They see within it enormous potential and spend their nights and weekends tinkering with it. What technology am I talking about? One can hardly accuse Bitcoin of being an uncovered topic, yet the gulf between what the press and many regular people believe Bitcoin is, and what a growing critical mass of technologists believe Bitcoin is, remains enormous. In this is what bitcoin means for the future of currency, according to a top economist post, I will explain why Bitcoin has so many Silicon Valley programmers and entrepreneurs all lathered up, and what I think Bitcoin’s future potential is.
20 years of research into cryptographic currency, and 40 years of research in cryptography, by thousands of researchers around the world. Bitcoin is the first practical solution to a longstanding problem in computer science called the Byzantine Generals Problem. To quote from the original paper defining the B. Byzantine army camped with their troops around an enemy city. Communicating only by messenger, the generals must agree upon a common battle plan. However, one or more of them may be traitors who will try to confuse the others.
The practical consequence of solving this problem is that Bitcoin gives us, for the first time, a way for one Internet user to transfer a unique piece of digital property to another Internet user, such that the transfer is guaranteed to be safe and secure, everyone knows that the transfer has taken place, and nobody can challenge the legitimacy of the transfer. The consequences of this breakthrough are hard to overstate. What kinds of digital property might be transferred in this way? All these are exchanged through a distributed network of trust that does not require or rely upon a central intermediary like a bank or broker. And all in a way where only the owner of an asset can send it, only the intended recipient can receive it, the asset can only exist in one place at a time, and everyone can validate transactions and ownership of all assets anytime they want. Bitcoin is an Internet-wide distributed ledger.
You buy into the ledger by purchasing one of a fixed number of slots, either with cash or by selling a product and service for Bitcoin. You sell out of the ledger by trading your Bitcoin to someone else who wants to buy into the ledger. The Bitcoin ledger is a new kind of payment system. Anyone in the world can pay anyone else in the world any amount of value of Bitcoin by simply transferring ownership of the corresponding slot in the ledger. Put value in, transfer it, the recipient gets value out, no authorization required, and in many cases, no fees.
That last part is enormously important. In lots of other places, there either are no modern payment systems or the rates are significantly higher. Bitcoin is a digital bearer instrument. It is a way to exchange money or assets between parties with no pre-existing trust: A string of numbers is sent over email or text message in the simplest case. The sender doesn’t need to know or trust the receiver or vice versa.
This is one part that is confusing people. It is perhaps true right at this moment that the value of Bitcoin currency is based more on speculation than actual payment volume, but it is equally true that that speculation is establishing a sufficiently high price for the currency that payments have become practically possible. The Bitcoin currency had to be worth something before it could bear any amount of real-world payment volume. Critics of Bitcoin point to limited usage by ordinary consumers and merchants, but that same criticism was leveled against PCs and the Internet at the same stage. Every day, more and more consumers and merchants are buying, using and selling Bitcoin, all around the world. The overall numbers are still small, but they are growing quickly. And ease of use for all participants is rapidly increasing as Bitcoin tools and technologies are improved.
The criticism that merchants will not accept Bitcoin because of its volatility is also incorrect. Bitcoin currency or be exposed to Bitcoin volatility at any time. Any consumer or merchant can trade in and out of Bitcoin and other currencies any time they want. Bitcoin as payment, given the currently small number of consumers who want to pay with it?
Let’s say you sell electronics online. Profit margins in those businesses are usually under 5 percent, which means conventional 2. 5 percent payment fees consume half the margin. That’s money that could be reinvested in the business, passed back to consumers or taxed by the government.
Of all of those choices, handing 2. 5 percent to banks to move bits around the Internet is the worst possible choice. Another challenge merchants have with payments is accepting international payments. In addition, merchants are highly attracted to Bitcoin because it eliminates the risk of credit card fraud. This is the form of fraud that motivates so many criminals to put so much work into stealing personal customer information and credit card numbers. Since Bitcoin is a digital bearer instrument, the receiver of a payment does not get any information from the sender that can be used to steal money from the sender in the future, either by that merchant or by a criminal who steals that information from the merchant. Credit card fraud is such a big deal for merchants, credit card processors and banks that online fraud detection systems are hair-trigger wired to stop transactions that look even slightly suspicious, whether or not they are actually fraudulent.
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As a result, many online merchants are forced to turn away 5 to 10 percent of incoming orders that they could take without fear if the customers were paying with Bitcoin, where such fraud would not be possible. Bitcoin’s antifraud properties even extend into the physical world of retail stores and shoppers. For example, with Bitcoin, the huge hack that recently stole 70 million consumers’ credit card information from the Target department store chain would not have been possible. You fill your cart and go to the checkout station like you do now.
