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Bitcoin keeps making the news

There has been a lot of commentary in the general news recently about Bitcoin, the digital currency that its creators and users hope will have the same, inelastic qualities ascribed to such things as gold. At a time when mainstream, fiat money has seen its value trashed in certain cases by central banks’ money-printing policies, it is easy to see the attractions.

But what the hell is Bitcoin? How does it work? And what do free marketeers of an “Austrian” bent make of it? Well, here is an essay by Jeffrey A Tucker, which I think is well worth reading.

Bitcoin is certainly making the news at the moment, judging by some very sharp market movements over the past day or so. Even if it turns out not to be quite as successful as hoped, if it sparks off more thinking about alternatives to government funny-money, that has to be a good thing.

A Bitcoin hedge fund has been set up in Malta. I am actually going down to Malta in May for a few days – perhaps I’ll look up the managers there to find out more.

45 comments to Bitcoin keeps making the news

  • I am actually going down to Malta in May for a few days – perhaps I’ll look up the managers there to find out more.

    Please do, I will be interested to hear when you discover.

  • Jaded Voluntaryist

    Since the whole point of BitCoin is that it is supposed to have a stable, predictable rate of inflation brought about by a pre-agreed, constant rate of increase in the supply it has the power to make some of the “proper” currencies look very bad indeed.

    Expect the whole operation to be shut down on trumped-up banking fraud charges should any national banks start to feel threatened.

  • Of course, JV. Not even that – it’s enough that it can be used to trade in – are you sitting down? – DRUGS!!!

  • Midwesterner

    The concept behind bitcoin is an old one found on at least one South Pacific Island. In the islander case, the coins are made of stone and weigh hundreds of pounds. It takes several strong men to move them. So they just sit all together in a particular location and everybody keeps track of who the current owner of a stone coin is. Since the stone coins are publicly visible and traded, any double claims immediately trigger a resolution. Making more stone coins is a difficult and time consuming process, but not impossible. As currency creation goes, it has a high burden much like mining gold. I wonder if the creator of bitcoin used it for a model.

    My concern with bitcoin is not the idea of currency with serial numbers and specific owners. I like that part. I am deliberately resistant to invasive technology including smart phones. But mostly, I am uncomfortable with anything that depends on the internet, or any electronic network and devices, to work. The advantage of gold and silver coins is that they always work. If you were in a restaurant and the power failed, instead of the transaction failing, your bill was calculated with pencil and paper and paid as normal. With electronic systems, including credit cards, debit cards or presumably bitcoin, when the connection is lost, so is the transaction and they rummage around trying to find the old manual credit card machine.

    What is the bitcoin response to either a deliberate or accidental event that takes down some or all of the internet? Or to an EMP or Carrington event, for that matter? When the smart phone goes dumb, how do you spend your coin?

  • Jaded Voluntaryist

    The other big problem with BitCoin is it assumes there will be no developments in higher mathematics, or computing power, which could move “mining” from being a difficult, resource intensive process to something which takes mere seconds. Were this to happen BitCoins could suddenly become worthless.

    Or even worse, that a mathematical shortcut might be developed which could render the whole self-authentication system completely ineffective and cause fraud to destroy the whole currency.

    Any system which is reliant upon the current level of ignorance has a fatal Achilles Heel. They are trying to create a reasonable simulation of the scarcity of gold using software and higher mathematics. But it is important to remember that it is just that – a simulation. Bit coins are only scarce because they were written to be that way.

    But people are smart. I’d put money on someone finding and exploiting a weakness in the BitCoin system over the next few years.

  • Laird

    I’m glad you posted that article, JP; I had been thinking about linking it somehwere but hadn’t found the right place. And I too would be interested in what you find when you go down to Malta.

    A fair point, Midwesterner, but then nothing is perfect. Gold coins can be stolen or lost; bitcoins cannot. Although I’m less concerned about the entire internet going down (there are too many redundancies) than with localized power outages; that would also prevent the use of bitcoins. So why not spread the risk: have both. And maybe other solutions as well, even (gasp!) paper dollars and/or euros and/or other fiat currencies. Diversifiction is often a prudent strategy.

