Understanding Bitcoin
aljazeera.com
aljazeera.com
Two critiques of the article, however, would be the complete failure to mention the deflationary risks of bit coin. You may agree or disagree with whether that's a problem, but it is one of the biggest, most consistent criticisms of bit coin out there, and it seems a tiny bit negligent not to at least mention it.
Also, the article mentions countries using bit coin as reserve currency to shield them from currency fluctuations. Which would be great if bit coin were super stable, but bit coin has already had a few big crashes. In theory, the predictable nature of bit coin should lead to stability, but in practice, it's behaved more like a tech stock, where no one's sure what it's eventual market value will be. Maybe it will become stable, but I think it's a little early to make plans as though it will.
Still, one doesn't have to agree with an article to get a lot of value out if it. Go Al-Jazeera for providing the most thought provoking article on bit coin I've read.
One point to consider is, that there is a free competition between different cryptocurrencies. There already exists some more inflationary bitcoin clones, and probably more will come. The markets will choose the currency, which they think is the best for them.
This is true, but that doesn't mean the currency will actually be better for them. Deflationary currencies are attractive to sellers and employees. They will choose them if given the option. The ill economic effects of deflationary currencies have been demonstrated.
Your phrasing seems to indicate that you believe that market-based outcomes are always ideal outcomes. I think that is incorrect.
I'd be interested to know what you are thinking of here (as evidence). I view that claim with pretty strong skepticism. But I'd be curious to see the best argument/evidence for it.
Of course, the value of the now illiquid currency will eventually become highly volatile likely ending in a crash. Hopefully after this happens several times most people would get the idea that investment in such things is not a good plan.
When someone uses the word "fiat" in casual conversation with me (without meaning the make of vehicle) I reply, "oh, a Bitcoin fan, eh?"
And fiat definitely is different from "real money" in important ways.
This is really the problem that all these discussions boil down to: definition of terms. From an operational perspective, I would claim that the money we have these days is as real as it gets.
Consider, for example, the claim in the article that our current monetary system requires trust. But is that really the case? I claim that the current money of the state is valuable to me and everybody else, no trust required.
Here's a simple line of thought to support this claim: My landlord wants the rent paid in the money of the state. This makes the money of the state valuable to me. I don't need to trust anybody or anything for this to be true.
Yes, that is huge. Debt-backed currency means someone is profiting off the mere existence of the currency, typically the banking system and government and anyone who owns the government bonds backing the currency, but at the expense of everyone else who uses and 'saves' it (that's not really saving).
The given rationalization for that is that a depreciating currency strongly incentivizes people to spend it or invest it instead of hoarding it in their savings accounts, improving economic growth. That's also the argument against a deflationary currency like gold-backed or bitcoin - that the ultimate result is decreased economic activity and growth.
However, that's an argument that grew out of an earlier time, when the world was less connected and dynamic. I suspect that a deflationary currency is much less of problem in our modern world, where economic activity happens at the speed of light and electricity and almost the entire world is integrated into a common market and economy.
In that world there is already huge incentive to spend an invest, and while a deflationary currency would represent a significant change, I don't think economic activity would ground to a halt under a deflationary currenncy.
In fact, the problem we're now seeing in the US and Europe is the opposite - too much incentive for borrowing and spending, not enough incentive for capital formation, eg savings. Too much debt at every level of society, from individuals to sovereign governments. I can't help but wonder if a deflationary currency that appreciates in value over time instead of depreciates would provide a higher bar for spending and investment, and alter that dynamic in favor of savings (which also a form of investment, as banks use savings to make loans).
Instead of US government bonds being the risk-free rate of return, a deflationary currency would be. That alone would be a huge economic shift, and might limit governments' out-of-control spending simply by giving investors a stronger alternative to government bonds. If a deflationary currency appreciates by, say ~3% per year, then government bonds would have to match beat that to attract investors, forcing governments to borrow and spend with more discretion.
Anyway, yes it definitely is something to think about. It's also probably a pure thought experiment, I don't see governments giving up the risk free rate of return status for their bonds any time soon.
The austerity that everyone except Germany wants eased is deflation in action. And pretty much every economist agrees that it's disastrous for the countries following those policies; much better would be floating currencies and inflation getting rid of the debt instead.
(In other words, I think you have it almost 100% backwards.)
