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, you can see for yourself over on sites like https://coinsspent.com/ that allow you to see where your bitcoins are now widely accepted.
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.
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.
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 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.
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