  • Sam Duncan

    As I understand it, JV, there’s a hard upper limit to the total number of Bitcoins: “mining” is just working out their serial numbers. So while some development in mathematics might net its inventor a windfall of the last few to be mined, once they’re gone, they’re gone. It might cause a sudden drop in value (depending on how many are left to be mined at the time), but couldn’t result in fiat-style runaway inflation. I may be wrong about this.

    However, your second point – that the authentication system might be cracked – must be a worry. On the other hand, it’s true of all cryptography. It’s not necessarily a reason to stop using it for the time being. I agree, though, that it does count against BTC as a good store of value.

  • Midwesterner

    Agreed, Laird. “Eggs and baskets”. But don’t count on bitcoin for an emergency spending money basket. Savings, maybe, but not SHTF money. Whether an ice storm or a hurricane or an earthquake, when you most need to spend money, bitcoin will be (apparently) unavailable.

  • Laird

    Another thoughtful take on the utility of bitcoins.

  • llamas

    JV wrote:

    ‘The other big problem with BitCoin is it assumes there will be no developments in higher mathematics, or computing power, which could move “mining” from being a difficult, resource intensive process to something which takes mere seconds. Were this to happen BitCoins could suddenly become worthless.’

    Bingo!

    I just love the way that Bitcoin is presented as though its concept (while fiscally sound, I do not disagree with any part of the system as designed) is somehow immune to any and all of the forces that have wrecked virtually every other currency that has ever been known to man.

    As JV says, Bitcoin is a mathematical model for how we would like a currency to behave. But any mathematical model can be manipulated eventually, no matter how secure the inventor thinks it is. And Bitcoin is partcularly apt for fraud and manipulation of all sorts because it relies almost-entirely upon trust in the scurity of the Internet and the encryption of the system that manages the currency.

    Let me know how that works out for you . . . .:-)

    Every currency will eventually be at risk for debasement (physical (clipping) or systemic (printing)) and Bitcoin is no different. The great risk with Bitcoin is that the users may not even know it is happening until it is too late.

    My feelings about gold are no secret. I think so little of Bitcoin that I’m not ashamed to say that I would chooose physical gold over Bitcoin as a store of value. At least the Krugerrand in my safe cannot exist anywhere else, and the only possible way to take it from me is at gunpoint.

    +1 to JV. With anything to do with currency, you have to think dirty, and nobody seems to want to think that way about Bitcoin.

    My personal suspicion is that we will see Bitcoin thefts based on kidnapping or other threats of violence – transfer your Bitcoins to this account in Latvia, or we start sending you your wife’s toes, one at a time. It has an immediacy about it that offers unique opportunities for criminal exploitation.

    llater,

    llamas

  • Midwesterner

    Excellent article, Laird. It articulately expresses most of the concerns I have but without being against bitcoins in principle. At this point I see bitcoins as a high risk speculative investment. Appropriate for some investors but not ready for prime time trade. Perhaps not ever, depending on the factors that JV and llamas raise.

  • Trusting Bitcoins is rather like trusting data saved in the Cloud. It has an upside, but not nearly enough to make me ignore the downside. I’ll stick with my money bin.

  • RRS

    The comment about the “Hedge” fund was interesting.

    Most hedges involve “futures” or “shorts”.

    How one could “short” a bitcoin, compared to say Pound Sterling, escapes me. That may be an “advantage.”

    But then Malta has never been on my itinerary.

  • RRS

    It is altogether possible that the equivalent of two (or more?) levels of Bitcoin will evolve, much like the internal and external Mark of the Nazi era.

    What does Jeff Bezos say!!!

  • Midwesterner

    Another really good article on bitcoin.

  • RRS: Bezos issued a coin of his own.

  • Midwesterner

    Many articles seem concerned that bitcoin will go into a deflationary crisis as demand rises. IOW, bitcoins could become so valuable that 10 would buy a bar of gold. They see that as a proof of the failure of the concept.

    I seriously doubt that dynamic. When bitcoin (which I’ll call “bitcoin A”) is perceived to be reaching structurally dangerous values, I imagine bitcoin B, bitcoin C, etc will arise. They will of course float freely against each other. There may even come a time when bitcoin A’s architecture makes it vulnerable to a new hack and its value slides as holders shift to a newer stronger iteration. The values of each iteration of bitcoin (A,B,C,etc) would hinge strongly on market perception of its ability to limit its supply to agreed amounts.

