We need to let the decentralized market test tell us what is the best money, or monies
by Robert P.
Murphy
Bitcoin is an
ingenious peer-to-peer "virtual" or "digital currency" that
challenges the way economists have traditionally thought about money. Its
inbuilt scarcity provides an assurance of purchasing power arguably safer than
any other system yet conceived.
But to
understand these claims, one must first understand the basics of Bitcoin. My
conclusion is that, in principle, nothing stands in the way of the
whole world embracing Bitcoin or some other digital currency. Yet I predict
that, even with the alternative of Bitcoin, people would resort to gold if only
governments got out of the way.
The Basic
Structure of Bitcoin
According to its
official website: "Bitcoin uses peer-to-peer technology to operate with no
central authority; managing transactions and the issuing of bitcoins is carried
out collectively by the network."(1.) Anyone who wants to participate can download the
Bitcoin software to his or her own computer and become part of the network,
engaging in "mining" operations and helping to verify the history of
transactions.
To fully
understand how Bitcoin operates, one would need to learn the subtleties of
public-key cryptography. In this section, I'll focus instead on an analogy that
captures the economic essence of Bitcoin, while avoiding the
need for new terminology.(2). Interested
readers can find various online articles that explain how a network of
computers implements Bitcoin.(3)
Imagine a
community where the money is based on the integers running from 1, 2, 3, ...,
up through 21,000,000. At any given time, one person "owns" the
number 8, while somebody else "owns" the number 34,323, and so on.
In this setting,
Bill wants to buy a car from Sally, and the price sticker on the car reads,
"Two numbers." Bill happens to be in possession of the numbers 18 and
112. So Bill gives the two numbers to Sally, and Sally gives Bill the car. The
community recognizes two facts: The title to the car has been transferred from
Sally to Bill, and Sally is now the owner of the numbers 18 and 112.
In this
fictitious community, an industry of thousands of accountants maintains the
record of ownership of the 21 million integers. Each accountant keeps an
enormous ledger in an Excel file. The columns run across the top, from 1 to 21
million, while the rows record every transfer of a particular number. For
example, when Bill bought the car from Sally, the accountants who were within
earshot the of the deal entered into their respective Excel files, "Now in
possession of Sally" in the next available row, in the columns for 18 and
112. In these ledgers, if we looked one row above, we would see, "Now in
the possession of Bill" for these two numbers, because Bill owned the
numbers before transferring them to Sally.
Besides
documenting any transactions that happen to be within earshot, the accountants
also periodically check their own ledgers against those of their neighbors. If
an accountant ever discovers that his neighbors have recorded transactions
for othernumbers (i.e., for deals for which the accountant in
question was not within earshot), then the accountant fills in
those missing row entries in the columns for those numbers. Therefore, at any
given time, there are thousands of accountants, each of whom has a virtually
complete history of all 21 million numbers.
In our analogy,
we are dealing with the end state, after all of the bitcoins have been
"mined." This will occur in the year 2140, when 21 million bitcoins
will be in circulation. In the real world, when people want to buy something
using Bitcoin, they transfer their ownership of a certain number of bitcoins to
other people, in exchange for goods and services. This transfer is effected by
the network of computers performing computations and thereby changing the
"public key" to which the "sold" bitcoins are assigned.
This is analogous to the accountants in our story entering a new person's name
in the column for a given integer.
Where Does
Encryption Come In?
As our analogy
has illustrated, far from being hidden or encrypted, Bitcoin's transactions are
very public indeed. This is what gives the system its resilience and why its
proponents say that no person or small group is "in charge" of
Bitcoin.
The encryption
involved in Bitcoin concerns theidentification of the legitimate
owner of a particular bitcoin. In our analogy, remember that Bill wants to sell
the integers 18 and 112 to Sally for her car. The accountants can look in their
public ledgers and see that "Bill" is, in fact, the current owner of
both 18 and 112. Yet, for the system to work, there must be some way that
the real Bill can demonstrate to all of the accountants that
he is the same person referred to in their ledgers. To prevent an unauthorized
party from fraudulently spending his bitcoins, this mechanism must be such
that only the real Bill can convince the accountants that he's
the right guy.
