Friday, January 31, 2014

The Implications of Bitcoin: Money Without Government

By Jon Matonis
Thursday, January 23, 2014

One of my favorite things about bitcoin is how it’s such an all-inclusive tent.

Bitcoin attracts political idealists from the right, political idealists from the left, Silicon Valley technologists, social science academics, philosophers, capitalists, socialists, and even apolitical speculators.

Alex Payne kicked off this latest round of analysis with his blog piece: “Bitcoin, Magical Thinking, and Political Ideology”. A self-described programmer and secular humanist, Payne worked as an early engineer at Twitter building the service’s developer platform and backend infrastructure.

Mostly, he criticizes Silicon Valley for its self-indulgent hyper-capitalism that lacks meaningful solutions to real-world problems. Oh yeah, and he specifically targets Chris Dixon, Andreeseen Horowitz, and their Coinbase investment.

Chris Dixon, Andreessen Horowitz’s partner on the Coinbase board, promptly shot back in defense with Why I’m Interested in Bitcoin where he disavowed himself of any libertarian ideology or “fantasies of a crypto-powered stateless future” and instead highlighted bitcoin’s technological promise in reforming the mismanaged financial system.

Personally, I prefer Marc Andreessen’s recent tribute in The New York Times, Why Bitcoin Matters.”

The divide between ideology and technology as the driving purpose behind bitcoin permeates the bitcoin investment community and the Bitcoin Foundation’s approach to public policy. Advocating and using a non-political monetary unit is a forceful political statement. Investing in a non-political monetary unit or its infrastructure companies is an equally powerful statement.

The bitcoin network cannot be separated from the bitcoin monetary unit and if the central bank, or the Federal Reserve in the United States, provided an important function, bitcoin would be unnecessary.

Carried through to its ultimate conclusion, the bitcoin unit competes with the government’s unit in a modern version of Hayekian currency competition.

More importantly, bitcoin is money without government: just as one cannot separate the bitcoin network from the bitcoin monetary unit, one cannot separate the bitcoin network effect from its central banking implications.

Personal Journey

My personal journey towards bitcoin began in the mid-1990s when David Chaum’s DigiCash company and technology debuted in America.

At that time, I was working in Silicon Valley at RSA Data Security’s new spin-out company, Digital Certificates International, that later became VeriSign. The new SSL encryption in Netscape browsers relied on these digital certificates for authenticating and securing web servers.

With Chaum’s DigiCash technology, for the first time ever, digital bearer features of physical cash could be emulated in software using cryptographic protocols.

This was pure genius and it hit me like a ton of bricks.

During the next two years, I started thinking through scenarios of monetizing equity mutual funds and real estate and how ideas like e-gold could be transformed into digital bearer instruments backed by gold, not just a ledger-based transfer system. I even published a research paper at the London School of Economics.

However, I quickly realized that the centralized nature of these two systems inherently gave them a limited life span due to a single point of ‘failure’ that could be used for suppression.

Predictably, the political pressures increased with DigiCash needing regulatory approval to operate as an issuing mint within a bank and then e-gold suffering a Department of Justice shutdown and asset seizure at the peak of its epic success.

My thoughts shifted to how precious metals and other commodities could be stored, assayed, and audited without revealing knowledge of their location. This proved to be a very difficult feat.

The Bitcoin Protocol Network Effect

In late 2008, five years ago, a developer named Satoshi Nakamoto devised a protocol which distributed trust across a decentralized peer-to-peer ledger and eliminated confiscation risk by replacing physical assets with a mathematical proof of work.

More than anything, it is these two features that would lead to bitcoin’s real world success because the system now had the attribute of survivability. When angels and venture capitalists invest in bitcoin-related business models, they are investing in a survivable protocol – a protocol that will survive political institutions.

Herein lies the dichotomy: how can VCs knowingly invest in a protocol that survives political institutions when it is those same political institutions that allow them to capitalise on their investments?

Money naturally operates like a virus and that makes digital bitcoin potently viral. It is viral cubed – money on the Internet with a network effect. A monetary unit does not stop expanding until it runs into artificially delineated boundaries or achieves widespread dominance.

