What’s being touted in some circles as the future of money looks hardly more peaceful than its past. Bitcoin, a formerly obscure cyber-currency, is now all over the headlines with reports of bankruptcies, thefts and FBI lockdowns. If our fate is to buy and sell in bitcoins, this instability is troubling. But despite the headlines, the triumph of Bitcoin and related cyber-currencies is a lot less likely than recent commentary would suggest. One cause of all this hype? The number of people who understand what Bitcoin is seems almost immeasurably small—and that probably includes some of its users.
Money, it should be conceded, is not a simple topic. Most people understand how gold, which is something of a primal money, is mined, refined and shaped into coins. It is rare, pure, easily divisible and has been cherished over the centuries. Paper money is more complex. From 1900 through 1971 (with the exception of during World War I), the US dollar was backed by gold, meaning its value was legally defined by a certain weight of the metal. That ended in 1971, when Richard Nixon shocked the world by breaking the link to gold and allowing the dollar’s value to be determined by trading in the foreign exchange markets. The dollar is valuable not because it’s as good as gold, but because you can buy goods and services produced in the United States with it—and, crucially, it’s the only form the US government will accept for tax payments. Among the Federal Reserve’s many functions is allowing the issuance of just the right quantity of dollars—enough to keep the wheels of commerce well greased without slipping into a hyperinflationary crisis.
But Bitcoin (capitalized as a concept, lowercased when referring to units of the currency, according to American Banker) is another animal entirely. It is the first and most famous of a large and growing family of so-called “cryptocurrencies.” Others include Litecoin, Feathercoin, Songcoin (“designed for The Music Industry”), Auroracoin (Iceland only) and Dogecoin (“the fun cryptocurrency”)—but Bitcoin is by far the largest. Its origin is traced to a 2008 paper written by the pseudonymous Satoshi Nakamoto. Newsweek recently claimed to have located the real one, but he promptly denied all, so the whole thing remains quite mysterious.
According to its semi-official definition, a crypto-currency is “a peer-to-peer, decentralized, digital currency whose implementation relies on the principles of cryptography to validate the transactions and generation of the currency itself.” (While that is one dense slab of prose, to be fair to the cryptoids, it wouldn’t be easy to define the dollar succinctly either.) What this means is that Bitcoin and the rest are electronic currencies created and transferred by networked computers with no one in charge. The role of cryptography is not merely to guarantee the security of the transaction, but also to generate new units of the currency, which are “mined” by having computers solve complicated mathematical problems. Once solved, new coins are created and their birth—with digital signatures guaranteeing authenticity and uniqueness—announced to the rest of the system. The creator earns the value of the new coins when they enter the system.
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Trading is done via exchanges, which communicate with other exchanges, but there is no central authority. Some trading is done online, but you can also buy bitcoins for cash in person.
The mining requires enormous amounts of computing power, though specialized processors have been developed to reduce power consumption, which in turn produce many tons of carbon. Even the most ephemeral coin has material roots.
That’s the technology of bitcoin; but is it money? The classic economist’s definition holds that money is a store of value, a unit of account and a medium of exchange. You go to the store and find that a can of tomatoes is priced at $3—a unit of account, which the store will book as revenue once it’s sold. You take $3 out of your pocket or via your debit card—you draw down the store of value (cash on hand or in the bank) and use it as a medium of exchange. The value of the US dollar is that everyone in the United States, and beyond, recognizes the currency as fulfilling these tests of money. The dollar is valorized by the goods and services that it can buy.
Bitcoin has serious problems in all three respects. From the beginning of 2013 through early February 2014, the price of a bitcoin has varied from $13.40 to $1,203.42—a ratio of 90 to 1. Its average one-day change (ignoring whether it was up or down) was 4.3 percent. In just one day last April, Bitcoin lost 48 percent of its value relative to the US dollar—and that came the day after it lost 33 percent. But by November 2013, Bitcoin had shaken off this case of nerves and risen 1,405 percent off that crash low. By contrast, the ratio of high to low in the Federal Reserve’s broad index of the US dollar’s international value was just 1.07 to 1. Its biggest one-day move was under 2 percent; its average one-day change was 0.3 percent. (The dollar’s biggest daily change was less than half of Bitcoin’s average daily change.) Yes, inflation has steadily eaten away at the dollar’s value, but in relatively steady and predictable ways over the decades. It does not gyrate by almost 50 percent in a day. So much for a store of value.