  • I agree, Mid. It is very worth watching and even buying into a few just to test the water.

    Also, I think that it may be too early to talk about a bubble, although it does seem to be prone to rather violent swings – not surprisingly, considering it is a very new concept, and considering the economic and political environment in which it operates.

  • Plamus

    Midwesterner: “Many articles seem concerned that bitcoin will go into a deflationary crisis as demand rises. IOW, bitcoins could become so valuable that 10 would buy a bar of gold.”

    And that’s a problem… why, exactly? There is indeed a hard limit on the total # of bitcoins that can ever exist (21 million), but the bitcoin is divisible to 8 decimal places. This puts the potential “nano” (not really 10^-9, but 10^-8) bitcoins number at just over 2 quadrillion. Thus, they are still useful for exchange, even if 90% of them are effectively not in circulation. Deflationary crisis (not only with bitcoins, but with any currency) is just a euphemism for saying people may sometimes treat it as a commodity, rather than a currency, and use it to invest (hoarding!) rather than spend. This is, of course, a nightmare for Keynesians and central bankers (overlap alert), but a boon for users of the currency, more so for the early adopters.

    As an economist, I implore all to train a resistance to deflation scare-mongering. To channel Gordon Gekko (much as I despise Oliver Stone): “Deflation, for lack of a better word, is good.”

  • Midwesterner

    I don’t think it is a problem. But also, I don’t think it will happen. As soon as the profits from investing in bitcoin A look tempting enough, new iterations of bitcoin will appear. That will put a brake on how fast bitcoin A can gain market share and value. Eventually I expect supply and demand for additional iterations to reach equilibrium. The limiting factor will be people not wanting to invest in an orphan currency that is aimed at demand that doesn’t exist.

    In any case bitcoin is still too technology dependent to replace old fashioned non-debased coin except as a network transaction facilitator. If somebody develops a ‘wallet’ that is not part of any other device, more people will probably become interested. I just don’t trust the security and integrity of anything that is connected to the net. A secure wallet would allow you to quarantine the IO so that you can audit it before transferring it (off line)to your account behind a firewall. It can probably be made stronger but more people are going to have to get badly burned before the system is ready for general use. Credit cards have had options available for dealing with fraud and theft that can’t work with bitcoin.

  • Alsadius

    I will say this: For all I mock gold-as-money, bitcoin at least manages to actually possess the alleged virtues of gold, which is to say that it’s immune to supply shock. It’s terribly vulnerable to demand shock, especially at this point where it’s just a vehicle for drug dealers and monetary-policy nerds, but if it ever gets widespread that will fade away. I think the expansion rate is too low, because forced deflation is bad, but it is at worst an interesting experiment.

  • Tedd

    Laird:

    Thanks for the article link, it was very informative. I didn’t find myself convinced by the supposed problem with adoption of the technology, though. Surely, if all that’s needed is a smart-phone and the right (open source) software, the technology to adopt Bitcoin is already fairly easily available to almost everyone in developed countries and, within a few years, probably the whole world. Compared to the true cost of managing “technology-independent” currency, doesn’t “technology-dependent” currency have an advantage, in the long run?

    As a thought experiment, if I imagine a world where physical currency could not be easily managed electronically (i.e., no ATMs, debit cards, online credit card purchases, etc.) but Bitcoin existed, it seems to me a slam dunk that Bitcoin (or something like it) would very quickly become a dominant currency. So isn’t the relevant question then: Can Bitcoin (or something like it) become on balance a more cost-effective medium of exchange than physical currency? It don’t immediately see any reason that it can’t, but I admit that I’m way over my head here with respect to my understanding of currency.

  • Richard Thomas

    Mid, you can generate wallets offline and transfer funds to them. You can even check the balance online without exposing your private key to the net. Spending the funds is a little more complex. Also check out Casascius coins. These things are actually metal coins with a small hollow. The hollow contains a small piece of paper sporting the public and private key, the public key is visible through a tamper-evident hologram stuck over the hole. The wallet is pre-loaded with one BTC. It’s not perfect but it does give some opportunity for offline trade. There are other options too depending on level of trust.

    People are already working on hardware wallets. In fact, it’s one of my projects at the moment (unfortunately stalled). There’s nothing too complex (cryptography aside) about the concept.

