Andrew Sorkin wrote “Render Unto Caesar, but Who Backs the Bitcoin?” at Dealbook NYT, which was also reposted at SMH Business Day, and I feel the need to write a rebuttal.
How can bitcoin be anything but a passing fad?
It might not be a fad for a few reasons: It’s a better form of money that allows instant and almost cost-less value transfer anywhere at anytime and it allows improved functionality that is not otherwise possible e.g. coloured coins, microtransactions, escrow and more.
If it all feels a bit like a 1999-style craze, that’s because it is.
Nobody would argue that the rapid uptake of new technologies like email was a ‘craze’, because email legitimately has value to society. Likewise, bitcoin legitimately has value to society because it helps create cheaper, frictionless transactions and is programmable money.
But bitcoin aspires to be much more than a collectible, or frankly, even gold. It aspires to be a universal electronic currency. On that score, it is unlikely to succeed.
This is an ‘all or nothing’ fallacy. Bitcoin doesn’t have to become 100% of the world’s money supply, and I doubt that it ever would become that. I could simply argue that Bitcoin may someday become 1% to 10% of the world’s money supply.
Let’s start with bitcoin’s value — or more accurately, the volatility of its value. Which merchants in their right mind are going to accept a currency that seemingly changes its value in wild swings every other day?
There are now many bitcoin payment processors (e.g. Bitpay, Coinbase) which offer merchants the ability to accept bitcoin for their goods/services, without actually having to accept bitcoin themselves. The payment processor accepts the bitcoin, does the currency translation on their back end and gives the merchant back exactly the amount of USD/AUD/other fiat currency that the merchant initially charged for the good/service. Yes, that’s right – zero exchange rate risk to the merchant. Because of how bitcoin works, this also includes zero chargeback risk (bitcoin transactions are irreversible), and greatly chance of the customer’s identity being stolen since bitcoin is like cash for the internet.
As for volatility in general, this will most likely decrease over time as the market expands. Why is this? Because it’s easier to move a $10B market than it is to move a $10T market. i.e. as the total market expands, it requires either more bitcoins or more money to create the same percentage price moves up/down.
Then there is the issue of how limited the supply of bitcoin truly is… The algorithm limits the total number of bitcoin ever mined to 21 million units.
Andrew calls this an issue but he doesn’t provide any economic reasoning as to why it’s a bad thing that the supply of a form of money is scarce. Andrew, I put it to you that money is supposed to be scarce. This is one reason why we don’t use grass or rocks as money. Because the overall effect of bitcoin’s currency supply may be deflationary, its value may rise over time – but this is not an issue as each bitcoin is currently divisible to 100 million pieces (called satoshis), and this can be subdivided even further if necessary in future. So we could just pay for things in 0.00001 of a bitcoin, and it’s really not a big deal because we can just give them nice easy names like ‘centi’ or whatever to signify certain fractions of a bitcoin. As for the general case, deflation in a sound money environment is actually good and for more on this, see my earlier post: “I heard deflation is bad!”.
But there is no Bernanke (or Janet Yellen) of bitcoin. Nobody knows who created it and no one controls it. That’s supposed to be a benefit.
Yes, decentralisation is a benefit because it means your purchasing power is not centrally inflated away from you. Nobody is forcing you to buy in to bitcoin anyway. As for nobody knowing who created it – that’s not a big deal since the code is open source and freely available to view by anybody. As for nobody controlling it? This statement isn’t accurate, the bitcoin software is coded by many different developers, and the bitcoin network generally works on consensus and only changes at the behest of the whole community. I recommend you read the bitcoin FAQ.
It’s also why the currency is often associated with illicit sales.
This is a meme that gets dragged out in almost every bitcoin article, and while there may be some people transacting in it for drugs etc – there are many many more people transacting in USD for drugs. Are we going to talk about the USD being used for drug trade in every article about the USD too? The vast majority of the bitcoin economy is made up of people transacting for legitimate goods, or people who wish to use it as a store of value or speculative investment – these are all legitimate uses of money.
But if, and this is a big if, your peer-to-peer transaction doesn’t work properly, there is no central clearinghouse to complain to.