Almost no one accepts payment in Bitcoin, nor do any businesses of note keep their books in Bitcoin; it fails both as a unit of account and a medium of exchange. And its short history—the first bitcoins were minted in 2009—has been turbulent. The US government seized funds from Mt. Gox, then the largest Bitcoin exchange, in May 2013, and just this past February, Mt. Gox collapsed from an undetermined mix of theft, fraud and mismanagement, leaving hundreds of millions of dollars in losses in its wake. There have been many other reports of thefts, frauds and hackings, which Bitcoin partisans dismiss as mere growing pains. But with no regulator, no deposit insurance and no central bank, this sort of thing is inevitable—it’s just tough luck. Introduce regulators and insurance schemes, though, and Bitcoin will lose all its anarcho-charm.
Keynes once called gold “part of the apparatus of conservatism” for its appeal to rentiers who loved austerity because it preserved the value of their assets. Bitcoin serves a similarly totemic purpose for today’s cyber-libertarians, who love not only the statelessness of it as money, but also its power to subject the institutional banking system to “disruption” (one of the favorite words of that set). And like gold, Bitcoin is deflationary. There’s a limit on how many bitcoins can be produced, and it gets more difficult to produce them over time until that limit is reached. Of course, new cryptocurrencies could arise. But the existence of the limit reflects the deflationary sympathies of the libertarian mind—in a Bitcoin economy, creating money to ease an economic depression would be impossible. Which is not to say that only libertarians love Bitcoin.
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To catch a glimpse of cyber-libertarianism in its natural habitat, I ventured to a December 19 holiday party organized by Cryptos.com, a business incubator for Bitcoin startups; BitcoinNYC, a meetup group; and Halfmoon Labs, which builds trading platforms. I was hoping to find some wildly anti-statist libertarians, and my hopes were further stoked by the first person I saw upon entering—a tall, skinny man with a red bow tie, the very picture of an Ayn Rand adept.
But it was not to be. Though the air wasn’t free of libertarianism, most of the partiers I talked with were interested in running Bitcoin-related businesses or speculating in the currency. Many had day jobs in tech or finance. It was mostly male (but not overwhelmingly so) and mostly white. Only one person was wearing Google Glass. From national surveys of unproved rigor, your typical Bitcoin enthusiast is a 30-ish libertarian white male—though the same survey finds 39 percent of the fan base leftish in some sense. The group at the holiday party, probably because of its business-y skew, was somewhat more diverse.
Cryptos.com founder Nick Spanos worked two cellphones. When I introduced myself and turned on my iPhone voice recorder, Spanos was not cooperative: “I don’t talk to reporters I don’t know. Turn the thing off.” After I did, he told me the place was filled with Bitcoin millionaires—ten of them under 21. When I asked what kinds of businesses they were in, he replied: “All kinds.” That was the end of the interview—a cryptopromoter for a cryptocurrency.
Another partier, Marshall Swatt, the chief technology officer at Coinsetter, a Bitcoin trading platform for institutional investors, was more helpful. Swatt told me that, after building trading platforms for established Wall Street institutions, he was looking for something more entrepreneurial. When I asked him whether Bitcoin was money or a trading asset, he said it was an open question. (In late March, the IRS ruled that Bitcoin is an asset, not a form of money, and that mining and trading gains are subject to income tax.) Bitcoin would need to develop a large consumer market to be taken seriously as currency. Swatt thinks it will: Virgin Galactic, Richard Branson’s scheme to take tycoons into space, accepts Bitcoin. But that’s by nature a small market. To get taken seriously, Swatt would love to see Bitcoin adopted by Google, Amazon, Facebook and Apple. Asked to explain its appeal, Swatt replied that it’s an “extremely well-crafted device,” secure and mobile. Unlike many Bitcoin enthusiasts, Swatt doesn’t talk trash about gold or fiat currencies—he sees it as a complement to state money. It’s deflationary like gold, but like money (and unlike gold), it’s easy to use. He predicts a trillion-dollar volume in Bitcoin someday, though with the supply so tightly limited, that would send the value of a single coin through the roof.
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Bitcoin’s limitations as a currency may be why most of the world’s central banks have tolerated it. States are fond of their monopoly over money. Federal Reserve chair Janet Yellen said in late Feburary, right after the Mt. Gox collapse, that the Fed lacked the authority to regulate Bitcoin because it’s outside the banking system. The Danish central bank stated in a press release: “Bitcoins are not money in a proper sense as there is no issuer behind them. Instead, bitcoins display the characteristics of a commodity to which users attach value. Unlike precious metals such as gold and silver, bitcoins have no actual utility value, bearing closer resemblance to glass beads.” The bank found the market too small to worry about; all the risks are on a small number of participants. And the market is very small: the value of all bitcoins outstanding is $5.9 billion—0.05 percent the size of the US money supply (by the Fed’s M2 definition).