It is naive to think that governments believe so much in competitive currencies that they would encourage and accept a digital monetary unit without a central issuer. Some smaller governments may believe in that, but only as a way to use it against certain other governments that currently have dominant monetary units.

What’s more likely is bitcoin growth in the developed world constrained by regulatory endpoints, legislative taxing powers, and bans on merchants, but only up to a certain maximum market cap for bitcoin. Sure, we’ll let it grow but not too much.

So what is that magical permissible level of adoption where going beyond that point jeopardizes central banking and monetary policy? Is it a $100 billion, $500 billion, $1 trillion market capitalization for bitcoin?

No one really knows, least of all the governments. A $1 trillion bitcoin economy may not be suppressible, but it definitely becomes a less friendly environment with respect to established political institutions.

I guess your viewpoint depends on what problem bitcoin is solving – high transaction fees and complex international remittances or the problem of central banking and the intertwining of money and state.

Fortunately, bitcoin solves for both. But, you can’t have one without the other. You can’t believe that central banks play an important and necessary role in society and also believe that bitcoin serves as a monetary solution.

I am pro venture capital. Building the bitcoin infrastructure around the world is important, but within certain jurisdictions it can also be a frustrating contradiction. The success of an investment depends less on the execution of a stellar management team and more on the degree of regulatory latitude. For venture capitalists, bitcoin is not like Facebook and Twitter where worldwide market saturation and dominance is the end game for the IPO home run.

Market saturation with bitcoin means that something else lost and it’s not a competing cryptocurrency. Therefore, it will be imperative for venture capitalists to remain astute about the evolving political landscape and agile enough in timing their exits.

Andreessen stated in The New York Times article that he’s with Ben and Milton when it comes to the promise of reliable digital currencies. However, Bernanke and Friedman were referring to digitized national units, not an alternative and independent numéraire.

The only plausible outcome may be jurisdictional competition. After World War II, wealth flowed to the US dollar as the world’s reserve currency.

Now, real wealth flows from the West to the East in the form of gold bullion and claims to natural resources. In the cryptocurrency future, wealth will flow to the regions that facilitate and exploit bitcoin’s massive potential for unleashing true economic growth.

Monday, January 20, 2014

Bitcoin Exchanges Go Local to Drive Adoption

By Jon Matonis
Wednesday, January 15, 2014

Much of the media attention surrounding bitcoin exchanges has focused on the larger global players, as they are the endpoints that have the majority of bitcoin’s trading volume.

This was satisfactory in the early days of bitcoin, as global price discovery was the driving requirement – but now there is a growing need for in-country exchange transactions, due in part to prevailing regulations.

A primary example of this can be observed by analysing the role of Coinbase. With a US-only customer base for buying and selling bitcoin, Coinbase is the leading domestic exchange in the United States. If you sign up, your account identity is closely integrated with your bank or credit union for superior ease-of-use.

However, Coinbase is not really an adequate exchange for bitcoin price discovery as its bid-offer spread is derived from wholesale partners, like Bitstamp. Also, Coinbase trading participants are confined to a single region, which reflects the demand and supply from that region only.

Separate functions

Price discovery and adoption operate as two separate functions within the global bitcoin ecosystem. The additional effort involved in establishing international exchange accounts may yield improved pricing, but at what cost?

Local country exchanges are simpler to use and they meet the needs of most local bitcoin traders. The larger international exchanges that provide two-way price quotes and accept deposit and withdrawal requests from around the world will always be around.

I predict that they will evolve into wholesale liquidity providers performing more of a clearinghouse role for the regional and domestic bitcoin exchange houses. Overall, global price discovery will be maintained.

Now, when we look at the local country exchanges, the precise role becomes slightly different: it becomes less about price discovery and more about ease of exchange and facilitating adoption.

One doesn’t go to a broker on the worldwide interbank forex market when they want to exchange pounds for dollars, they simply go to a local bank or airport currency kiosk. Increasingly, the ATMs in airports provide the best overall exchange rates for national currencies.

