Is Bitcoin Erasing 300 years of Monetary Evolution?

Today, economist and Nobel laureate, Paul Krugman, wrote in the New York Times, that Bitcoin is taking us back 300 years in monetary evolution. As a result, he predicts all sorts of bad things.

A significant basis for Mr. Krugman’s argument is that the US dollar has value because men with guns say it does.

Is Bitcoin erasing 300 years of monetary evolution?

Running with the metaphor that fundamental change to an economic mechanism represents ‘evolution’, I think a more accurate statement is that Bitcoin is not erasing the lessons of history. Rather, it is the current step in the evolution of money. Of course, with living species, evolution is a gradual process based on natural selection and adaptation. With Bitcoin, change is coming  up in the rear view mirror at lightning speed.

The Evolution of Money

When a medium of exchange is portable, fungible, divisible, unforgeable and widely accepted, it becomes money. For at least six millennia, barter was gradually replaced by various mediums of exchange.

  • Obsidian —» Cowry shells —» Gold —» Promissory notes (backed by a Bank, employer or wealthy industry) —» Fiat (national currency)

But what backs these forms of money? What gives them value?

The first 3 currencies above were accepted as money on 5 continents. They were backed by their scarcity and unique characteristic properties (Aristotle called this intrinsic value). But even gold cannot serve as a widely used currency today. Although it is portable and scarce, it is not easily tested or subdivided in the field; it is risky to transport and difficult to track; and it is not suited to instant electronic settlement. But what about Fiat money. What backs it?

What Backs National Currencies?

Fiat has been backed by various different things throughout history. They are all compromised attempts to establish confidence and trust. They are compromised, because the fall short of one or more facets of trust.

In the list below, monetary backings in Red are what Mr. Krugman calls “men with guns”. That is, he claims that government demands give value to the dollar:

  • Value tied to gold —» Promise of redemption —» Legal tender (public must accept it for all debts) —» settlement of taxes —» The “good faith and credit” of workers

Unfortunately, the transition away from a trustworthy basis and the constant temptation of kings, dictators and politicians to print money based on credit (or nothing at all—as in the case of our fractional reserve system), has created a house of cards that few people believe is sustainable.

Bitcoin changes all this.

Finally, a crowd-sourced trust basis was invented (or discovered). It is unhackable, un-inflatable, unforgeable and immutable. Most important, it allows a government to be decoupled from its own monetary policy and supply. This is a remarkably good thing for businesses, consumers, creditors, trading partners—and especially for governments.

And Bitcoin is backed by something better than guns, gold or promises. It is provably scarce, capped in supply, completely fair, and built on a massive, crowd-sourced network of bookkeepers and auditors. It is the first currency—and quite probably the last—built on genius math and indisputable trust.

Despite the gross misunderstandings and misconceptions of early pundits, it does not interfere with a government’s ability to tax, to spend or to enforce tax collection—and it does not facilitate crime.

Bitcoin is new, but the goal of distributing trust is not as radical as you might think. It addresses a problem that economists and mathematicians have pondered since Aristotle and the ancient Greeks…

Background

Ever since the transition from real gold to government notes, bank notes and bank ledgers—economists have wondered if value can arise from a public trust that is durable, distributed and stateless. Until 2009, the answer seemed to be that this was impossible because of the double-spend problem.

But 9 years ago, something changed; and the change is dramatic. It will take an additional decade for most people to understand and appreciate this change…

In the first paragraph, I cited Mr. Krugman’s statement that the US Dollar has value because of “men with guns” (a reference to the fact that its use is legally compelled for payment of any debt and for government taxes). But this is not what gives it value. The dollar, the Euro, a Picasso painting and a fresh serving of hot french fries all derive their value from supply and demand. Bitcoin is no different. The trick is to generate viral demand and a ubiquitous infrastructure needed to achieve a robust two-sided network.

In the white paper that introduced both blockchain and Bitcoin (the first blockchain application), Satoshi taught us that a widespread and easy to access communications network (the internet and universal access to smartphones) can give rise to value that is based on a different type of trust. Instead of trust in a government, a bank, or testing the chemistry of a precious metal, value can arise from trust in a formula that is ubiquitous, redundant and constantly monitored and vetted.

All of these things have a value based on demand and the available supply. But with Bitcoin, the medium of exchange (and additionally the store and transfer of value), can be achieved by math, distributed trust and a pure, two-sided network.

So, is Bitcoin taking us backward in time, utility, safety and governance? I have never been awarded a Nobel Prize—but it seems pretty clear to me that Bitcoin is taking us forward and not backward.


Ellery Davies co-chairs CRYPSA, hosts the New York Bitcoin Event and is keynote speaker at Cryptocurrency Conferences. He sits on the New Money Systems board of Lifeboat Foundation. Book a presentation or consulting engagement.

Is the US dollar backed by more than Bitcoin?

Bitcoin is getting to be a frequent topic here at AWildDuck.* Regular readers know that I am bullish on the exchange medium. Not just as an investment, but as an emerging world currency. And, as the story continues to unfold, the fundamentals just keep getting better and better.

