Wednesday, June 1, 2011

Bitcoins and the Separation of Money and State


[This piece was originally written and published for "The Refinery," Silver Circle's official movie production blog.]

Fans of Silver Circle are well aware of the calamity that is the US dollar – a currency in the slow process of realizing its own death.  The film explores a possible not-too-distant future where the dollar’s collapse begets an underground economy in which silver becomes the new money (not too outlandish, considering silver and gold used to be America’s money).

But, markets are often unpredictable things. Perhaps some medium of exchange other than precious metals could come to prominence in a post-dollar world. Perhaps an entirely new form of money may emerge, and perhaps that money is already here.

Enter Bitcoin.

What in the world is Bitcoin? Sounds nerdy.
Bitcoin IS nerdy, but so was the internet before it became sexy… and if you like money, Bitcoins are even sexier.

Broadly speaking, Bitcoin is a completely decentralized digital monetary system. The “coins” themselves are encrypted codes, and they exist on users’ physical computers stored in a “wallet” file. It’s like cash in your pocket.  

But unlike cash, an owner of Bitcoins can literally send her coins to someone else anywhere, anytime, with no transaction cost, no “clearing house” that might freeze or impede the transfer, and total anonymity. Review that sentence again and you’ll understand why Bitcoin is a big deal.

There are a few caveats: “instant” really means “up to an hour,” and one may pay a small fee (much less than 1%) to have a transaction processed more quickly. Anonymity can be achieved with basic precautions, but is not fool
-
proof. Backing up one’s wallet is also recommended, as Bitcoins can be lost forever (again, like cash).

So Bitcoins are special codes that can be traded securely from one computer to another over the internet. But does that make it a “money?”

Bitcoins as Money
For something to be used as money, it must be valuable. Why are Bitcoins valuable? Why would anyone want them in the first place? The answer is simply that they possess the very attributes that make any medium effective as money, just as the attributes of gold and silver make them monetarily useful.

Just like gold and silver, Bitcoins are divisible (down to eight decimal places, actually), homogenous (every Bitcoin is equal), durable (they don’t decay), portable (extremely), identifiable (hard to counterfeit), and scarce. Unlike gold and silver, Bitcoins can be transferred across the world instantaneously and a zillion dollars-worth can fit in your pocket.

On the topic of scarcity, there will never be more than 21 million Bitcoins in the universe, 6 million of which exist currently. The mechanism by which they’re produced isn’t crucial for this introduction, but it’s important to understand that Bitcoins are produced on a predictable pattern of diminishing inflation (whereby inflation will end at zero percent). The USD and all fiat currencies, by comparison, are produced on an unpredictable pattern of increasing inflation (whereby the currency itself will end at zero value). Anyone who dislikes having their wealth stolen from them by a central bank may well be interested in this feature.

Enough econ talk, we understand that these nerdy Bitcoins can be effectively used as money, but who cares?

Governments will care, and this is where the idea gets interesting.

Bitcoins and Governments
You can be sure that Bitcoin will be impugned for enabling illicit activities. Drugs, gambling, prostitution –  all these industries (and others that are actually bad) could benefit from using the new money. And yet, plastic baggies make the drug trade more efficient;  playing cards enable gambling; discount hotels drop the transaction costs of prostitution –  should the mere fact that a particular invention advances a distasteful industry make the invention itself distasteful?  

Effective tools can be used for both good and bad behavior, and only a fool would try to ban the tool itself .  We can thus expect that Congress will try to ban Bitcoin– sacrificing the good it will do for people and markets in order to reduce the harm to central banks and fiat currencies.

Yet fixating on the illicit uses distracts us from a more important discourse. To truly understand the revolutionary nature of Bitcoin, one’s focus should be squarely on its decentralization. There is no central organization keeping track of transactions. That important function is handled by the peer-to-peer network as a whole. This means the government may not stop Bitcoin usage without shutting down the entire internet (though it could certainly try to prosecute vendors who publicly accepted Bitcoins – and this is no minor concern in the U.S.S.A.).

This decentralization also means the government cannot inflate or otherwise “manage” the money supply.  It cannot centrally control the most crucial part of an economy – its monetary system. In fact, the government can’t even determine who possesses Bitcoins, so long as the user is careful with her identity.

Bitcoin enables users to realize true monetary freedom and privacy, with all the benefits and concerns inherent in such a system. Free markets and free people (redundant terms) everywhere should rejoice.

Others will be less enthused.

Central planners will be infuriated by the crippling effect of Bitcoin on their authority and ability to control. Bernanke will complain at the sudden loss of the Fed’s economic hegemony.  There will be YouTube videos of Geithner tilting his head forward and looking serious as he addresses Congress. Paul Krugman may throw a tantrum. His paper, the New York Times, will explore how Bitcoins hurt the children and kill old people. The pretty girls on Fox News won’t get it until Bitcoins arrive in the mail as credit cards. The banking cartels – perpetually in bed with the government – will not be pleased. The IRS? Let's just say its thievery will be more difficult.

One can imagine that every authoritative force in the world may bear down on Bitcoin if it grows in popularity. The countervailing power will be capitalism itself – the incessant need of men to produce and trade toward efficiency with effective and honest money.

The Real Impact of Bitcoins
In the same way that “a nation of laws” is preferable to a “nation of men,” an economy of lawful money is preferable to an economy of fiat. Lawfulness is here derived from a kind of natural law written into the coding of Bitcoin – and this natural law cannot be manipulated at the whim of anyone, no matter how benevolent and wise they perceive themselves to be.

With Bitcoin, a man in London can send his friend in China a payment at the click of a button and the exchange is between the two of them, administered by the entire peer-to-peer network. The full value sent by one is received immediately by the other. The exchange doesn’t pass through a bank, nor through PayPal. It doesn’t pass through border check points, nor the clutches of hungry and murderous governments. It’s not carried via courier nor armored truck. It is efficient.

Bitcoin enables a kind of global free market that has never been possible before, and it arrives at the twilight of the United States’ fiat dollar. That is why Bitcoin is so relevant.

Like all new and disruptive things, Bitcoin is more likely to fail than to succeed. There are a million reasons why it could fail. However, if it does succeed, the ramifications will be of the magnitude of the internet itself and if one understands money one realizes this is not an overstatement.

If the “separation of money and state” is a familiar concept to the next generation of schoolchildren, Bitcoin will have succeeded.
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