Bitcoin: Can cash have value if it isn’t real?

The Bitcoin discussion, below, offers a solid introduction to
digital currency. After reading it, check out
our 2013 update

It’s likely that early man had no widely accepted currency. They dealt in the food they hunted or gathered, and the clothes they fashioned from whatever materials were available. Perhaps some individuals offered services, such as labor, transportation or healing. But without currency, they weren’t buying and selling these things. Instead, each transaction was a gift or a trade.

Trading is good, but it is difficult for a trade to involve more than 2 parties. Also, It’s difficult to save for a rainy day. Food spoils quickly when there is no refrigeration.

Economies built on private trades

  • Limited to private transactions.
  • No exchange/settlement: An Inefficient market
  • Difficult to accumulate wealth
  • Doesn’t facilitate governments or public works projects

Eventually various forms of cash began to emerge. According to the comic strip, B.C., caveman traded clams for goods and services. That’s not far from what historians tell us. Beginning at around 1200 BCE, the Chinese exchanged the shiny shells from a Pacific sea snail for goods and services. For centuries Cowry shells were accepted as a portable “coin” because they were both rare and impossible to counterfeit. Historians think that it may have been the first medium of exchange.

“Medium”is a good word for money, because it is an intermediate layer between things of value — the thing that you sold today and the thing that you will buy tomorrow.

Was the Cowry shell really the first form of currency? It’s difficult to look further into the past, especially into events that occurred before written language. But we can be certain that with the rise of central governments, currencies were coined by banks and by nations. But this gives rise to two classes of currency. Things like gold and Cowry shells which have inherent value because of their limited supply—and things that are valuable because of someone says that they are valuable (dollars or other national currencies).

Cowry shells are like gold. They are portable and honored everywhere, just like a coin. And yet they are not minted by a central authority. Instead, they have value, as long as the new supply is limited by natural law, and as long as individual traders believe that their suppliers will continue to desire them. With all monies – clams, gold or government-issued cash – when a majority of productive individuals agree that coins have value, it becomes possible to save and to time shift assets. For example, if you produce clothes – but you aren’t immediately hungry – you can sell your clothes and accumulate wealth. Unlike asparagus or shoes, currency is fungible and it doesn’t spoil. Of course, it is also easier to tax.

Let’s jump forward several millennia. Today, people buy and sell with dollars, euros, pounds, shekels, Zlotys and Yuan. Each currency is minted by a government and backed by either a precious asset (typically Gold) or by the promise of a central bank or government. But wait! Few currencies in circulation today are backed by the recent behavior of a transient government. And most governments are saddled in debt. They have no ability to make good on their promise. The only reason that money in your pocket or bank has value today, is because you feel reasonably certain that vendors will treat it with value tomorrow. But for how long? Given the dearth of underlying assets, the value of money is about as far from “real” as one can imagine.

Putting your faith in money is terribly risky especially in the 21st century. It is rapidly eroded by inflation and debt. It is easily taxed. It is manipulated by day traders and emerging nations, and it’s value is dramatically influenced by energy, and political/social policy.

Before we move on to virtual currency, let me point out that the “virtual” part is nothing new. We already trust computers to keep track of our savings and we prefer bank statements over folded paper in our wallet or mattress. Very little of the money you spend is traded in the form of paper or coins handed from one individual to another. Credit cards, checks and automatic debits bypass the cash stage. Few people use cash to pay taxes, purchase a home or car, or even to buy groceries. Instead, credit cards and mobile payments are accepted everywhere, even at McDonald’s and at the post office.

And investing has become even more virtual than buying. When you purchase stocks or bonds, the entire transaction is virtual. You digital cash (computer bits) is converted into a new row on a spreadsheet. This row of characters and numbers reassures you that you own a tiny sliver of a mutual fund in Omaha. This fund, in turn, owns a fraction of 1400 companies or is the beneficiary of municipal debt (more computer bits). It can’t get more virtual than that. Can it? Well, yes. In fact, it can!

Even though money you spend today is virtual, it is still minted by a government (or in the case of Hong Kong, by a bank). You have no idea how much of the stuff they print and how it is distributed from the printer. The value you perceive in your pockets and all of your accounts is based on trust. So who are you trusting? Is it your own banker or business partner. Not on your life. You are placing your trust in the same entity that taxes you and the entity that can’t balance its own checkbook.

Bitcoin is different. First, it is totally decentralized. No bank or government is required to validate the coin, record a transfer, or to determine if a virtual coin was spent twice by the same party. And get this: New coins can be “minted” by any user, but the process is inherently limited and trustworthy. Moreover the more that is minted, the more difficult it becomes to mint additional currency. Eventually, the total amount in circulation will level off to a known and verifiable number of coins.

Confused? Of course, you are confused. But, believe it or not, there are already currency exchanges for Bitcoins. They are even bought and sold on eBay. Why? Because Bitcoin circumvents government manipulation. It also deters taxation, tracking, inflation and… Well, you get it. Bitcoin comes pretty close to a perfect currency.

Bitcoin: A virtual, decentralized, trustworthy currency

In my dreams, I fancy myself as a futurist. I like to think that I could hold my own with Ray Kurzweil, Esther Dyson, Bill Joy or Alvin Toffler. Putting myself into that mold right now, I would speculate that Bitcoin or something built much the same way will quickly subsume the world’s economies—perhaps even in the next 15 years. The fallout will be seismic, because governments will need to base taxes on real estate and transaction fees rather than income, property or savings. After all, it’s difficult to hide land or a home, and it’s pretty easy to issue a speeding ticket or charge for a marriage license.

See our April 2013 Update

 

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