Bitcoin’s in the news at the moment on account of its roaring success as a speculative asset, something that, like gold before it, might make you rich if you own it.
But this is not what Bitcoin was intended to be. It was intended as a revolt against the power of Big Finance. It was founded by a brilliant programmer(s), under the pseudonym of Satoshi Nakamoto, on the quite reasonable ambition that people should not have to trust banks in order to make payments or store money. Instead of using such a middleman, you should be able to make payments just as you used to do with coins – except that the coins would be made of bits, not metal. Hence ‘Bitcoin’.
Nakamoto saw this as far more than a technical task; he saw it as a mission to get the banks out of the way. His intent was clear from a text message embedded in the first mined Bitcoin block: “The Times 3 January 2009 Chancellor on brink of second bailout for banks.” Satoshi’s February 2009 Bitcoin charter, Bitcoin open source implementation of P2P currency, states he created his currency because he wanted a system that did not need to trust central banks or commercial banks, and perhaps as a reaction to the global financial crisis.
Bitcoin is an interesting attempt to solve a real problem. But it seems to have failed in that attempt. The enthusiasm that remains for it is in part, I suspect, a by-product of its embedded philosophy. Many people like sticking it to the bankers, and bitcoin seems to some a good vehicle for that.
Echoes of paranoia
Bitcoin’s creator spelt out his view of the financial world in his February 2009 screed:
The root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.
You can hear in this manifesto the echoes of a centuries-old and slightly paranoid view of the financial system as a giant conspiracy.
Financial paranoia pops up all the time. But it’s most common after financial crises: a certain type of politician, philosopher and commentator start complaining about those terrible financiers who secretly control and manipulate the entire society. They talk of the Rothschilds, the Illuminati or ‘the Jews’ – sometimes all three. They deride the foolishness of fractional reserve banking, where banks hold liquid deposits equal to only a fraction of their deposit liabilities. In the US the fear of ‘the money power’ goes back at least to Andrew Jackson’s campaign against a federal bank, and the subsequent panic of 1837. In Australia it reached its zenith in the 1920s and 1930s in the writings of the left-wing Labor politician Frank Anstey, whose 1921 book Money Power is a classic of financial paranoia.
For many of Nakamoto’s supporters, Bitcoin is the great weapon that will defeat the money power. If you go to the sites where Bitcoin’s fans gather, you will encounter the same sort of people who were buying Anstey’s book on the streets of Melbourne 96 years ago. They think most things about money are a conspiracy against their interests, and they often think that’s all they need to know.
The money supply problem
Here’s the problem: running a financial system is hard. For a start, you will want to regulate the creation of money, so that there’s always enough but never too much. (To understand monetary policy in basic terms, read Paul Krugman’s “Baby-Sitting the Economy”, one of the greatest pieces of economics journalism ever written.) This is the money supply task, and it’s real, and difficult, and important if you want to keep your economy out of recession.
Nakamoto picked up on a strand in monetary thinking that argued the money supply task should be kept out of the hands of regulators. This kind of simple money supply rule is not ridiculous; Milton Friedman toyed with it.
Nakamoto’s virtual currency would start with just a few units of currency, but you could create more by ‘mining’ them on computers, and mining would become harder over time, so that there would only ever be a maximum of 21 million bitcoins in the world.
But this idea about money supply was untried when Bitcoin began, and now it looks problematic. The trouble is that people who fancy themselves in-the-know start hearing that your currency is scarce, and begin collecting them as an investment. Now each unit of currency is worth more and more every year, every month, every day, and soon everyone is buying and no-one is transacting.
Not a transaction system
Bitcoin has a bunch of other problems besides its money supply management:
- You have to pay a fee of several dollars to get your transaction processed. This makes a Visa payment look pretty attractive.
- Transactions are far slower than they would be via a bank. At one point in June, the average ‘confirmation time’ for a Bitcoin transaction was reportedly 42-and-a-half hours.
- Because you’re using computers to mine Bitcoin, you use electrical power. As the mining task has become harder, the power demands have become huge. It is estimated that Bitcoin mining now uses more electricity than Denmark or New Zealand, and surging Bitcoin prices only encourage more power use. The noted Australian economist John Quiggin has rightly dubbed this an environmental disaster.
Some of Bitcoin’s problems may get fixed, or the enthusiasm may move to another virtual currency that solves these problems. Meanwhile, Bitcoin may be acting as a useful spur to improve existing bank and payment infrastructures.
But right now, Bitcoin is not a transaction system’s bootlace; it’s notably worse than the systems it is supposed to replace. And Bitcoin’s price means it’s a poor store of value too. As I write this in December 2017 it’s up more than 1700 per cent since the start of the year. Anything that can rise that fast can fall that fast too.
Instead of being a means of payment or a store of value, Bitcoin is the world’s great new speculative asset, a bubble stranger than almost any before it, a ‘currency’, which, if it were more influential in the world, would likely be creating a great wave of hoarding and deflation.
At least it remains a fine illustration of the shortcomings of a financial system built on paranoia.
After the bubble
My guess – not to be relied upon for investment purposes, I beg you – is that at this point in the bubble, Bitcoin will keep going up for a few months. And then at some point in the future, the bubble will pop.
At some later point in the future, someone will find a better way to do money. It may be an evolution of something we have now, like PayPal. It may be a virtual currency that solves Bitcoin’s problems, or something that uses some of the Bitcoin technologies, which better minds than mine adjudge to be quite clever. But the future of money is unlikely to be Bitcoin itself.