Two Goldman Sachs economists, Dominic Wilson and José Ursua, largely concurred with the Danish evaluation. “We would argue that Bitcoin and other digital currencies lie somewhere on the boundary between currency, commodity and financial asset. Our best definition would be that it is currently a speculative financial asset that can be used as a medium of exchange.” But they also make an important point: the peer-to-peer technology behind Bitcoin could become a model for moving money around without third-party verifiers, like banks.
Bitcoin is not without friends on Wall Street. Gil Luria of Wedbush Securities is following it; he describes the recent volatility as “extended price discovery,” which is a way of saying that no one knows what it is, what it will be or what it’s worth. His firm is selling his Bitcoin research for payment in bitcoins.
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The political cast of the Bitcoin universe is mostly libertarian, but it does have a left wing. These users celebrate Bitcoin’s evasion of state surveillance and policing—which, in the post-Snowden era, is nothing to sneeze at.
Take sex workers, often subjected to outrageous degrees of scrutiny. A Marxist-feminist professional dominatrix who practices in Britain under the name Mistress Magpie is an enthusiastic Bitcoin proponent. She explains her enthusiasm as beginning with her deep techno-geekiness, and adds that Bitcoin is also practical for someone in her line of work—anonymity is important, whether operating in real life or online. Unlike libertarians, who see cryptocurrencies as a possible gateway to a new society, the socialist in Mistress Magpie sees them as a way to operate furtively under capitalism, in a way that might not be needed in a more open socialist society. Even for her, though, Bitcoin doesn’t go far—the majority of her clients are not well versed in digital currencies. Furtive payment is also good, of course, for drugs and other illegal procurements—a sort of anarchic market operating beyond regulation. Though the FBI shut down Silk Road, the online mall of illicit goods, its offspring live on. A friend whose politics are well left of center—and not unusually anti-statist either—loves that he can pay for DMT (a short-acting hallucinogen) using bitcoins in an encrypted transaction.
Apart from anonymity, though, it remains difficult to see what problem Bitcoin solves for people with left-wing politics. The switch to paper money was a response to the crisis of the old gold-centered system, and Bitcoin has managed to replicate many of gold’s bugs with few of its features. Leaving aside the entrepreneurs and speculators, who are simply looking to get rich quick, the political vision of Bitcoin is of a decentralized, stateless world with competing money systems.
Competitive currencies that would end the state’s monopoly over money have long been a dream of the right. In a 1976 paper, Friedrich Hayek argued for allowing multiple currencies to circulate within individual countries; competition would lead to the use of the soundest—meaning most austerity-friendly—currency and put a check on the attempts by governments to inflate their way out of trouble. That would mean no fiscal or monetary stimulus in an economic crisis—just let things run their purgative course. In this view, the New Deal lengthened the Great Depression; had the bloodletting continued after Roosevelt’s inauguration, things would have righted themselves sooner or later. And we should have done the same in 2008 and 2009. Cryptocurrencies would be an advance over the idea of competitive currencies—improvised money systems that could challenge the state monopoly itself.
There are big reasons to think, however, that neither Bitcoin nor any of the myriad cryptocurrencies emerging online will ever pose a serious threat to the state monopoly on money. In the nineteenth century, the United States did have competing currencies: all kinds of little banks issued banknotes that often turned out to be worthless because they were accepted only within a small radius and weren’t actually backed by anything. Some Bitcoiners drag this out as a worthy precedent anyway. But Bitcoin could never establish itself as a currency in any serious way without regulation and some sort of insurance scheme, because investors and consumers would not trust substantial savings to it. But were Bitcoin to legitimate itself through regulation and become a serious money, it’s impossible to imagine that states would tolerate it for long. It would be simple to outlaw cryptocurrencies, enforcing a ban at the point of conversion from state money to cryptomoney without attempting to crack the coin’s infinitely complicated algorithm.
Bitcoiners share with other hard-money proponents a fear of inflation and financial collapse. But there is no inflation, and government money has proved far more stable than its alternatives, either gold or Bitcoin. No bank deposits were threatened during the financial crisis of 2008, because they were FDIC insured; you can’t say that about Bitcoin in its short life. But libertarians—and there are a lot of them in tech and finance, the two parents of Bitcoin—are always worrying about inflation. They worry about it the same way that hedge fund titans see talk of eliminating their tax breaks as a rerun of Nazi Germany.
But maybe I’m just bitter. I bought 0.05 bitcoin on February 5 for $39.72. As of April 24, it was worth $24.79—down 38 percent. Some bulwark against the irresponsible state.