Similarly for bitcoin, users will tend to stay local even if that means paying a slightly higher price and commission. And, until bitcoin merchant acceptance is widespread, the localized exchanges and bitcoin ATMs provide an excellent way for global bitcoin travelers to acquire the necessary amount of local currency.

For example, some local bitcoin exchanges in Sweden have been setting up reputable physical offices for face-to-face exchanges.

Regarding person-to-person exchanges arranged at selected meeting places, I have written about before. They offer an incredibly useful service which will complement, and in many cases precede, local bitcoin exchange companies.

Local focus

The marketplace for bitcoin exchanges is rapidly maturing and taking on a more specialized and local role with specific features and languages. Depending on the jurisdiction, we will see things like Bitcoin ATMs, directories, and physical bitcoin storefronts.

Throughout all of this, the online bitcoin exchange will operate in the local language with tailored integration into that country’s financial institutions and payment methods.

In the Netherlands, the domestic exchange operates much the same as Coinbase with simple integration into a customer’s bank account. With just 10 major banks in the country, Dutch company Bitonic can link with all of them by just going through the iDEAL e-commerce payment network. Bitplaats exchange also operates in the Netherlands.

In Sweden, the country boasts at least four domestic exchanges that cater exclusively to the Swedish market for bitcoins, including, Safello, Kapiton, and FYB-SE.

Recently in India, it came to light that a burgeoning entrepreneurial class was driving bitcoin adoption in that country with domestic exchanges like buysellbitco, Unocoin, INRBTC,, and bitcoinex.

Hong Kong has probably seen one of the most rapid increases in bitcoin exchange activity. Outside of mainland China, Hong Kong operators enjoy access to a leading financial services center prompting many to speculate that it could quickly become a digital currency trading hub and pave the way into China. Both Bitfinex and ANXBTC are based in Hong Kong.

These are the exchanges that will be driving bitcoin forward in the developing world. Many of them are not really known outside of their local regions but they represent the trend unfolding in bitcoin trading volume where domestic retail exchanges cater to local needs and the global exchanges operate at the wholesale level.

The allure of the vast global remittance market has attracted entrepreneurs for years and the dream is slowly being realized as centralized and legacy infrastructure gives way to multiple bitcoin endpoints. We may not even notice the new network being built, but cross-border transactions in bitcoin operate on a 24-hour basis and they don’t require permission.

Soon, the domestic bitcoin exchanges in your country will start to seem as ubiquitous and pervasive as petrol stations or mobile phone stores. That will be a truly global network. The ultimate victory comes when received bitcoin is held and spent, not exchanged.

Sunday, January 12, 2014

What a Landmark Legal Case From Mid-1700s Scotland Tells Us About Fungibility

By goonsack
DGC Magazine
Monday, November 18, 2013

John Campbell of the Bank,
 cashier of the Royal Bank of
 Scotland, c. 1749. A banknote
 can be seen on the table.
Although the case in question (Crawfurd v. The Royal Bank) happened in the mid-1700s, I think it is highly relevant and bears nicely on the recent controversy surrounding CoinValidation. This post will also be of interest to anyone fascinated by the history and/or theory of money.

While this particular case involved paper banknotes (which arguably are irredeemably flawed) rather than a ‘hard currency’, it still illustrates nicely the rationale behind a decision which impacted a widely used currency at the time. Of primary consideration in this case was how its resolution would affect the usability of the currency (i.e. a facet from which currency largely derives its value).

As we’re probably all aware of by now, CoinValidation’s plan, if successfully implemented, would presumably lead to the blacklisting of some coins based on their past transfer history (e.g. having at some point been sent to/from deep web contraband marketplaces, having been paid as ransom to malware operators like those of CryptoLocker, having been stolen, having been allegedly ‘laundered’, having been associated with scams/ponzis, &c). In effect, this would destroy the fungibility of bitcoins. Some ‘clean’ coins would be easier to spend and transact with, while other ‘less clean’ or downright ‘tainted’ coins would be more difficult to use. Thus we would be left with a difficult-to-navigate and frustrating-to-use system whereby some coins are worth more than others (due to their varying spendability). And this largely defeats the purpose of a currency as a facile medium of exchange in the first place.