But instead of handing over your credit card to pay, you pull out your smartphone and take a snapshot of a QR code displayed by the cash register. The QR code contains all the information required for you to send Bitcoin to Target, including the amount. Well, maybe criminals are still happy: They can try to steal money directly from poorly-secured merchant computer systems. This is a myth, fostered mostly by sensationalistic press coverage and an incomplete understanding of the technology.
Much like email, which is quite traceable, Bitcoin is pseudonymous, not anonymous. Bitcoin is a classic network effect, a positive feedback loop. The more people who use Bitcoin, the more valuable Bitcoin is for everyone who uses it, and the higher the incentive for the next user to start using the technology. In fact, Bitcoin is a four-sided network effect. There are four constituencies that participate in expanding the value of Bitcoin as a consequence of their own self-interested participation. All four sides of the network effect are playing a valuable part in expanding the value of the overall system, but the fourth is particularly important.
All over Silicon Valley and around the world, many thousands of programmers are using Bitcoin as a building block for a kaleidoscope of new product and service ideas that were not possible before. For this reason alone, new challengers to Bitcoin face a hard uphill battle. If something is to displace Bitcoin now, it will have to have sizable improvements and it will have to happen quickly. Otherwise, this network effect will carry Bitcoin to dominance. One immediately obvious and enormous area for Bitcoin-based innovation is international remittance. 400 billion in total annually, according to the World Bank.
Every day, banks and payment companies extract mind-boggling fees, up to 10 percent and sometimes even higher, to send this money. Switching to Bitcoin, which charges no or very low fees, for these remittance payments will therefore raise the quality of life of migrant workers and their families significantly. In fact, it is hard to think of any one thing that would have a faster and more positive effect on so many people in the world’s poorest countries. Moreover, Bitcoin generally can be a powerful force to bring a much larger number of people around the world into the modern economic system. 175 have a long way to go.
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As a result, many people in many countries are excluded from products and services that we in the West take for granted. Bitcoin can be used to go straight at that problem, by making it easy to offer extremely low-fee services to people outside of the traditional financial system. A third fascinating use case for Bitcoin is micropayments, or ultrasmall payments. The fee structure of those systems makes that nonviable. All of a sudden, with Bitcoin, that’s trivially easy. Bitcoins have the nifty property of infinite divisibility: currently down to eight decimal places after the dot, but more in the future.
So you can specify an arbitrarily small amount of money, like a thousandth of a penny, and send it to anyone in the world for free or near-free. Think about content monetization, for example. Another potential use of Bitcoin micropayments is to fight spam. Finally, a fourth interesting use case is public payments. This idea first came to my attention in a news article a few months ago. 25,000 in Bitcoin in the first 24 hours, all from people he had never met. Think about the implications for protest movements.
Today protesters want to get on TV so people learn about their cause. Tomorrow they’ll want to get on TV because that’s how they’ll raise money, by literally holding up signs that let people anywhere in the world who sympathize with them send them money on the spot. Bitcoin is a financial technology dream come true for even the most hardened anticapitalist political organizer. The coming years will be a period of great drama and excitement revolving around this new technology. For example, some prominent economists are deeply skeptical of Bitcoin, even though Ben S.
Economists who attack Bitcoin today might be correct, but I’m with Ben and Milton. Further, there is no shortage of regulatory topics and issues that will have to be addressed, since almost no country’s regulatory framework for banking and payments anticipated a technology like Bitcoin. But I hope that I have given you a sense of the enormous promise of Bitcoin. Far from a mere libertarian fairy tale or a simple Silicon Valley exercise in hype, Bitcoin offers a sweeping vista of opportunity to reimagine how the financial system can and should work in the Internet era, and a catalyst to reshape that system in ways that are more powerful for individuals and businesses alike. The firm is actively searching for more Bitcoin-based investment opportunities. I personally own no more than a de minimis amount of Bitcoin. This post originally appeared in The New York Times.
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For over a century now, the world has lacked a genuinely international means of payment. This is partly due to decisions made at the Bretton Woods conference in 1944, when the US dollar was adopted as the principal international settlement currency, rather than John Maynard Keynes’s suggestion of an independent global currency that he called “bancor”. Although the Bretton Woods gold-backed structure ended in 1971, the US dollar became ever more dominant. In 2008, the dollar’s global reach enabled an American financial crisis to spread to the entire world, causing a deep recession and long-lasting malaise. Ever since, there has been a deep longing for a more stable international financial system, one which didn’t depend on debt, wasn’t dominated by the US and was immune to political whims.
