Bitcoin in 1,000 words (or so)

“I think the Internet is going to be one of the main forces to reduce the government’s role. The only thing missing, but soon to develop, is a reliable digital currency.”

Milton Friedman

On August 18, 2008, at the height of the subprime crisis, the domain bitcoin.org was registered on the Internet. Shortly thereafter, under the pseudonym (or not) of Satoshi Nakamoto, a document was published explaining what the subject consisted of a brief presentation of a encrypted digital currency, based on blockchain technology. This new currency, thanks to Blockchain technology, — according to Klaus Schwab a centerpiece of the so called Fourth Industrial Revolution — , allows direct peer-to-peer exchange without the need for third parties. Its design contemplated a finite number of bitcoins, which turned it into a deflationary currency in the long term once reached the 21 million bitcoins (at present, we have mined just over 16.3 million). A new means of digital payment was thus generated without the need for intermediaries, such as when we pay in cash, with the promise of becoming a new form of money in the future as long as it becomes a commonly accepted means of payment.

Almost ten years later, Bitcoin is in the path of becoming the equivalent to gold in the Digital realm. Blockchain tallows to keep a distributed management of the Bitcoin ledger, an open accounting book, which is what allows the exchange, private and direct, without the need for Banks, Visa, Mastercard or the more modern PayPal.

The performance and properties of Bitcoin, (not by chance), want to be similar to the environment that generates the discipline of monetary rules (we can compared to gold as well, but in a digital environment. Today, as the monetary expert George Selgin points out, Bitcoin is a means of payment, although it incorporates the possibility that it becomes a new form of money as long as its acceptance is universalized (cf. Bitcoin: Problems and Prospects, Center for Monetary and Financial Alternatives, The Cato Institute, Washington DC, 2014). Selgin arguments are rooted in the classical definition of money by the Austrian economist Carl Menger (cf. “On the Origins of Money,” trans. C.A. Foley, The Economic Journal 2 (1892), pp. 239– 55.). The fact that eventually Bitcoin could consolidate as the new digital currency has promising advantages.

Bitcoin main strength is that does not depend on political will or any Central Bank; its value oscillates in a genuine way depending on supply and demand in the market. Bitcoin also incorporates its own cost of production, which again follows a logic similar to the extraction of gold, corresponding to the cost of electricity consumed by the servers needed to decrypt each of the blocks and gradually releasing the bitcoins (the so called mining). It is precisely this refined design, with a limited supply with procurement cost, which gives Bitcoin its great potential to eventually become a new form of non-inflationary money.

The quest for searching alternatives to protect savings

The financial crisis instead of illuminating new patterns of behavior, has served (basically) to perpetuate bad habits. One of these bad habits has been to solve economic problems (for example, lack of solvency and competitiveness) with the instruments of monetary policy, adequate only to liquidity problems. Briefly, we have replaced a large private debt problem with a public debt problem, both fueled by excessively lax monetary policies before and after the financial crisis. This is the old solution of trying to pay the debts via inflation.

In this scenario, the big losers are the savers, the workers, and the pensioners who watch over and over again how the purchasing power of their savings, salary, or pension falls hopelessly. The financial repression has exhausted the alternatives in which to be able to protect the savings with a relatively low level of risk. One of the few bastions that remained for all those who were reluctant to jump into the new speculative bubble was physical gold. The new digital currencies are new solutions in the Internet environment to the old problem of saving protection against inflation processes.

Although gold has more than 5,000 years in its possession as the most genuine form of money, Bitcoin still plan many doubts about, as we said, the extent to which it will achieve, and how it will become the new global currency in the digital universe; hence its erratic evolution, but (in my opinion) unstoppable in the long run.

Strengths and challenges

The great strength of Bitcoin is that it is a form of depoliticized money: we no longer need the Government, or any Central Bank to manage the currency, which opens up great horizons. This, for many, is the great revolution of Bitcoin and his promise. As it is a deflationary currency (with limited supply), Bitcoin does not erode its purchasing power through inflationary processes, and therefore it is a healthier currency on which a more stable financial system could be rebuilt, where the type of Interest depends on market factors, genuine savings and quantity of investment projects, and not on arbitrary manipulations by the public authorities in their multiple modalities.

The distributed nature of Bitcoin is better suited to the dispersed nature of knowledge, and makes unnecessary the existence of a central issuing institute in charge of adjusting the money supply at any given moment to the complex, changing and dynamic environment posed by the irresolvable problem of economic calculation in a planned economy (cf. Mises/Hayek).

Of course Bitcoin brings not a few challenges. Some have to do with their security, although due to the dynamic and distributed nature of validation with blockchain technology, Bitcoin’s accounting book is practically incorruptible. We recently had a test of the traceability strength of Bitcoin (also of the rest of crytodivisas) with the cyber attack by WannaCry (to mention only one example). However, the key issue with regard to Bitcoin is its monetary dimension and its great challenge is to see to what extent it effectively becomes a new deposit of value within the digital universe. From the Modern Monetary Theory (and other braches of old and new Keynesianism), Bitcoin has received similar critics to the one that historically has received the Gold Standard (see, for example, Paul Krugman, “Bitcoin Is Evil”, The New York Times, 28 de diciembre de 2013.).

The bulk of these criticisms confuse the existence of a limited money supply with lack of liquidity. For an important part of monetary theory, the value of a currency depends on its ability to pay debts and taxes, that is, to fulfill its role as a means of payment. In this sense, and ignoring the basic mechanisms of monetary inflation, the great advantage of the current system with respect to the gold standard, for example, is that the money supply resembles a chewing gum, which allows to rescue all kinds of insolvent debts in the system; A deeply dysfunctional architecture that favors situations of moral hazard. In addition, it is forgotten that the main function of money is that it must be a deposit of value, which is why it is a desirable and interchangeable good for other goods.

Bitcoin’s main challenge, supported by other crypto-currencies, is whether, as we said at the outset, it will be consolidated as a commonly accepted means of payment and a truly solid deposit: that is, as a new form of money, or if we are simply facing a new Tulipomania. Economist Peter Shiff, for example, has shown a healthy skepticism about Bitcoin as its cost of extraction is limited to the energy consumed in the mining process and its limited, for the time being, use / acceptance in line with Selgin (cf. “Gold Bug Peter Schiff Calls Bitcoin ‘Digital Fool’s Gold’”, Bitcoin.com, March 1, 2017; Javier Santacruz, “¿Son tan buenas como el oro las monedas virtuales tipo Bitcoin”: https://www.oroyfinanzas.com/2014/01/buenas-como-oro-monedas-virtuales-bitcoin/). Others like the Lebanese philosopher Nassim Taleb, entrepreneur Peter Thiel, or the digital authors Dominic Frisby or Nathiel Popper, are more optimistic.

We know for certain that this consolidation process, and as with any technology (even more so if it has disruptive properties), it will not be free from turbulence; but also that the promises that Bitcoin opens are huge and promising. The digital universe expands at a speed of vertigo, and in this new universe the new monetary pattern may not be the dollar, nor the euro, nor even gold, but Bitcoin.