On Bitcoin’s potential: Q&A on what Bitcoin can and cannot offer a troubled world

FollBitcoin Image - Golumowing my debate with Andreas Antonopoulos on ABC Late Night Live, graduate students of mine (at the University of Texas) were kind enough to piece together a related Q&A reflecting my views on BTC. Read on…

What is Bitcoin (or BTC for short)?

It is a beautiful algorithm.

If Einstein, von Neumann and Nash were the beautiful minds of the 20th Century, BTC is the 21st Century’s beautiful algorithm. A brilliant answer in search of a worthy question. A breath-taking solution to as yet undiscovered problems! But democratising and de-politicising money will not be one of them, I am afraid. It will not replace government issued money and it is not about to enfranchise the world’s billions that live in poverty, contrary to the lofty pronouncements of its evangelists.

What makes the BTC algorithm ‘beautiful’?

It makes possible a decentralised network within which trust is built because everyone is monitoring everyone else. There is no sentry. No guardian. No Leviathan who may become tyrannical or fall asleep on the job (as regulators did prior to 2008). Instead there is a type of benign Benthamite Panopticon where everyone is kept honest because everyone else is watching every activity, every exchange, every transaction. It is truly splendid. But it is not a sound foundation for an alternative monetary system.

How big/significant is BTC?

It is tiny in size and macro-economically insignificant. Its total global value in real money is less than the bailout money ‘given’ by European taxpayers to a smallish Greek bank last year. Of course, BTC enthusiasts will argue that what matters is its growth potential. I am not convinced. (See also my post The dangerous fantasy of apolitical money)

More broadly, there is a terrible disconnect between BTC enthusiasts and economists. Economists do not understand the ground-breaking potential of the BTC algorithm (one which I plan to write about extensively in the future). At the same time, BTC enthusiasts are relying on a primitive theory of money. It is important to bridge that chasm – for the sake both of economists and of BTC enthusiasts.

In an attempt to effect this ‘bridging’ a few comments are in order: Recall that people want to hold a currency for two reasons: one is to use it to buy stuff with (Nb. this is called the ‘transactions demand for money’). The other is for speculative reasons – for instance, you buy yen because you think that the yen-dollar rate will go up (the so-called ‘speculative demand for money’). BTC activity is, to date, mainly of the ‘speculative demand’ type.

Currencies, that are growing as currencies, are typified by a rapidly increasing ‘transactions demand’ which reflects growing real economic activity transacted with this currency. But the bulk of the growth in demand for BTC is speculative (only a tiny and, indeed, falling proportion of BTCs is used to buy stuff), indicating that, while BTC may be an asset, it is no currency. To paraphrase Keynes, it is a bubble on a whirlpool of speculation, rather than a growing stream of enterprise.

Two separate problems: The Security Problem and the Economic Problem

We should not confuse BTC’s Security Problem with its Economic Problem, even though both point to how dangerous the fantasy of non-government money really is.

  • The Security Problem is that a hacker can hack into your computer and disappear with your BTCs. And if you entrust your BTCs to an unregulated BTC bank, it is the banker that may run away with your BTCs or be hacked himself – the equivalent of a bank robbery. The Mt Gox experience.
  • The Economic Problem is entirely separate. Whereas the Security Problem may wreck BTC, if BTC is not wrecked and takes over a large macro-economy (as people abandon government issued money for BTC), it is BTC that will wreck the economy. Why? Because it is designed to mimic the Gold Standard – the monetary system that caused one depression after the other, from the 19th Century until 1929, and which was replaced because capitalism cannot breathe under a fixed quantity of money.

Mr Nakamoto, BTC’s creator (whoever he, she or they may be) used ‘built-in scarcity’ in order to ensure that BTC would grow in value relative to the dollar, the euro, the yen etc. and thus attract ‘disciples’ to the BTC community. Unwittingly, however, Nakamoto was reinventing a deflationary currency by simulating a Gold Standard through the BTC algorithm. So, if the Security Problem does not shoot down BTC first, and BTC or something similar ‘takes over the world of money’, we are on our way to re-engineering the crashes of 1884,1890,1896,1901,1907 and 1929…

On BTC’s ideological drive

It is quite touching and not altogether unwarranted that the coders and practitioners of crypto-currencies feel that they are writing history. That their work is the laboratory of the future. In a sense it is. But not as they imagine it.

The LWD (Libertarian Wet Dream) is based on the conviction that almost every imaginable miracle can be accomplished through individualistic, decentralised action and that free enterprise is, somehow, exempt from tyranny, abuse of power and downright inefficiency. Well, 1929, the sorry state of the American health system, and the Gold Standard like Eurozone are three examples of how dangerous this dream is. Markets without state intervention crash and burn. Period.

Lastly, it is helpful to remember, whenever we encounter ideological evangelists of new technical fixes to old-fashioned socio-economic problems, and who make a point of addressing the world in the name of the ‘dispossessed’, the ‘oppressed’ and the poor, not far behind them there usually lurks a selfish aristocracy. The BTC community is no different!