The case Hew Crawfurd brought against the Royal Bank of Scotland in 1749 had the potential for similar ramifications.

In 1748, Crawfurd sent two large-denomination banknotes, which he had made marks upon and recorded the serial numbers of, through the mail to an associate. Unfortunately the banknotes were not delivered. After enquiring as to their possible whereabouts with the banks, as well as posting newspaper advertisements, one of the notes eventually turned up rather mysteriously at the Royal Bank, although it wasn’t clear whose hands it had passed through to get there. Based on Crawfurd’s diligent recording and marking of the bills in question, however, there was no question that it was one of the two that were sent. Crawfurd was duly notified of the note’s reappearance.

While Crawfurd was eager to be reimbursed for his loss, his claim put the banks in an unenviable position. After all, they presumably had no knowledge that the banknote now in their possession was ill-begotten. Would it be fair to them to eat the loss? And more importantly, what sort of precedent might this set?
Kenneth Reid writes:

"The Banks’ concern is easily understood. If holders of banknotes were vulnerable to infirmities of title of which they knew nothing, then this would indeed be ‘a barr to the circulation’ of notes and hence a threat to the whole idea of paper money. And even if that position could be resisted—even if bona fide holders took an unblemished title—there was the further difficulty of assessing the holder’s state of knowledge. Crawfurd had marked the banknotes and advertised his loss. Must a holder be taken to know this and to realize its significance? ‘If’, the Banks reasoned, ‘the writing upon notes and advertising the numbers in the Publick Prints should be found sufficient to interpel people from receiving such notes in payment it would be a mean of putting an intire stop to the circulation of notes and of opening a door for frauds by malicious and designing persons’" (emphasis mine)

After hearing arguments from both sides of the dispute, judges ultimately decided in favor of the bank. The stated rationale for their decision largely rested on a distinction they made between money and real property, and how the terms of ownership should be established:

“The Judges, he wrote, were unanimous ‘that money is not subject to any vitium reale1; and that it cannot be vindicated from the bona fide possessor, however clear the proof [of] the theft may be’. Accordingly, ‘Mr Crawfurd had no claim to the note in question’. Thus was established the rule of bona fide acquisition of money in Scotland. The decision also relieved the Banks of the concern, raised once more during the litigation, that newspaper advertisement might ‘amount to a sufficient Interpellation to all the World’ as to deprive the recipient of good faith.”
1 ‘an inherent taint or defect in a title to property’
While the decision they penned rested on carefully crafted legalese, it is nonetheless accepted that other, more pragmatic, considerations undoubtedly influenced the judges’ decision. Reid writes:

“Policy issues, as might be expected, were highly prominent in Lord Strichen’s Report. Trade, it was argued for the Banks, rested on the free circulation of money, and free circulation rested in turn on the reliability of notes and coins. If Crawfurd was able to vindicate the banknote, no merchant could risk taking money in payment ‘without being informed of the whole History of it from the Time that it first issued out of the Bank or the Mint till it came to his Hand, which is so apparently absurd, that it seems hardly to merit a Consideration’. And as banknotes would thus be rendered ‘absolutely useless’, this would ‘in a great Measure deprive the Nation of the Benefit of the Banks, which could hardly subsist without the Circulation of their Notes’. It was in vain for Home to object that, just as people continue to buy goods despite the (slight) risk that they might be stolen and subject to vindication, so they would continue to accept money if the risks were the same. If money could be vindicated, counsel for the Bank of Scotland concluded, ‘no Man could be sure, that one Shilling in his pocket was his own, and both Banks might shut their doors’.”
(emphasis mine)

Of course there were probably many other factors at play here. Although Crawfurd was of some means, it’s likely that the bank was able to afford the very best representation in this case. Moreover, in Reid’s research paper (linked below) he even points out that there was a fairly overt conflict of interest between the banks (the issuers of notes) and the judicial system at that time in Scotland. Reid also points out that there was some Roman jurisprudence (a source for many legal arguments in the case) that would seem to have roundly supported Crawfurd’s case rather than that of the bank.