Without delving
into the mathematics, suffice it to say: There is a way that the legitimate
owner of a bitcoin can publicly demonstrate to the computers in the network
that he or she really is the owner of that bitcoin. Only
someone with the possession of the "private key" will be able to
produce a valid "signature" that convinces the computers in the
network to update the public ledger to reflect the transfer of the bitcoin to
another party.
"Mining"
New Bitcoins
Although we
glossed over the details, the process by which computers in the network verify
transactions is intimately related to the increase in the quantity of bitcoins.
When Bitcoin was first implemented in early 2009, computers in the
network—dubbed "miners"—received 50 new bitcoins when performing the
computations necessary to add a "block" of transactions to the public
ledger. Currently, the reward has dropped to 25 new bitcoins per block, and the
amount will continue to be halved every 210,000 blocks (which will predictably
occur about every four years because the computational difficulty of the mining
task is periodically calibrated to the recent computational power of the
network). Eventually, probably in the year 2140, the number of new bitcoins
awarded per block will be rounded down to zero, thus capping the total quantity
of bitcoins in existence (at 21 million).4
In principle,
the developers of Bitcoin could have released all 21 million units of the
currency immediately with the software. Yet that would have almost certainly
killed the project in its cradle. With the current arrangement—where the
"mining" operations needed to keep the system running simultaneously
yield new bitcoins to the machines performing the calculations—there is an
incentive for owners to devote their machines' processing power to the network.
If people want to pay fees on the side to expedite the verification of a
Bitcoin transfer, they can do so, but (in this early phase) the network
eventually will get around to processing a transaction even if the parties
involved have attached no extra fee. Such a feature is an ingenious way to
encourage the widespread adoption of Bitcoin.
Guaranteed
Scarcity: Bitcoin's Supreme Virtue
Economically,
the chief attraction of Bitcoin is its mathematically guaranteed scarcity. Even
a pure commodity like gold could eventually flood the market if a vast new
stockpile—perhaps on the ocean floor or an asteroid—were discovered, or (more
fancifully) if the "replicator" technology of Star Trek ever
became reality, such that a machine could turn baser matter into gold bars.
A solution to
this problem is an intangible money, such as Benjamin Klein's and Friedrich
Hayek's idea of privately issued, competing fiat currencies.(5) Here, the danger is that the issuing institution—once
it had gotten the world to accept its notes or electronic deposits as
money—would face an irresistible temptation to issue massive quantities.(6)
Bitcoin has no
such vulnerability. No external technological or physical event could cause
Bitcoin inflation, and since no one is in charge of Bitcoin, there is no one
tempted to inflate "from within." If the computers in the Bitcoin
network endorsed an illegitimate creation of new money, it would be akin to a
majority of grammar teachers suddenly agreeing that "ain't" is
acceptable usage.
Some critics
argue that Bitcoin's fixed quantity would imply constant price deflation. Although
this is true, everyone will have seen this coming with more than a century's
notice, and so long-term contracts would have been designed accordingly. Also
keep in mind that people could trade claims on fractional
units of the fixed stock of bitcoins. (In fact, the Bitcoin protocol itself
allows for the transfer of units as small as one one-hundred millionth of a
bitcoin.)
Is Bitcoin Fiat?
Could It Ever Be Money?
Whether to call
Bitcoin a "fiat" currency depends on the definition. If
"fiat" means a currency that is not legally redeemable in some other
commodity, then yes, Bitcoin is a fiat currency. But if "fiat" means
a currency relying on government fiat to define what will
count as legal money, then Bitcoin is not.
More
substantively, some critics (who are often proponents of hard money such as
gold) object that Bitcoin is in a perpetual "bubble" because it has
no "intrinsic value." Yet these critics often seem to overlook just
how much the exchange value of gold and silver is (and was) due to their use as
media of exchange. Thus, if Bitcoin is currently in a bubble, then, by the same
token, gold bullion in the year 1900 (say) was also in a massive bubble because
it was trading for a far higher exchange value than could be explained merely
by its industrial and ornamental uses.