BTC’s insights into possibly helpful interventions in the Eurozone: my FTCoin proposal

I admire the BTC algorithm and I think we should all try our hardest to find good problems to throw it at. As one who has been engaging in the Eurozone debates, it was natural that I would begin to think of ways that BTC-like technologies could be utilised in that context. In the Eurozone, nation-states are asphyxiating in the straitjacket of the Gold Standard-like design of the euro. They need more monetary room in which to breathe, especially so as Europe’s surplus countries seem unwilling to move in a rational direction. To this effect, I suggested (see this post) that nation-states organize their own crypto-currencies based on future tax credits expressed in euros – coining the term FTCoin (as in Future Tax Coin). FTCoins could, I argued, help fiscally stressed Eurozone states win that monetary ‘space’. Why a crypto-currency? Because its algorithm is uniquely suited to creating the trust that is sadly missing in much of Europe. Given that Greeks (in particular) but also Italians, Spaniards etc. will need to trust that the state will not over-reach into the future tax pool when selling tax credits today, it is important that every citizen has access to the tax credit ledger. Enter FTCoins, which can be designed as government tax credits to be distributed and traded as a crypto-currency, complete with its blockchain (but created through an algorithm that connects their quantity to, say, a fixed portion of the nation’s GDP). 

The idea is at a very early stage of development. But it points to ways in which BTC technology can be combined with fiat money in the context of a process that is placed both under democratic scrutiny and community monitoring. 

Further reading

Bitcoin and the dangerous fantasy of ‘apolitical’ money

BITCOIN: A flawed currency blueprint with a potentially useful application for the Eurozone

Can the Internet Democratise Capitalism?

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  • Looks like all the socialists are getting scared that governments will have only taxes left to steal from citizens when as BTC and ist competitors get bigger!

  • Prof Varoufakis Καλημέρα!!! Thank you for your great posts on BTC and other issues. I have a proposition… I think that it would be great if you’d elaborate a little bit more on deflation and its nature. Why it happens and what are its consequences – by giving examples (historical or imaginary) in theory and in action.

    There are a lot of people on the libertarian right or in the anarchocapitalist movement (Austrian-libertarians etc) who see money as a neutral mean of exchange and hold that deflation is not actually a problem. They even claim that deflation is compatible with economic growth and prosperity. Well some of them critisize BTC for not having intrinsic value (like gold) but for no other reason. They don’t see the problems you see in it. I think that they have an ongoing influence in people who search answers for the economic mess we are in worldwide and they succeed in persuading a great number of them that the root of all evil is the government and its intervention in the economic process.

    So maybe its better to demonstrate why these people are wrong, first and foremost, in their theoretical approach to the matter. It’s sure that an austrian would reject your arguments as statist” and “socialistic”. You should definately do it better than me showing their errors…

    • What Kostas says. Yup, Bitcoin is gold. It’s worth explaining and educating us on why gold and other deflationary money is bad.

  • Great article on how BTC is A) mainly a speculative vehicle, for now, and B) a gold-like form of money that would choke the life out of any economy that adopts it (indeed, with the total potential number of bitcoins being restricted to just 21 million, and that, due to algorithmic difficulties, not for decades, it would become highly confusing just having to deal with bitcoin fractions – 0.00000001 of a bitcoin is already out there, and this would only get more fractional as the number of users expands and the number of BTCs does not. Imagine meaning to pay for a new table, say, with 0.00000001 of a bitcoin, but paying 0.0000001 of a bitcoin instead. Remember, there is no reversal of a transaction now, unless the seller agrees to it – http://bitcoinbasic.com/).
    Right now, the security of bitcoin is worse than abysmal. There was a second, smaller, Mt. Gox-like theft a few weeks afterwards, and for all we know, others have taken place and been unreported to date (Mt. Gox had apparently taken place years before it was reported).
    This site lists 8 separate and very real problems with Bitcoin – http://bitcoinbasic.com – at the end.
    Perhaps people also need to be reminded more strongly of the limitations of the gold standard, since there are even stronger calls to return to that.
    Personally, I would rather have truly government issued money, at least as a public option, as in the Lincoln Greenback (aka U.S. Note). We could always hold Congress accountable, or the president under certain emergency powers: http://www.opednews.com/articles/Debt-No-More-How-Obama-ca-by-Scott-Baker-Banks_Constitution-In-Crisis_Constitution-The_Constitutional-Amendments-131018-391.html
    Sorry, but taking the human out of the monetary equation is a bad idea.

  • Don’t agree with a lot of the articel as banks somtimes have “moral” opinions on your transaction. Imagine you want transfer money to a poor person and your bank cancels the transaction because the poor person is considered criminal. The money may help the poor person in society but that not something anti money laundring laws are concerned about or bank policies of what is bought with your visa card. Bitcoin can faciliate trade to parties that credit and bank access for various reasons

  • Did you really intend to use “the sorry state of the American health system” as an example of a market without state intervention?

  • @Pavlos,

    I agree….this whole article is written on the basis that a fixed currency is bad……..sorry but I don’t buy that the examples given are any worse than the OUTRIGHT THEFT that government induced inflation is.

    The government is reaching into your pocket and stealing 6-10% of your net worth each and every year……….

    How can a currency fixed in number that stops this be a bad thing.