    There are already alternative currencies trying to gain ground. I remain skeptical about them but wish them the best of luck.

    The deflation scare thing needs to stop. That was a ghost-story invented by people who wanted to steal your wealth by artificially inflating the currency. Seriously! Mild, sustained deflation can be accounted and compensated for. We’re an adaptable species.

  • Richard Thomas

    Mid, those options for fraud and theft work both ways though. Try buying bitcoins with Paypal. Almost impossible to do at a decent price. Way too easy for a fraudster to order up some bitcoins then claim they never received them and get a chargeback. Chargebacks are a very big issue for retailers of other goods too and have to be reflected in higher prices for goods (never mind also having to reflect the service charges of those methods of payment)

    Though even then, Bitcoin has an answer. Our old friend escrow. Pick the third party escrow provider that’s mutually agreeable and have at it. A very libertarian compatible option, I feel.

  • Midwesterner

    It does sound interesting. I looked into eGold back when it was making a noise and asked my accountant about it. She hadn’t heard of it and I explained it to her. She thought about it for a bit and then told me if I started conducting business in eGold I could find another accountant. Apparently under IRS rules, it is necessary to track capital gains (gold «» $,£,€,etc) on each transaction. She does mostly local businesses so might have been missing something specific to FOREX but I will be very surprised if it isn’t exposed to cap gains under IRS rules. I’m wondering if bitcoin doesn’t also fall under them as well. I assume so. Until somebody automates that part of the process, it can’t go mainstream. It shouldn’t be difficult. Somebody could write an ap for that. In the meantime, people in compliance with IRS code will find it too much of a burden. Maybe somebody on the thread knows more about that facet of things.

    After the $ systemically melts down and evaporates away, it probably won’t be an issue. But that is a little late for making the change. (pun sorta, kinda intended)

  • RRS

    Refresher:

    Money:

    Medium of Exchange

    Standard of Value

    Unit of Account

    Standard of Deferred Payments

    Store of Value

    Of those, which are the functions of Bitcoin? Which are not?

  • Richard Thomas

    RRS: The “standard of value” is undergoing a little err.. adjustment at this time but it fulfills all the others pretty handily. It is certainly not perfect for instantaneous payment but then, what is?

    I would say that Bitcoin’s major weakness *is* its dependence on the internet. But I’d say that’s probably a good reason for improving the dependency of the internet more than anything. That and that the government will surely be coming after it before much longer.

    wrt taxes, if you’re trading it for a profit, you’ll have to declare, as you say. It should be no different than any other forex trading though.

  • Laird

    Mid, Plamus and Richard both made the points I was planning to about the deflationary concern expressed in that Felix Salmon article you linked. I have some other minor quibbles with that article, too, but nothing worth taking up bandwidth here over except to note that he clearly has bought 100% into the “need” for government-controlled currency and central banks. One should keep that mindset in mind when reflecting on his issues with bitcoin.

    The income tax implications of eGold or bitcoin transactions are real and not inconsequential, but they would equally apply to the use of physical gold/silver coins, too; does your accountant also object to them? Anyway, if bitcoin is truly anonymous and untraceable, I would suggest that reporting to the IRS the implicit capital gains resulting from bitcoin transactions would not be high on my list of priorities. As long as you confine your bitcoin transactions to personal (as opposed to business) ones, so you don’t have to report them for expense deductions, etc., neither the IRS nor your accountant would ever have know about them.

  • Midwesterner

    I linked the article for the information, not the opinions. I’ve already said I think the deflation fear is unfounded and why I think so.

    Yes, I presume transacting in gold and silver coins has the same problem (and would get the same reaction from my accountant:-). You make my point with your last sentence. If bitcoin is as a practical matter confined to non-business use, it can never go mainstream until this system collapses. That is bad for its utilitarian value. Bitcoin is going to fall under the same enforcement attack that took down eGold. The difference is, not having a central core to go after, they will soon demonize bitcoin with all that infers. Remember, we are talking about people who have perfected forfeiture in the case of drug allegations and with a presumption of guilt in the case of IRS disputes.

  • Laird

    Bitcoin will undoubtedly be demonized; that’s the obvious next stage after the current round of ridicule and airy dismissal. But I disagree that it can’t “go mainstream until this system collapses”. Yes, growing business use would certainly facilitate broader acceptance, but even if Bitcoin is confined to private use (including, but hardly limited, to Silk Road transactions), with enough people using it, even if only occasionally, it could form the core of a functioning alternative currency system when the current one collapses. And it might even accelerate that collapse.

