challenging so as supposedly to put a ceiling of 21 million on the total issue. The system lacks the transparency required for a sound currency of determinate value.

    Its wide fluctuations do give bitcoin an appeal for speculators. Yet for anyone interested in a nongovernmental currency that performs all the functions of a normal money and that, moreover, allows a high degree of anonymity in transactions, ideas for reform must run along other lines. Bitcoin remains a puzzling distraction.
  • My last puzzle centers on a fund-raising letter from Speaker John Boehner enclosing a purported survey of opinion. The questions are slanted to draw desired answers. The phoniness of the whole business is epitomized by the date on Boehner’s letter, “Monday morning” — nothing more. (I received the letter and survey on Monday afternoon, November 18.) Many such appeals — complete with the provocative phony dating — have arrived in my mailbox from Republican politicians over the years; I wonder what the Democrats send out. Anyway, how can anyone believe that such phoniness attracts rather than repels voters and contributors?

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