Nobody said bitcoin was perfect. Just like nobody said the internet is perfect, but the benefits obviously outweigh the costs. Besides, these kinds of complaints will be dealt with over the years as more entrepreneurs come into the bitcoin economy, and start offering ‘bitcoin bank’ type services as a layer over the bitcoin protocol. Risk of coin loss can be mitigated through insurance, and these bitcoin banks can provide an easy to use front end for the less tech-savvy, while the more techy/hardcore bitcoiners can “roll their own” solution. This can be analogised to how the invention of the desktop computer meant that people could have personal computers rather than having to go visit the library to use a big clunky mainframe computer. Nobody’s forcing you to use one or the other, you have the choice.
Finally, there is the question of what happens if other alternative digital currencies also rise.
I think you’ll find that most people in the bitcoin community welcome free market competition. If bitcoin gets replaced, that means it probably got replaced by something even better. That ‘even better’ currency hasn’t appeared yet, so we’re mostly happy to use bitcoin for now. There are good reasons to believe that alternative coins currently do not offer significant advantages, and they currently lack a strong network effect and infrastructure to help drive use/acceptance/adoption. For more on this, see The Problem with Altcoins.
Can you imagine a world in which we all transact with dozens of different currencies every day with different rules? Neither can I.
How silly – you don’t happen to mean the same world where dozens of fiat currencies currently exist and are exchanged on forex markets? Where payment processors exist that can do the conversion for users/merchants? Oh, because in that world, an infrastructure exists to deal with multiple fiat currencies. So dream a little bigger Andrew, imagine a world where infrastructure (mostly computer software) exists to help deal with multiple cryptocurrencies, and you will see that this is not insurmountable at all.
As for Andrew’s final two paragraphs:
In truth, the best bitcoin can hope for is to be a second-rate version of gold, if that. And Warren Buffett once described gold this way: “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
That’s pretty much the way a Martian might think about bitcoin.
I don’t think Andrew or Warren Buffett have correctly understood the economic reasons behind using gold or bitcoin. Now for the long version of this I strongly recommend you read Konrad Graf’s “On the Origins of Bitcoin“, but in the interest of brevity I’ll write a shortened version here:
Just how there is a market for goods and services, there is a market for ‘good types of money’, and things may compete to become money. Money solves the double coincidence of wants requirement/problem (e.g. “You want my chicken but you only have bread? I don’t want bread, but I’ll take gold if you have it, since I know I can later exchange gold for other things I want”). Over time, people notice that other people start to use goods ‘as a money’, for various purposes (e.g. unit of account, medium of exchange, store of value). We can identify certain monetary attributes that would be useful in money (e.g. divisibility, scarcity, transferable, fungible, can’t be easily counterfeited, easily identifiable) and ‘good moneys’ will have these attributes. It is for this reason that gold/silver have served as money for thousands of years, in virtually all cultures around the world. Bitcoin’s monetary attributes in these things are superior, which is why there is an underlying economic incentive to use/accept bitcoin even though it’s intangible and “not backed by anything”. So to an outside observer, yes it may look odd – but there are economic reasons which may not be apparent to that outside observer.
Another factor to consider is monetary network effects, as people realise that other people are willing to accept a good as a form of money, they become more willing to accept it as money themselves. How do we see this in the real world? We can look at bitcoin user adoption and merchant acceptance, which is exponentially increasing over the years. For examples of these, see here and here.
I don’t want to come off looking like I think bitcoin is infallible – there are stronger criticisms or reasons to doubt bitcoin, however Andrew has not given any of them. If you’d like to see examples, I list some in an earlier blog post, such as: A massive undiscovered vulnerability in the code or cryptography, possible difficulties with scaling the bitcoin network up, Competitor cryptocurrency (or other form of money) which is significantly improved in such a way that bitcoin cannot copy the feature. To me, these appear to be possible, but unlikely – so that is why I’m overall bullish on bitcoin.
Borrowing a line from reddit user kovaniac: Have you ever seen a deflationary currency being dropped in a pool of inflationary currencies, backed only by bankrupt states? Neither have I, but I do expect it to be a spectacle.