There is an argument that the fixed and, more importantly, uniform interest rate across the entire zone caused problems.
I personally find the argument even more convincing that it's a wage structure problem. If you look at unit labor costs (essentially wages divided by productivity), then it becomes painfully obvious that Germany has been doing significant wage dumping - their unit labor costs have remained flat, violating the 2% inflation goal.
This caused the trade imbalances that are at the root of the current mess.
These were fairly prominent figures and all of this has been part of the local nationwide political dialogue years before there was any debt/banking/Euro crisis. Nothing happened.
[0] And others, everywhere, I'm sure, but I'm making a statement about Germany here.
Why do people keep saying this? Ben Bernanke does not pocket the profits he makes off the currency. Almost all profits from printing money go straight to the Treasury.
"But now the Government can print money to monetize their debt--" except almost all credible inflation forecasts indicate the Fed isn't printing enough money, so I don't think we need to worry about this.
As for the banking system, the service charge on my bank account suggests they are not doing very well on the whole profits-from-holding-money thing.
But he is plainly wrong about this -- he made up his own definition of 'fiat' which has nothing to do with the commonly accepted meaning:
"...money that derives its value from government regulation or law: the initial value of fiat money is established by government decree."
http://en.wikipedia.org/wiki/Fiat_money
Bitcoin is simply not a fiat money: it isn't mandated by law that bitcoins have value, instead it is people (markets) who decide that. It's the exact opposite of fiat money.
Maybe he's confused because fiat money is usually ("goldbugs") contrasted on a different axis -- whether or not the money has intrinsic value (market value besides its use as currency), or is exchangeable for something that does. E.g. the gold-backed dollar, or more general commodity money (mostly historic). Commodity money and fiat money are opposites in this regard -- gold/commodity-backed money has intrinsic market value independent of its status as a currency, whereas fiat money is "worthless paper". Bitcoin is like fiat money in that it has no intrinsic value apart from as a currency. But it is not fiat money; and neither is it commodity money.
Also there are three definitions on that page.
> The term fiat money has been defined variously as:
> - any money declared by a government to be legal tender.
> - state-issued money which is neither convertible by law to any other thing, nor fixed in value in terms of any objective standard.
> - money without intrinsic value.
Under the last definition bitcoin would be easily considered fiat.
Also he could and does debate whether you could consider the system that regulates the bitcoin currency a government which would qualify it under the other definitions.
> Bitcoin is simply not a fiat money: it isn't mandated by law that bitcoins have value, instead it is people (markets) who decide that. It's the exact opposite of fiat money.
It isn't mandated by law the value of any other law what the value of any fiat currency is. The initial value is as you said in your definition but the initial value of bitcoin is defined (the cost to produce a valid block).
Due to its nature Bitcoin is really a special case when trying to categorize it anywhere. I also think the author uses a good definition to draw out the differences.
Then I regret citing it, it is wrong. That third definition actually misrepresents its source (Mankiw's Principles of Economics) -- what Mankiw actually says is:
"fiat money: money without intrinsic value that is used as money because of government decree" (emphasis mine)
"Money without intrinsic value is called fiat money. A fiat is simply an order or decree, and fiat money is established as money by government degree..."
http://books.google.com/books?id=3ojsWuqmorEC&pg=PA644&#...
"It isn't mandated by law the value of any other law what the value of any fiat currency is."
I meant that fiat money only has value (as opposed to... no value) because it is mandated by law -- you are required to accept it as payment of debt, to pay taxes using it, etc. Sure, what the value is in real terms is a market decision.
There is currently nothing that could stop anyone to provide bitcoin credits and make paper money for bitcoins. This is the mistake that should be avoided. If bitcoin really takes off, than this will be the real challenge we will be facing.
It's the paper money that ruined the system where states could print them at will. They decided to stop printing money to stop inflation, but then banks created money through credits and turned people, cities and countries to slaves. Worse than all, it's now the bankers who define the rules, not the countries. So they bent it to their own adventage. They are so greedy and selfish that they didn't care if it created a bubble that will explode soon or later. Bailing out banks is the most stupid thing we could do in such situation. We're just on for another tour on the carrousel.
This can all be reproduced with bitcoin.
A) Debt necessarily creates a society with certain undesirable characteristics.
B) Our monetary system is based on the creation of debt, as new money is created exactly when someone borrows, ie. gets into debt.
