Monday, January 26, 2015
Note: Excellent audio version is available on SoundCloud.
Bitcoin has its share of critics and skeptics, and opposition to the emerging technology – especially among the intelligentsia – shows no sign of abating.
Notable commentators on the topic range from author Jeffrey Robinson to finance blogger Karl Denninger, Boston University professor Mark Williams, rabid Keynesian Paul Krugman, Austrian economist Gary North and FT Alphaville's Izabella Kaminska.
Generously, I'm assuming that the pundits listed above have a thorough and accurate understanding of the bitcoin protocol that facilitates its native token's dual role of currency and commodity.
Typically, the arguments put forth by an elite group of critics like this could be easily attributed to a lack of economic credentials or real-world experience in sophisticated financial markets. But that is simply not the case here – which makes it all the more puzzling to comprehend. Since the various critiques fall short on any convincing economic analysis, I suppose one could put it down to mere philosophical differences on the origin and nature of money.
With the resilience of distributed peer-to-peer networks amplified by powerful public key cryptography, we are all in new territory now; the world stands on the precipice of a fundamental realignment in the transfer of value. At its root, bitcoin is a value transfer protocol. We may voluntarily choose to utilize it or not. Most importantly, there is no coercion imposed through legal tender laws.
Value is subjectivePerhaps most disturbing to the bitcoin critics is the fundamental myth that bitcoin exposes – the myth that the State confers value on money and that we need 'kings' to coin our money.
We are constantly reminded by the critics that money can only be a legal creature of the State and that it is the "civil society system which puts the value into currency". Expounding on the thesis advanced by German economist Georg Friedrich Knapp in The State Theory of Money (1924), an exposé advocating the Chartalist approach to monetary theory claiming that money must have no intrinsic value and strictly be used as tokens issued by the government, these modern-day chartalists promote the notion that only governments and sovereign issuers have the ability to confer legitimacy to money.
A belief in central banking is also a belief in the central planning of an economy. Additionally, it represents central planning of the highest order, because it interferes with the market's price discovery process for money – the rate of interest.
As the antithesis of central planning in money, bitcoin gradually achieves more and more market-based legitimacy. Institutional and government legitimacy are not required for bitcoin to serve as store of value, medium of exchange and unit of account.
Kaminska's first piece on bitcoin in early 2013 highlighted a fairly good interaction between Chris Cook and an Austrian economist on the intrinsic value debate. Here's more on subjective and intrinsic value with Willem Buiter, chief economist at Citi.
Volatility is a red herringBut wait, isn't all this volatility damaging bitcoin and its reliability as a store of value and medium of exchange?
As bitcoin grows and matures, multi-jurisdictional exchanges will emerge which also include specialized derivatives products for hedging risk and this will have the effect of increasing market capitalization and smoothing out price volatility. Bitcoin swaps are already being conducted over swap execution facilities.
Although important, the speculative volatility is actually a sideshow to the main event of bitcoin establishing a footing in the financial world. Even at a mere six years old, bitcoin exhibits no more volatility than the luminary Swiss franc or North Sea Brent crude oil, with the latter losing more than 50% of its value in about six months.
Fear not deflationBut what about the hoarding of bitcoin? Isn't that bad for its use as money?
I prefer to call it savings and maybe it's time to unlearn all those lessons taught in school. Savings and deflation are not bad for an economy. As Jörg Guido Hülsmann once said: "We should not be afraid of deflation. We should love it as much as our liberties."
Contrary to the central banking and political class insistence that deflation must be prevented at all costs, an economy with a monetary unit that increases in value over time provides significant economic benefits such as near-zero interest rates and increasing demand through lower prices.
Ultimately, the market will reach an equilibrium between investment and savings because in the absence of an equilibrium the benefits of a savings-only strategy would evaporate. Proper economic growth through sound investments will lead to a productivity-driven deflation.
Ironically, it's the store of value function for bitcoin which enables and reinforces its use as a medium of exchange. According to Daniel Krawisz of the Satoshi Nakamoto Institute, hoarders give bitcoin value and he states that "the initial price of bitcoin was caused by people who wanted to hold it, not people who wanted to spend it. Furthermore, each subsequent step in bitcoin’s advance must begin with more holders, not more spenders."
No naked shorts, so farI am continually amazed by those who shout "market manipulation" yet fail to see the very blatant manipulation they abhor present in the naked short selling of precious metals and in the Plunge Protection Team. We all know the world's most important trading desk sits on the 9th floor of 33 Liberty Street.
Kaminska writes: "Bitcoin markets are a hotbed for unscrupulous market practices. Everything from HFT, front-running, rebating, preferential order flow, poor margining, naked shorting, and now the truly popular one – active 'collusion' by big players. It’s all there."
In reading this, you would be forgiven in thinking that Kaminska might also be referring to highly-regulated markets populated by the likes of MF Global and the interest rate rigging cartel of RBS, Citigroup and JP Morgan. She is not. Certainly Kaminska doesn't condone that type of market activity, but that's not really the point.
The point is that we have a brand new marketplace, for a digital bearer instrument no less, germinating in parallel to the entrenched incumbents and along the way battling the retail and wholesale payments oligarchy as well as the vested interests of legal tender threatening bans. Of course, the bitcoin exchange markets experience illiquidity, lack of market depth, and a few bad actors willing to exploit such conditions. They are in the vanguard of cryptographic security architecture for dynamically-connected bearer wallets.
Fraud on any level, whether State-sponsored or from malicious principals, has no excuse and should not be tolerated. The solution is not to ensconce the new exchanges in the straight-jacket of the perceived level playing field with too-big-to-fail benefits and socialized losses, but to encourage multiple competitive exchanges across multiple jurisdictions. We wouldn't have the COMEX tail wagging the spot market dog if we had robust precious metals derivatives markets on every continent.
With bitcoin and exchanges, it's all about jurisdictional arbitrage.
Should we really believe that the two young founders of Bitstamp match the antics of Jon Corzine? After all, episodes like Bitstamp are not due to an orchestrated crisis of liquidity.
But who will protect the people?The European Banking Authority published their report on virtual currencies complete with a risk drivers chart of 70 bitcoin risks, which was promptly hailed by the FT Bitcoinmania crowd.
For a sane and thoughtful response, we turn to Ken Tindell, who believes that the "EBA’s considered opinion is that European financial institutions should shun bitcoin like a dead skunk and go nowhere near it until the 'scheme operators' are persuaded to change bitcoin to be managed by a wise and omniscient regulator." He concludes that the EBA doesn't really understand bitcoin and they exaggerate the risks to support a mandate which deters financial innovation unless it fits into their limited construct.
In the United States, the Consumer Financial Protection Bureau did the same thing with the publishing of its advisory warning to consumers about the risks of virtual currencies.
To better assist consumers, I described some of bitcoin's superior attributes in the area of financial protection, because when the words 'financial protection' are in your agency's official name, it appears disingenuous to omit features from what may be one of the world's most protective financial instruments ever designed.
In no particular order, bitcoin provides protection from counterfeit bank notes, protection from financial surveillance, protection from identity theft, protection from physical loss of assets, protection from cross-border restrictions and excessive fees, protection from payments blockades, protection from government-sponsored inflation, and protection from confiscation. Can your currency do all that?
Furthermore, without a central bank and without taxpayer-funded deposit insurance, it is somewhat comforting to know that bitcoin's lender of last resort is the same as the lender of last resort for gold – those silly believers of subjective value.
In the province of financial journalism, bitcoin unmasks the Statists.