    And incidentally, if the market value (expressed in dollars or euros) goes too high I’m not aware of anything which prevents subdivision by more than 8 decimal places. I don’t see a need for a “Bitcoin B”.

  • RRS

    How many here are familiar with the role of the WIR in Schweiz?

  • Julie near Chicago

    RRS, Not I! But of course, a challenge is a challenge. Thus, WikiFootia:

    “The WIR Bank, formerly the Swiss Economic Circle (GER: Wirtschaftsring-Genossenschaft), or WIR, is an independent complementary currency system in Switzerland that serves small and medium-sized businesses and retail customers. It exists only as a bookkeeping system, with no scrip, to facilitate transactions.

    “WIR was founded in 1934 by businessmen Werner Zimmermann and Paul Enz as a result of currency shortages and global financial instability. ….”


    https://en.wikipedia.org/wiki/WIR_Bank

    And some very interesting-looking references at the bottom, too.

    If you have further info you’d care to share, I daresay we’d all be interested. :)

  • RRS

    Wow!

    Wikipedia.org has something on everything. So, looking further, we can see that they also cover Complementary Currencies. For those here interested that is a place to begin (tho’ I did not realize its existence until Alisa’s question).

    If you will note the reference in the last line in the Wir Bank entry,
    you will understand that in “boom” times there is less internal use of the WIR and more of the Sfr. In times of constraints, particularly of credits for commercial and production use, there is wider use (entirely internal) of the WIR. It serves as an internal “balancing” monetary mechanism.

    A major limitation on Complementary and Local currencies is the limitation of market areas and conditions. However, experts like Bernard Lietaer have been exploring the possibilities of broadening uses and applications.

    Note that the term is Complementary not Competitive. In some of the successes, there is an implication that the existence of monopoly (usually governmental) currency has been a major contributing factor.

  • Laird

    I don’t pretend to know more about WIR than what’s in the Wiki article (and hadn’t heard of it before RRS’s comment). However, from what I see it appears to be nothing more than an alternate delivery/transfer system for Swiss Francs (or whatever currency the country is using at any particular time). I presume that however much the value of SFs fluctuates in the ForEx markets WIR would track it (not that that’s particularly important to it, since it’s entirely an internal system). Bitcoin, on the other hand, is an alternative to governmental fiat currencies; witness its recent runup in price when expressed in dollars. In that respect it’s more like gold. So while WIR is interesting in its own right it’s not really the same thing as Bitcoin, and serves an entirely different purpose.

  • RRS

    1 WIR = 1 Sfr

    Entirely internal so far as I am aware. Thus no advantages to hedging vs. Sfr. direct.

    Complementary and local currencies also serve as alternatives to monopoly fiat, or even asset-based, currencies of central banks and governments.

  • RRS

    Oh! WIR means “we” in German & Schweizer Deutsch.

  • I don’t recall asking a question, RRS – not that it’s important.

    Interesting about WIR – I didn’t know about it.

  • Dale Amon

    Whether Bitcoin is the alpha or the omega, it does appear to be the first successful implementation that I am aware of that mirrors the work of David Chaum (October 1985 ACM Transactions v28n10, “Security Without Identification: Transaction Systems To Make Big Brother Obsolete”. Chaum tried to get a company called DigiCash going in the early 1990′s and there was also an article by him on that topic in the August 1992 Scientific American issue, “Achieving Electronic Privacy” pgs 96-101.

  • Dale Amon

    I will also add that although some of the critiques may be true to some extent, the issue really comes down to what weapons do we actually have for ripping the control of money out of the cold dead hands of the Statists? You use the weapons you have, not the perfect ones which do not exist.

  • llamas

    Dale Amon – you are right and I do not disagree, The perfect is the enemy of the good.

    Only to add that I am less concerned about ‘ripping the control of money out of the cold dead hands of the Statists’ than I am about keeping control of money out of the hands of criminals. Statists are earnest, but generally more-or-less incompetent – I don’t doubt that Bitcoin could stay ahead of them without too much difficulty. Criminals, on the other hand, are both earnest and competent, a much-more worrisome combination.