Regardless of whether one ascribes impartiality to the judges in this case, or even whether or not one thinks the case was correctly decided based on previous jurisprudence, there’s little question that the emerging paper currency system would have been greatly imperiled had the case been decided in favor of Crawfurd.

Putting aside the obvious flaws inherent in paper banknotes, which were widely adopted in Scotland after their issuance first began in 1695, they did enable trade and commerce to occur on a previously unprecedented scale, and with less friction than seen with previous monetary systems (i.e. precious metals). In a society without telecommunications, Internet, and cryptocurrencies, the paper banknotes (although low-tech by modern standards) were nonetheless an innovation in the transfer of value within the country.

We’ll never know exactly what would have happened if the judges, by their decision, had abbreviated the fungibility of banknotes, or ‘the absolute currency of money’ as one Scottish legal scholar put it. But it seems likely that they would have thrown the monetary system into disarray, and interrupted a medium for commerce that many had come to rely upon for their wealth and prosperity. Perhaps this would even have been a major setback to the economic development of the country. Certainly this was one major concern that the judges had to take into consideration.

At the time of the decision, some arguments in favor of the bank notably argued that tracking ‘the whole History’ of a given banknote would be so cumbersome to those transacting as to render the whole currency system useless. Ironically, the electronic and highly traceable nature of bitcoin does somewhat (though nowhere near entirely) mitigate this argument. But perhaps the more relevant question for today’s world is whether it is wise to entrust the adjudication of a given monetary unit’s history to some arbitrary entity. The deciders of whether or not a given unit has a ‘clean’ or ‘tainted’ history are given enormous power. Even the Scots arguing this case back in the 1700s recognized the danger this presented, in that it could lead to “opening a door for frauds by malicious and designing persons”.

Now we find ourselves at a similar crossroads as the Scots did… but instead of an intranational paper currency, there is potentially a decentralized, global value transfer protocol at stake. We must ask ourselves whether altering the monetary framework in order to punish lawbreakers and wrongdoers is something worth jeopardizing the very ‘currency of money’ for.

Luckily, in making this choice, we are not wholly subjected to the caprices of some empaneled judges. Ultimately bitcoin is controlled by the people. Ultimately we can vote with our money, in line with our values.

And while actively determining and participating in what may well be the future of money, I sincerely hope we all look to the lessons of the past for guidance.

For further reading, here is my source for this post:

Sunday, January 5, 2014

Price Discovery in the Absence of Bitcoin Exchanges

By Jon Matonis
Tuesday, December 31, 2013

Recently, authorities in India, China, Korea, Denmark, France, and Norway have issued stern warnings regarding the use and trade of bitcoin and other digital currencies.

As a consequence, important exchange outlets for price discovery have been slowed or shuttered following the government advisories. Furthermore, India and China represent nearly half of the globe’s total population.

The world has mostly underestimated the latent demand for a free and nonpolitical currency unit. In the face of this percolating demand, the arrogance of our monetary overlords is startling.

Imagine if we were forced to use a particular brand of toothpaste in the same way that we are coerced into using the prevailing unit of legal tender. The response might not be so submissive. Contrary to the misinformation in this article, bitcoin is not illegal in any country in the world.

In two separate incidents following the Reserve Bank of India advisory warning, trading operators’ premises were raided by the Enforcement Directorate (ED) citing a clear violation of Foreign Exchange Management Act (FEMA) rules. A top ED official said:
“We have found that through the website 400 persons have recorded 1,000 transactions that amount to a few crores of rupees. We are gathering the data of the transactions, name of the people who have transacted in the virtual currency from Gupta’s server that is hired in the US. At present, we believe that this is a violation of foreign exchange regulations of the country. If we are able to establish money laundering aspect then he can be arrested.”
In the days ahead, the ED will be challenged either to define bitcoin as a currency or to clarify the nature of bitcoin as an asset under Indian law.

