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I first paid little attention to
Bitcoin, thinking that there are probably more Elvis Presley impersonators than
there are people in the world who have traded or owned it. But seeing that
central banks have issued policy statements on Bitcoin, that the FBI has
'seized' Bitcoin assets used by drug dealers and that tax authorities have
given guidance on capital gains liabilities, while financiers are planning to
offer exchange traded funds denominated in Bitcoin, I decided to take a second
look. This article gives my assessment of this digital, alternative 'currency'.*
Bitcoin
emerged from the rubble of the international monetary system in 2008, when
numerous banks had a near-death experience and some were actually buried. It
was devised by a team of software specialists, led by one Satoshi Nakamoto. In
March, Newsweek claimed to have unmasked this international man of
mystery as an unassuming, Japanese-American retired engineer, but the latter
denies this and lawsuits are pending. However, it is possible to analyse
Bitcoin without going into the personalities involved.
There are two
key aspects of Bitcoin: an Internet-based payments system and a special
currency unit for payment between different Internet accounts. The first is
reasonably innovative; the second is bizarre. Although they are closely linked,
it is useful to consider them separately.
The system
With Bitcoin you can make payments
between individual accounts on the Internet in a way that does not use the
banking system. This raises a number of questions about account access,
identity and security that the software developers have tried to, and mostly
have, solved (see Wikipedia's 'Bitcoin' article for an extended discussion of
the technicalities, pitfalls and scams). Bitcoin claims a number of advantages
over the normal bank payments systems. First, there is no charge for the
transaction, unless you decide to leave a 'tip' in order to speed up the
process. Second, 'tip' or not, it will probably be more rapid than many bank
payments systems, especially across national borders. Third, making a payment
between countries in terms of Bitcoins does not involve other bank charges.
Fourth, the payments made to other system users can remain anonymous. All of
these factors can appeal to those with less than a happy experience of dealing
with their bank, especially those who wish to transact in secret. The belief
that Bitcoin is a challenge to the banking system, even to the Fed and other
central banks, has some popular appeal.
Ben Lawsky,
New York's Superintendent of Financial Services, has praised the technology
behind the payments system (interview on Fox Business News, 3 February 2014).
He thought that some version of it might in future be used as a cheaper, more
efficient method of transferring money. In this sense, Bitcoin, or a similar
technology, could eventually offer a challenge to some banking services
and would be a threat to this particular source of bank revenue.
However,
although finding an alternative to the banking system might seem like a good
idea, the problem is that the Bitcoin payments system can only transfer
Bitcoins from one account to another. This raises the next question: what is a
Bitcoin and what is its relationship to the normal money we use? This is where
the bizarre aspects of Bitcoin come in, ones that are interesting for also
highlighting some equally odd aspects of the monetary system that we take for
granted.
The money
Bitcoins are created by a
computer algorithm that allocates 'coins' to those who have the computing power
(and energy resources) to do the relevant 'mining'. Coins only exist as entries
on a ledger in the computer system, not as physical articles. The algorithm
determines the pace at which coins can be created. This pace diminishes over
time so that, ultimately, the total number of coins available will be limited
to 21 million. So far, there are a little over 12 million coins.
If the
genesis of Bitcoins seems weird, consider by comparison what happens with 'real
money'. The Federal Reserve is the monopoly issuer of dollar currency, as are
central banks in other countries, and a $20 bill, for example, costs only 10
cents to produce. However, the vast bulk of what we call money is created via
the banking system. This happens through banks making loans to consumers and
companies. For example, a bank creates money by making a $100,000 mortgage loan
to a household, crediting its account with the funds. After the purchase, those
credited funds end up in the seller's bank account, and are balanced against
money transactions that the second bank has with the first. The first bank
doesn't need $100,000 in cash to make the loan. If it did need extra money, it can
rely on the central bank (here, the Federal Reserve) providing funds to the
banking system. You might suspect that a few things could go wrong here! So, do
you prefer to trust the workings of an algorithm or the workings of the
monetary system? In the wake of the 2008 crisis, with bad debts, successive
financial scandals, 'quantitative easing' and the bailing out of banks at
taxpayer expense, Satoshi Nakamoto's algorithm has, not surprisingly, gained
some ground.