C) Bitcoin does not involve debt when it created; when you "create" BTC, no debt is involved. Of course you do devaluate the entire currency when you create additional BTC, but the same is true when M2 is increased in fractional-reserve banking.
Did I get the argument right?
I'm sure many people disagree with A (which I have only paraphrased very broadly since it seems hopeless to represent it in a few sentences here). B seems to be a widespread characterization of fractional reserve banking, and fairly accurate to me (but all of this bewilders me) -- is it controversial? C seems interesting; although of course this raises the question whether there aren't other alternatives that could replace/complement our monetary system (and he does discuss some in an article he links to).
1. If Bitcoin ever became significantly widespread, people will start making debt contracts denominated in Bitcoin. It is merely the underlying base that is different, but debt will still exist.
2. For a monetarily sovereign state, government debt is very different from private debt. Private actors can be forced by having debt, monetarily sovereign governments cannot. In my view, it is the responsibility of the government to take on enough debt to make it possible for citizens to be debt-free.
It is true that, under current institutional arrangements, the interest paid on government debt is effectively a transfer payment to the owners of that debt (the treasury bonds), which tends to be a transfer from poor to rich, which I view as undesirable.
This is easily fixed by changing the institutional arrangements slightly. Essentially, the government simply has to use the central bank for funding to drive down its interest rate.
Think about it: governments create money "by fiat" and then pay people with it and collect it from people. FIat money is not debt. My having dollars doesn't mean I am in debt, nor does it mean anyone is in debt to me.
Credit and debt are fundemantal to economics, and will exist in any economy. (As they should - without loans and other forms of debt, people would not be able to get the capital they need to do things they need to do to get more capital. They are basically good things.)
By the way, there are alreay people lending bitcoins and thus there are already people who owe debts expressed in bitcoins. There are already bitcoin banks, bonds, options, stocks, and insurance (and probably other things). As a bitcoin user, I've seen this firsthand.
Money as Debt is an entertaining 45 minute video on the topic. It's considered to be somewhat partisan, though, and I'm not that it's entertaining for everybody.
http://vimeo.com/2244372 http://en.wikipedia.org/wiki/Money_as_Debt
Actually, the typical way modern central banks create money\* is by giving out loans (consisting of money they just created) to banks, which must post some collateral for it. When it's paid back, the money returned to the central bank is destroyed.
This is done to create a "spring" effect in the money supply -- as having money in existence has a cost, it prevents too much liquidity pooling up in the economy. If the banks are not using the money, they want to pay it back to the central banks to get rid of the interest payments.
\* Most money is not created by the central banks, but by the commercial banks, by using fractional reserves to "multiply" the money supply. However, fractional reserves always use the central-bank-created "base money" as the base they multiply.
Technically, this is incorrect. Dollar bills are a debt of the central bank. Take a look at the Fed balance sheet, you will find that dollar bills are considered a liability from their point of view.
This has interesting consequences. If you consolidate the Treasury and the Fed - which is valid from an economics point of view, since they are just different branches of government (no matter what the Fed conspiracy people may tell you) - then both dollar bills and treasury bonds are just different types of debt of the government. It just so happens that dollar bills have zero maturity and zero coupon (interest).
Once you understand that, it is only a short step towards asking why the hell everybody is so concerned about the federal government debt. If it was really desired, one could just swap all treasuries for dollar bills - and the only primary effect is that it changes the yield curve for government debt from almost zero everywhere to zero everywhere.
I find this fascinating. If you asked a random person (including myself three years ago) what would happen if all the government debt were paid off with paper money, they would tell you - slightly paraphrased - that the world would explode. But when you look into the technical details, you find that it's just this subtle change in the yield curve. So what's going on there?
It is an informal value transfer system used primarily in the Middle East and Africa.
Is there really no such thing in the west? Isn't "Western Union" essentially the same?
Given the world's energy situation, it's neither a smart nor a feasible "implementation" of alternative currency.
So if energy is scarce, then it becomes more expensive, so it's less profitable to run miners, so some people stop mining and Bitcoin automatically takes less energy to generate coins.
Maybe bitcoin could be upgraded to sha3, but it would probably require action on the part of every owner. Anyone who fails to upgrade in time would find their bitcoins have evaporated. Makes it hard to react in a short time frame, whereas a bank could, in the worst case, pull the plug and ban online transactions until they've upgraded.