Bitcoin emerged from the financial crisis as a fledgling international digital currency. Satoshi Nakamoto’s white paper presented it as a peer-to-peer electronic cash system, but from the start, its gold-like properties were evident: it was traded like a commodity, it had a restricted supply and it operated seamlessly across borders. Recently, Bitcoin appears to have turned away from its original purpose and become primarily a new class of asset. Other cryptocurrencies are gradually replacing it as international media of exchange. But some argue that this is merely a transitional phase and Bitcoin will nevertheless eventually become the world’s premier international currency. Those who see Bitcoin in this way are known as “Bitcoin maximalists”. One of their number, Pierre Rochard, asked me to do a thoughtful review of a new book by Saifedean Ammous, a Lebanese professor of economics who describes himself on Twitter as a “Bitcoin economist and carnivore grill-master”.
I was immediately attracted by the name of the book – “The Bitcoin Standard”. So I asked for a review copy. I hoped to find a rigorous assessment of the economic costs and benefits of adopting Bitcoin as an international monetary standard. But right from the start, it was clear that the author had another agenda. The table of contents reads like an Austrian goldbug tome”, said one of my friends. Of ten chapters, seven are about money and its history, including an entire chapter on Monetary Metals, and only three about Bitcoin.
By far the best part of the book is the last three chapters. On Bitcoin itself, Saifedean clearly knows his subject, and his arguments are generally balanced and nuanced. He sidesteps the “everyone will use Bitcoin” trap, recognising not only that Bitcoin’s illiquidity means that most transactions will inevitably be off chain, but also that there will inevitably be competing applications. He also acknowledges that blockchain cannot solve every business problem. Personally I think he is too quick to dismiss the threat to Bitcoin’s supremacy from other cryptocurrencies. He seems to think that everyone will value Bitcoin’s deflationary nature and expensive proof-of-work verification as much as he does, but the reality is that people have choices, and they don’t always choose the gold-plated solution. The history of computing shows us that often it is the solution with the best marketing that wins the day, not the one that is technically best.
I also think he is unwise to downplay the considerable energy cost of Bitcoin mining. Perhaps in the future there will be abundant cheap electricity from solar and other renewables. But apart from these concerns, the chapters on Bitcoin are pretty good. The problem is the rest of the book. Saifedean has framed the narrative as a gold standard apologetic, leading towards Bitcoin replacing gold in a new digital version of the classical gold standard. So you have to wade through seven chapters of Austrian economics and hard-money fetishism before getting to the meat of the book.
It’s like having to cross a swamp to reach the barbecue. Saifedean obsesses about “sound money”, which for him means either Bitcoin or gold. But he is distinctly cavalier about the soundness of his facts. There is no better evidence for this than the fact that the rarest metal in the crust of the earth, gold, has been mined for thousands of years and continues to be mined in increasing quantities as technology advances over time, as shown in Chapter 3. If annual production of the rarest metal in the earth’s crust goes up every year, then it makes no sense to talk of any natural element as being limited in its quantity in any practical sense.
Even more problematic are the logical inconsistencies. If the new increased pace of production is maintained, the stockpiles grow faster, making new increases less significant. It remains practically impossible for goldminers to mine quantities of gold large enough to depress the price significantly. But the same apparently does not apply to other metals.
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Just because something has been rising at a low stable rate for decades doesn’t mean it will continue to do so. Just ask the American construction industry. For me, the most difficult sections of the book are those on monetary history. Saifedean’s aim seems to be not to give an accurate description of the development of money in all its forms, but to support his hard-money ideology. Just bought some coffee with this stuff that is not money.
9 April 2018 Fortunately, ignoring credit-as-money is not particularly serious in the chapter on Primitive Moneys. The discussion of the debasement of the Roman currency, ending with the shift of the imperial centre to Byzantium and the gradual decline of Rome, is interesting. I am also amused by Saifedean’s assertion that today’s Islamic dinar, which is derived from the Byzantine bezant, holds its value because it is made of gold. I suspect that the more significant reason is the reverence in which it is held because it is seen as divinely mandated. Religions are far better at preserving institutions over the long term than any other form of social organisation.
New generations of Europeans came to the world with no accumulated wealth passed on from their elders, and the absence of a widely accepted sound monetary standard severely restricted the scope for trade, closing societies off from one another and enhancing parochialism as once-prosperous and civilized trading societies fell into the Dark Ages of serfdom, diseases, closed-mindedness, and religious persecution. Nor is Saifedean’s assertion that feudalism followed on from the fall of Rome. Historians are divided on exactly when feudal structures started to emerge, but the earliest estimate seems to be about 800 AD. That is more than three hundred years after the fall of Rome. The untruths continue in the next chapter, where Saifedean describes the rise of the city-states Florence and Venice. According to Saifedean, merchants physically carried the silver and gold coins minted by the city-states.