However,
Bitcoin enthusiasm overlooks what determines the value of money. Such an
omission is easy, because a dollar token of money or its representation in a
bank account might seem to have as much value as the digital signals from a
computer. If anything, the limit on the supply of Bitcoins (but don't believe
all you read) might promise a more solid future value than the potentially
unlimited supply of dollars. The rise in the price of Bitcoins from less than a
dollar at inception, to more than $1,000 in 2013, then at $440 in early May
this year, has been a roller coaster. But this can still leave enthusiasts
feeling that, as with gold, there is some kind of 'intrinsic value' determined
outside the influence of the government or the banks.
There are
nevertheless key differences between the determination of the price of Bitcoins
and the purchasing power of the dollar. These highlight the dollar's role as
money and Bitcoin's role as essentially a speculator's plaything, even if we
leave aside the huge volatility in Bitcoin's price.
Pricing and
payment in dollars, or other currencies, is the means by which transactions are
done and accounts are settled within the borders of a monetary system. In
principle, anything else could be agreed by parties to the deal, from
bottles of whisky, to tickets for a football game, to organic vegetables, to
Bitcoins. But the universal means of pricing and payment is in currency, and
the currency chosen is determined by the national state. The state gives the
social stamp of approval and makes a currency legal tender, acceptable for
pricing, payments and calculations of wealth according to a set of commercial
laws.
But what
determines the value, or purchasing power, of currencies? The answer has many
dimensions, although two are critical: the productive power of the national
economy issuing the currency (more than one in the case of the euro), and the
position of that economy in the world system. Productive power will influence
the prices of goods and services, rates of inflation and competitiveness in
international trade, in turn influencing the exchange rate of a currency in the
market. Global status has an important impact too. Foreign investors buy US
dollar-denominated securities because the US is top dog in world finance, and
this usually keeps the dollar's exchange rate higher than it would otherwise
be. The US gains revenues from the world economy via the role of the dollar,
and the US government's political power is also boosted by its financial power,
as when it imposes sanctions against Iran, Syria, Russia or other countries
that act against its wishes. However, that global status would not long survive
if the productive power of US capitalism declined significantly compared
to its rivals. So, while the value of a national currency might seem to be
arbitrarily determined, there is a close link to a country's productivity.
For Bitcoin,
however, there is no such link. The most one could argue is that there is some
relationship to the amount of effort to create another unit of Bitcoin, since
the price might settle at levels higher than the cost of 'mining'. But even
then, the mining work is not organised as part of social production: resources
are not applied according to competition in the capitalist market, with the
price tending to reflect that. Bitcoin miners can decide to spend a lot of time
on their hobby and pay little attention to the electricity and computing bills:
this is essentially private production, not social production of commodities by
capitalist companies.
The cigarette card
Probably the best analogy to
pinpoint the economics of Bitcoins is that they are like Babe Ruth cigarette
cards, or special edition stamps, that attract collectors. A limited supply is
weighed against a hyped up (or deflated) demand to determine the price. The
result is that Bitcoin's price is basically determined by speculative demand:
it might jump or slump. A limit on supply is supposed to create a scarcity
value, but the demand for Bitcoins could easily get much scarcer. While Bitcoin
is the leading 'digital currency' at present, there are also more than 170
others being traded, so in future it could be eclipsed and the price could drop
back to less than a dollar.
Don't get
misled either by reports of Bitcoin ATMs appearing all over the world to think
that its growth could dislodge the banking system. The machines are real
enough, with something over 100 already set up in a dozen countries. But that
is hardly one on every street corner. Also consider that the transaction costs
on the machines are reported to be around 8%, which is worse than you would get
from a foreign exchange bureau (and at least they give you a form of money).
Nevertheless, it is good business for the machine installers. Always remember:
you can be cool and alternative, but also a sucker.
Bitcoins are
likely to remain digital Babe Ruth cigarette cards, at best. Even if one
imagined that at some point the government would accept tax payments in terms
of Bitcoins, or a wide range of businesses would accept it for payments for
goods and services, the amount of the Bitcoin payment would be set on the basis
of the relevant dollar, euro, sterling, etc, price that you need to pay. It
would not be set purely in terms of Bitcoins simply because they are not money,
backed by the state.
Bitcoin is
intriguing as a use of modern technology. However, an alternative economic
system is not built by a different technology. It is built by people who
recognise that the power of capitalism rests upon the state's maintenance of
the capitalist economic system and who want an alternative to that. Many
millions of people around the world are finding that the economic system does
not work for them, and that it is increasingly perverse to argue that
capitalism is the best way of organising social production. Yet Bitcoin is no
answer to that problem.
Tony Norfield
Note: This article first appeared on 5 June 2014 in the 'Field Notes' section of BrooklynRail.