    For proof, consider that the state is generally laughably-incompetent when it comes to preventing vast fraud – against itself. All state systems that involve money in any form are generally wracked with fraud. The criminals are always smarter.

    llater,

    llamas

  • Midwesterner

    Only to add that I am less concerned about ‘ripping the control of money out of the cold dead hands of the Statists’ than I am about keeping control of money out of the hands of criminals. Statists are earnest, but generally more-or-less incompetent – I don’t doubt that Bitcoin could stay ahead of them without too much difficulty. Criminals, on the other hand, are both earnest and competent, a much-more worrisome combination. – llamas

    v.

    Of all tyrannies, a tyranny exercised for the good of its victims may be the most oppressive. It may be better to live under robber barons than under omnipotent moral busybodies. The robber baron’s cruelty may sometimes sleep, his cupidity may at some point be satiated; but those who torment us for our own good will torment us without end, for they do so with the approval of their own conscience. – C.S. Lewis

    Speaking for myself, I fear thugs in control of the law more than freelancers. You couldn’t go to prison for hiding your gold from Al Capone. You could if you hid it from FDR.

  • Laird

    I agree with Midwesterner, llamas. I fear money under the control of the state much more than money under the control of criminals. More specifically, I fear a government having control of 100% of the currency more than I fear a few assorted criminals managing to gain control over a small portion of it.

    There are limits to the damage criminals can inflict; not so with the state, whose cupidity, arrogance and lust for power knows no bounds. And as to the “incompetence” of the state, that may be true, but sooner or later that power comes under the control of the competent, the earnest but misguided, and the over-educated fools (such as Bernanke). We’re only just beginning to see the damage they can wreak. (Also, I think you overestimate the competence of most criminals.)

  • llamas

    @ Midwestener – your points are well-taken.

    But, to extend your point further – in Chicago, 1923, who do you fear more? Capone? Or the Chicago PD?

    You couldn’t go to prison for hiding your gold from Capone, to be sure – but where you could go was to the Calumet Sanitary Canal, wearing cement galoshes. Whereas many people had no difficulty at all in secreting their gold from FDR. There was ample opportunity before EO6102 came into force to simply remove gold from the jursidiction of the US.

    It should also be borne in mind that EO6102 did not confiscate gold, as is popularly held – what it did was compel people to sell their gold to the Government at the current fixed value (then $20.67 per troy oz). I thought a gold standard was a good thing?

    llater,

    llamas

  • Midwesterner

    Chicago, 1923, who do you fear more? Capone? Or the Chicago PD?

    I’m a native of Chicago, llamas. With the subsequent years for experience since 1923, the answer turns out to be “The Chicago PD.” For just one small example, my mother was shaken down for a bribe by a traffic cop. When she would not pay the extortion, he wrote her a ticket. It’s the Chicago way. If you shot Al Capone and his cohort trying to break into your house, you are a hero. If it is the Chicago PD breaking into your house . . . ? Why do you think the Chicago mob government is so desperate to keep the law abiding citizens disarmed?

    And nice straw man there. We are discussing who is the most dangerous coveter of your gold and you deliberately choose a date when the government had not yet claimed that power. Even in his wildest fantasies, Capone wouldn’t have dreamed of taking all of the gold in the land. FDR dreamed it and achieved it.

    It should also be borne in mind that EO6102 did not confiscate gold, as is popularly held – what it did was compel people to sell their gold to the Government at the current fixed value (then $20.67 per troy oz). I thought a gold standard was a good thing?

    [Expletive deleted]! You really don’t pay a lick of attention when Paul, Laird or many of the rest of us talk about gold do you? You are probably proud of that. But it is comical when you accuse one of the strongest articulators of the distinction between “gold standard” and “gold backed” of supporting the standard. I support physical gold, not a shell game where the government (not Al Capone) hides a little bit of gold under a bunch of shells labeled “Federal Reserve Note”. All the standard is, is more government price fixing.

    what it did was compel people to sell their gold to the Government at the current [government chosen] ‘value’

    Fixed it for you. I believe this is called “making you and offer you can’t refuse”.

    Are you expecting us to believe that you would defend your life, liberty, and property from Reno and Co. with the same alacrity you would from Capone and Co.? Really? I don’t believe you.