Also, the South China Morning Post reported that China’s central bank met with payment processors on 16th December, ordering them to “stop giving clearing services to bitcoin, litecoin, and other cryptocurrency exchanges”.  The payment processors were ordered to sever their relationships with bitcoin exchanges by the end of January.

This action had a significant impact on bitcoin exchanges in China, such as BTC China.

In Korea, financial authorities announced that “the virtual currency does not have ‘intrinsic value’ due to its lack of stability while there is concern at the absence of structure and indicators to measure it.” Participating government agencies discussing the impact of bitcoin included the Ministry of Strategy and Finance, the Bank of Korea, the Financial Services Commission, and the Financial Supervisory Service.

In Denmark, Michael Landberg, chief legal adviser at the Financial Supervisory Authority in Denmark, said the most likely outcome for bitcoin exchangers would be an “amendment to existing financial legislation so that we have regulation covering it.”
Landberg added:
“It is also important to have this included in money laundering acts. We’ll seek to follow the mainstream. Bitcoins are not forbidden in the US and the UK It is out there and will continue to be out there. It just needs to be regulated. The challenge for us is how to do that.”
Currently, Denmark’s FSA doesn’t have the legal authority to prevent trade in bitcoin rendering it unable to stop a company that exchanges real currencies for bitcoin.

A report from the Bank of France said: “Even if bitcoin does not today meet the conditions to become a credible means for investment that could therefore threaten financial stability, it represents a clear financial risk for those that hold it.”

Warning that the use of bitcoins as an investment tool is limited because there is no underlying asset and the virtual currency is subject to high volatility, the central bank said speculators are at risk, as they would have no legal recourse if there is a loss of confidence in the cryptocurrency or if they are victims of theft from hackers.
According to the Bank of France report:
“The system can collapse at any moment if investors want to unwind their positions but find themselves holding portfolios that have become illiquid.”
In Norway, the director general of taxation, Hans Christian Holte, said the currency “doesn’t fall under the usual definition of money.” Instead, the Norwegian government decreed bitcoin to be an asset upon which capital gains tax can be charged.

Even the European Banking Authority (EBA) weighed in with its own report on virtual currencies warning consumers that they are not protected through regulation when using virtual currencies as a means of payment and may be at risk of losing their money.

These various warnings from around the world have not yet affected the larger price discovery mechanism for bitcoin which still occurs in certain jurisdictions. But, what if exchange-based price discovery for bitcoin was impeded in the future. What would be the price setting mechanism for conversion in and out of national currencies?

Just as with other restricted or ‘banned’ goods around the world, bitcoin trade would react by going local and going to a person-to-person model, such as Additionally, small exchanges in certain countries would still cater to a local population in jurisdictions where crackdowns were not prevalent.

It might not be easy to chart aggregated price quotes from hundreds of small operators, but price discovery finds a way like water finds a way to flow downhill.

These global authorities are genuinely afraid of something like bitcoin with its limited issuance model and distributed trust architecture not requiring intermediaries.

However, they don’t fear it because of the potential for money laundering, terrorist financing, or harm to unsuspecting consumers. Authorities fear bitcoin because it threatens the adherence to their fabricated monetary illusion.

The genie is out of the bottle and centralized banking institutions are no longer seen as necessary for the provision of an exchangeable monetary unit. This cuts to the core of government’s power and prerogative of issuance, making bitcoin primarily a central bank concern – not a money laundering concern.

Some may attempt to harness the genie in the name of innovation and consumer protection, however the power of bitcoin will prove too difficult to contain. The best solution from authorities will be to accept the changes and to modify political behavior around a forthcoming model of decentralized currencies.

Saturday, January 4, 2014

The Universe Wants One Money

By Oleg Andreev
Friday, June 28, 2013

In this post I address issues of competing government currencies, competing private currencies, gold, silver, bitcoin and alternative “crypto-currencies”.

We all know that variety and competion is a good thing. We all want slightly different things, value the same things differently or make different trade-offs. That’s why we have a wide variety of products, prices, quality, colors and materials on the market. Interestingly, money is different. We all want one single universal money. It may not be obvious to many people, so let me explain.