Some critics
rely on the work of Ludwig von Mises and his
"regression theorem" to argue that the world will never embrace
Bitcoin as a true money. According to this argument, Mises demonstrated that
all money—even today's fiat money—must have been, at some point in the past,
linked to a commodity that was useful in the days of barter. Since Bitcoin has
no such history, the critics argue, we have the authority of Mises himself to
show that Bitcoin will never be more than a fad.
This article
won't address the question of whether this is a valid interpretation of Mises'
writings. Instead, I will make the modest point that if Mises
is used to rule out Bitcoin's acceptance as money, then it seems that Mises has
already lost. If this logic is correct, then Bitcoin should never have been
adopted as even a medium of exchange because it served no
useful role as a regular commodity. (Recall that money is simply a medium of
exchange that is accepted by everyone in the community.) But Bitcoin has
already surpassed that hurdle, as there are websites on which people from all
over the world exchange their bitcoins directly for goods and services.
Conclusion
Bitcoin is an
ingenious concept that challenges the way economists have traditionally thought
about money. Its inbuilt scarcity provides an assurance of purchasing power
arguably safer than any other system yet conceived.
Critics argue
that because of its lack of commodity backing, Bitcoin is doomed to eventual
failure. Yet the popular versions of these arguments either would apply just as
well to gold or have already been proven wrong by the use of Bitcoin as a
medium of exchange among a small (but growing) group of users.
Having said all
of this, I still think that gold remains the preeminent money for humans at
this stage of the globe's economic development. If governments around the world
got out of the way, humanity would (I predict) once again embrace gold, not
Bitcoin, as the true free-market money. But this is just a personal judgment
call. We need to let the decentralized market test tell us what is the best
money, or monies.
Footnotes
2. The analogy
developed in this section is my own, but my understanding of the cryptographic
aspects of Bitcoin is due to extensive discussions with software developer
Silas Barta. In a joint article, Barta and I introduce the analogy, but dwell
more on the encryption mechanics rather than the economics. See Robert P.
Murphy and Silas Barta, "Bitcoin From an Austro-Libertarian Perspective, Part
I," April 15, 2013, Free Advice blog post, available at:http://consultingbyrpm.com/blog/2013/04/bitcoin-from-an-austro-libertarian-perspective-part-i.html.
3. A simple
introduction to the whole system (and its new terminology) is from the Bitcoin
website itself:http://bitcoin.org/en/how-it-works. For an
in-depth yet readable introduction to the encryption techniques involved in
Bitcoin, see Silas Barta, "Explaining—not setting—Bitcoin straight,"
June 10, 2011, Setting Things Straight blog post, available at:http://blog.tyrannyofthemouse.com/2011/06/explaining-not-setting-bitcoin-straight.html. Finally, the
original paper explaining the theory of Bitcoin is available. See Satoshi
Nakamoto, (2008). "Bitcoin: A Peer-to-Peer Electronic Cash System,"
available at: http://bitcoin.org/bitcoin.pdf. (Note that
"Satoshi Nakamoto" is a pseudonym.)
4. The technical
details of mining are available at the Bitcoin wiki:http://en.bitcoin.it/wiki/Mining. The projected
quantity of bitcoins over time is also available at the Bitcoin wiki:http://en.bitcoin.it/wiki/Controlled_Currency_Supply.
5. Klein, Benjamin,
"The Competitive Supply of Money," Journal of Money, Credit, and Banking,
Vol. 6, 1974, November, pp. 523-553 and Hayek, Friedrich. (1978 [1990]) The
Denationalisation of Money—the Argument Refined.(London: The Institute of
Economic Affairs, Third edition.) Available at:http://mises.org/books/denationalisation.pdf.
6. See Selgin,
George and Larry White. (1994) "How Would the Invisible Hand Handle
Money?" Journal
of Economic Literature,
Vol. XXXII (December), pp. 1718-1749.
No comments:
Post a Comment