These were accepted all over Europe because of their metal value. European cities minted their own coins, yes, but merchants did not carry them from city to city. Trade developed at that time not because of the florin and the ducat, but because of letters of credit and bills of exchange. Saifedean does not even mention the Florentine banks that played such a crucial role in international trade at that time. Saifedean then does even more violence to historical accuracy. He skips straight from the 13th century to the 19th, thereby implying that throughout this time all trade was conducted in gold and silver coinage. Two particular technological advancements would move Europe and the world away from physical coins and in turn help bring about the demise of silver’s monetary role: the telegraph, first deployed commercially in 1837, and the growing network of trains, allowing transportation across Europe.
Ordinary people, of course, used physical cash for payments, and at that time most of that physical cash was silver and copper coinage. But banknotes were widely used for large transactions. But trade itself mostly involved paper, as it had for centuries. Some of Saifedean’s points about the latter half of the 19th century are fair. For example, the demonetisation of silver possibly was at least partly responsible for the decline of India and China. But there are other reasons too. For example, Bengal’s cotton weaving industry collapsed during colonial rule because of competition from cheaper British cottons brought in by the East India Company.
It’s also fair to say that the near-universal adoption of a gold standard based on the British pound facilitated international trade to a then unprecedented degree. However, this was the most centralised monetary system in history. European central banks, led by the Bank of England, cooperated to manage the gold price and international money flows. The international trade boom facilitated by the gold standard was even more remarkable when you consider that trade in the latter half of the 19th century was anything but free. True, the British Empire was at its height then, covering a third of the globe, and countries that were part of the Empire had what amounted to “free trade” with Britain. And Britain itself famously adopted unilateral free trade in 1846 when it repealed the Corn Laws.
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In fact the world is much closer to global free trade now, under the “unsound money” system that Saifedean hates, than it was under the classical gold standard. The last three decades have seen globalisation on an unprecedented scale, and an equally unprecedented fall in global poverty. We should think very hard before throwing that away in pursuit of a golden chimera. After this, Saifedean’s narrative goes horribly wrong.
The twentieth century began with governments bringing their citizens’ gold under their control through the invention of the modern central bank on the gold standard. The only central bank that was invented at the beginning of the twentieth century was the Federal Reserve, which was created in 1913. As World War I started, the centralization of these reserves allowed these governments to expand the money supply beyond their gold reserves, reducing the value of their currency. Yet central banks continued to confiscate and accumulate more gold until the 1960s, where the move toward a U. I genuinely don’t know where to start with this. He seems to be talking about all central banks as if they were the Fed. But there is worse to come.
In retrospect, the major difference between World War I and the previous limited wars was neither geopolitical nor strategic, but rather, it was monetary. So nothing to do with the fact that four great European Empires were fighting for supremacy? Nor that because of their colonial possessions, they were able to bring in fighters from all over the world? Nor that the British were eventually able to call on their historic alliance with the USA? Had European nations remained on the gold standard, or had the people of Europe held their own gold in their own hands, forcing government to resort to taxation instead of inflation, history might have been different. World War I eventually ended in 1918. Saifedean does not connect that devaluation with the Treaty of Versailles, in which Germany was forced to relinquish much of its productive capacity to France and Poland, and was additionally saddled with enormous reparation bills.
The geographic changes brought about by the war were hardly worth the carnage, as most nations gained or lost marginal lands and no victor could claim to have captured large territories worth the sacrifice. The Austro-Hungarian Empire was broken up into smaller nations, but these remained ruled by their own people, and not the winners of the war. The major adjustment of the war was the removal of many European monarchies and their replacement with republican regimes. The Treaty of Versailles set up both the Weimar hyperinflation and the rise of Hitler. It was one of the most disastrous decisions ever made. And it doesn’t even warrant a mention?
Germany suffered from hyperinflation after the Treaty of Versailles had imposed large reparations on it and it sought to repay them using inflation. The reparations had to be paid in gold or in kind. Germany couldn’t “use inflation to pay them”. Inflation actually made paying them impossible. Drawing a veil over this unfortunate episode, we move swiftly on to the Wall Street Crash and the Depression. Dismissing Liaquat Ahamed’s book Lords of Finance on the grounds that it is “Keynesian”, Saifedean accepts without question Murray Rothbard’s partisan analysis. Rothbard blames the credit bubble that burst so disastrously in 1929 on the UK, which returned to the gold standard at too high a parity in 1925 then leant on the US to loosen monetary policy to ease its gold shortage.