How money is different from everything else? On one hand, money is just an asset. You can produce, buy, sell or hold it. On the other hand, money is a medium of exchange. It allows you to trade your 8 hours in the office for a new iPhone. It also allows you to delay consumption decision. You can spend 8 hours of work today, but then be free to decide when and for what to spend your salary. If suddenly you need to buy a ticket to Hong Kong, you can do it without working extra couple of hours to earn it.

The function of money is to exchange the widest variety of products between each other. iTunes credits allow you to choose between many songs. This make them money to some degree. But dollars are even better money because they can buy all those songs, but also a myriad of other things as well. Therefore, people tend to keep savings in dollars, not in iTunes credits.

It seems obvious that the best money is the cheapest and the most widely recognized and accepted one. Cheapest in a sense of handling it. If your money is a huge stone you have to carry around, it is more expensive than a small gold coin (provided they both have the same price in terms of goods they can buy). Piece of paper named “gold certificate” could be even cheaper than gold itself, but carries a risk of fraud, so in some cases it could be even more expensive to hold than the gold itself.

For a huge part of the civilized human history we used two metals as money: gold and silver. They were not perfect, but universally accepted and recognized. All other things like seashells, diamonds, IOU papers were less universally recognized, so they were naturally used in some very niche markets while everyone was keeping cash in gold or silver.

Both gold and silver were durable, easy verify, easy to cut and melt together, compact enough to be stored and moved around cheaply. And they were very hard to obtain, so there was very low inflation cost (every new gram of gold created eats into everyone’s savings because it increases purchasing power of its owner comparing to everyone else around). Other things were either easy to produce, or not durable, or hard to split in arbitrary parts.

Why gold did not outcompete silver? Or vice versa? That’s because they both had weight. For small purchases gold would have to be split in tiny difficult to handle pieces, while to make big purchases one would need to move several kilograms of silver comparing to much smaller amount of gold. This naturally created two parallel global markets: one for small purchases where the silver was used (and small droplets of gold would be impossible to handle) and another market for big purchases where silver was too heavy, so the gold was used instead.

Make a thought experiment now: if there was a gold-like metal that allowed moving both big and small amounts equally cheaply, it would be useful on both “small” and “big” markets. Thus it would be more marketable (more exchangeable) which by definition would make it a better money. Better than gold and better than silver. People would then tend to keep their cash in that magic metal because it would allow them access to bigger variety of goods: from bread to houses. And they would not lose money on conversion rate like when they sell some silver for gold or the other way around.

There was a competition in private coinage. Kings and private merchants were making their own coins in gold and silver and selling them for premium. The well-recognized coin was easier store and to verify if you trust the issuer. Instead of measuring each coin, you could simply read the number on its face. Names like “dollar”, “pound sterling” and others were all names for private coins or bullion and meant particular weight of the metal. That is, dollar was not some sort of separate money, it was simply a name for a certain amount of silver, like “gram” or “ounce”. The money was still the same — gold or silver, but there was a big variety of shapes of that money.

Of course, gold and silver were still quite limited. You could not drop a bag of gold across the ocean. That’s why people invented banking. Bank was simply a warehouse for your metal. You give them gold, they give you a receipt. Then, if the bank had good reputation and connections with other banks in the world, you could transfer those receipts of any face value quite cheaply anywhere. The only real cost was trust in those banks. Because if the bank is robbed or steals your metal, your receipt becomes worthless. If the bank prints additional receipts for the same amount of metal, the value of your receipt goes down proportionally (or you face a risk of bank run, when more people try to redeem their receipts than is available in the vault).

In old days, private currencies were simply those receipts for gold or silver. Each currency could have different name and different reputation. Bigger bank’s notes had more value on the market because they had less risk associated with them and as a result, wider acceptance. But ultimately, they all were receipts for the same metals that you could redeem at any time and move to any bank or under a mattress. Because people valued receipts only for their ability to represent readily accessible metal. Without the metal, those pieces of paper would be worthless.