Bitcoin has been around since late 2010. Less than 3 years. As an immature exchange medium, its wild swings make it too volatile to be recommended in any portfolio with short term objectives. But with bungling at the largest and earliest exchange and a perceived tie to the criminal bazzar, Silk Road, events have muddied the inevitable path toward legitimacy. They amplify the small risk and delay widespread adoption.

I’m cool with that, because with widespread misunderstanding comes opportunity for those that see the long term picture—especially when it comes to a tectonic paradigm shift. As a long term investment, Bitcoin is a slam dunk. It can’t go down, any more than an original Rembrandt can lose value in the long run.

But, what surprises me, is that three years on, we are still faced with pundits who fail to appreciate the dramatic tipping point that is looming just down the road. They point to volatility rather than fundamentals. Perhaps, most frustrating, they point to the lack of government backing or a central bank as a deficit rather than a bonus and—in fact—the Raison d’être.

Bitcoins are backed by something even better than US dollars

Backing that beats US dollars

Here is a new article from a credible source that ought to understand the intersection of technology with economics:

When armchair analysts dig into the risk or folly of Bitcoin as a currency or investment, I bite my tongue. (Well, not this time!).

Let’s talk about item #2, If Bitcoin fails, it has no safety net. The argument is built around a premise that Bitcoin is backed by the “expectation of acceptance by others” while the US dollar is backed up by something more tangible (e.g. a government that can “step in”). That premise is wholly ludicrous. Both the dollar and Bitcoin have value that is backed by nothing tangible. And Bitcoin wins handily on the intangibles.

Background

In 1933, Teddy Roosevelt ordered Americans to redeem all private reserves of gold for printed notes. Americans were no longer allowed to own gold coins, bullion or certificates. (That left only the gold content of industrial products, jewelry and ornaments). For the next 40 years, the US insisted that it was still on a “gold standard”, because it amassed a stockpile of gold bullion in Fort Knox, Kentucky. With this as collateral, the government guaranteed the value of printed currency and it pegged the dollar value of what it printed. Of course, it was a guarantor only in theory, because it was illegal for US citizens to redeem their gold. They weren’t even allowed to own gold overseas.

From 1934 until the early 1970s, the value of a dollar was fixed at 1/35 oz of gold. In other words, the US government was effectively promising foreign treasuries the foreign trade settlement was bound by the transfer of gold at a value of $35 for each oz.

The dollar’s relative stability throughout the post war era was a result of the Bretton Woods agreement in which a large number of nations pegged their own currencies to the US dollar.* In fact, the value of the dollar increased, even though it was still worth 1/35 oz of gold. Everyone trusted the USA to maintain the value of its own currency with something. Most hoped that it was the gold at Fort Knox, but some economists say that it didn’t really matter, because the US was such a dynamic and growing economy, with a history of predictable inflation. And therefore, it had a high degree of trust.

But as we approach the ’70s, trust probably accounted for more dollar purchasing power than gold. In 1971, under Richard Nixon, the US terminated convertibility of the dollar to gold, even for foreign banks. By 1973, the US decoupled its currency from gold altogether, and in 1974, Americans could, once again, legally buy gold in any form.

So, what backs the dollar today? In academic jargon, it is a fiat currency.* To economists, it is backed by the full faith and credit of the US government. But in reality, this just means that the US can print or borrow more money to pay past debts. In truth, it is backed by something, but that something is no more than what backs a Bitcoin: It’s value is based on the confidence of the person accepting or saving the coin that it will be accepted in the future by someone else—and at a rate they can believe in today.

But wait! Though both the US dollar and Bitcoin are fiat money—backed only by the perception of buyers and sellers, in fact, Bitcoin has the distinct edge…

Why Bitcoin?

Why is the long term value of a Rembrandt painting unlikely to tank? To retain value, any asset must meet two criteria: Limited availability and precious to behold (I use art as a metaphor—preciousness can be anything valued by a pool of perspective owners). Bitcoin is a limited commodity by pedigree and it is precious because of a vast trust-matrix built on a foundation of mathematics. When a two-sided market develops around something with a provably limited supply, trust becomes more durable than decree.

Bitcoin is the future of currency because it has the edge in all areas: it can be more certainly trusted, it offers an advantage to saving, it is a stateless exchange medium and requires no backing. This isn’t to say it is not backed… In fact, it is backed by solid mathematical principles that are open to peer review.

In the long run, the dollar is a weaker and more risky currency than Bitcoin. It has no natural cap and is subject to counterfeiters and manipulation by the people who authorize its printing. A wallet or bank cannot easily be provably “backed up” and its value inflates rather than deflates with adoption. Although armchair economists who focus on protectionism, exceptionalism, or short term objectives may see some of these things as benefits, they are all serious deficiencies.

Advantage: Bitcoin

Ellery Davies is editor of awildduck.com. He is a frequent contributor
to The Wall Street Journal, Yahoo News, CNet and PC World.

Past Posts about Bitcoin

* Resources