Today things are different. After several huge economic disasters created by the governments of Russia, Europe and U.S. in the beginning of 20th century, we now have state-issued money in almost every country with a nice twist that now the money is not redeemable for metals. People use that money, though, because various controls and regulations make it almost impossible to use gold, silver or respective certificates in daily transactions. Every bank needs expensive license and must not be very creative at what it can offer to its clients.

Dollars can buy things in U.S., euros can buy things in E.U., but if you try to use them in inappropriate places, you would have to pay very high conversion fees. (Setting up your own clearing house or exchange with the lowest fees is not possible due to regulation.) It should be clear now that if, for instance, U.S. Dollar can buy more than Russian Ruble, Russians would tend to use Dollars in daily life. The reason why it does not happen anymore (it used to during liberal times in the 1990s) is stricter controls on currency exchange that make it illegal to price goods in dollars and expensive to exchange currencies frequently. For the same reason, gold and silver are not used: they are too expensive or illegal in some contexts, or there is a huge risk and cost on those who are going to store them. Several years ago, Liberty Dollar, alternative silver-based currency was shut down and all silver was confiscated by U.S. government. Founder was pronounced guilty of “making, possessing, and selling his own currency”.

Here we do not discuss whether it is good or moral to make your own currency or store other people’s money. The point is about demand for a single, most universally accepted money. If gold, silver and foreign currencies need violent intervention to not be used, it’s only a proof of existing demand. Because if there was no natural demand, no government would care setting up restrictions in the first place.

Now we enter crypto-currencies. It is a fancy name for Bitcoin and its many clones based on the same source code. Bitcoin itself is very different to ubiquitous government money, application-specific “credits” (like in multiplayer games) or gold and silver. It is absolutely digital, does not have a single controlling entity and is very cheap to store and transfer both huge and tiny amounts of money. This property makes Bitcoin very useful on certain markets: be it illegal market, or “sending money to family in another country”, or a market where banking is unavailable or too expensive.

What about alternative Bitcoin-like currencies? They all provide the same security risks and benefits. Nominally, they all have different divisibility (so called “larger number of coins”), but at the scale of trillions of smallest units in total money supply extra divisibility does not really matter.

Economically, all Bitcoin clones (altcoins) have the same problem: they all have much smaller market exposure than Bitcoin while not technically superior. When people decide in which one to keep their money, they would keep it in the money with the biggest market. There is not point in “diversification” in the long term. If Bitcoin fails for some reason, all its clones fail for the same reason automatically. If Bitcoin works well, any amount in altcoins is simply inferior in its purchasing power. It does not mean there won’t be any market. You can always keep some empty plastic bottles for selling later, but the bottles can only buy cash, while cash can buy anything.

Second problem of alt coins is mining. In the long term, any miner will throw 100% of computing resources into the most profitable currency. Even if Bitcoin is only 1% more profitable than Litecoin, since there is no fundamental difference between them, all the resources will be thrown into Bitcoin. In the short term, there are plenty of enthusiasts who find themselves equipped with a lot of outdated GPU hardware that was once used for Bitcoin, but now cannot compete with specialized ASIC hardware. These people now mine Litecoin in short-term expectation for any amount of reward. It is sort of a private club of people trading in their own funny money. All new miners devote all their energy to Bitcoin, while people who will sell or retire their GPUs will make Litecoin network weaker and less technically stable.

In the end, it is clear that we want the single money to be able to sell anything and buy anything. We all want it to be cheap to store, move and verify. And secure. With as little trust in middlemen as possible. Today we find ourselves with a lot of artificial barricades in the sphere of money, which causes artificial demand for various local currencies. Gold is being seized or moved from the country. Foreign currency is prohibited for merchants to price their goods at. Legal tender laws force you to accept government-issued currency as a payment for debts.

Regulations and licensing limit variety of private currencies or money substitutes. But all that trouble only proves almost universal desire to use the single virtual entity for buying food and saving for the future. Bitcoin gives us a mechanism to overcome all these regulations and trade as freely as was ever possible. Maybe it will allow us to achieve that single, most marketable entity that we all so desire.

Reprinted with permission.