David Landon Cole
The bitcoin – a currency based on a hash function – is often touted as the future and a recent article on The London Economic buys into that. I have a few objections with the piece that I’d like to look at.
The premise for the article is an unattributed post on Reddit. The post claims that the US Federal Reserve commissioned research internally into the bitcoin, suggesting that it would overtake the mighty greenback between 2021 and 2026; that is to say, within seven to 12 years. On completing the research, the group was disbanded and the work went down the memory hole.
Various Redditors have already pointed out the very many problems with that post, but the main one for me is where’s the beef? Show us the research. If this research is so red-hot, why can’t we see it so we can look at its assumptions, evidence and methodology? Unless they were operating under quite stringent security measures, it would’ve been easy to take a copy, electronic or physical, for distribution. The supposed leaker claims impressive academic credentials; I would expect them to know the importance of peer review. The paper was, it would seem, a model or set of models of what would happen. As the saying goes, all models are wrong – only some are useful. That latter part may or may not apply here but we cannot know. At the moment, we have a statement with about as much strength as what some bloke down the pub said.
Let’s turn our attention to some of the more general objections I have with the feature. Now, we’re all agreed that the internet’s great. I don’t like making grand predictions, but it does seem that the internet and world wide web may go down among the great achievements of humanity. That doesn’t mean, though, that it is good at everything, or that everything it does is good.
We are told people and corporations are adopting bitcoin as a means of trading. A quick search reveals some impressive names. They are, however, all consumer-facing. It doesn’t seem that business to business transactions are taking place to a significant degree at all; no-one has insured an oil tanker in bitcoin. The figure for the total number of places accepting bitcoin seems, on a quick search, to be somewhere in the range of thirty to forty thousand. In the UK alone, there are 4.9 million businesses.
Although the dollar is argued to be an international monopoly that is under threat from the bitcoin, I would disagree. First of all the dollar is pre-eminent amongst currencies but it is not a monopoly. I can tell this by the pounds in my pocket, not to mention the euros in a jar at home, or the global trade in yen, Swiss francs and so on.
Apparently, we are now onto a question of who runs this planet, or the classic ‘1% vs 99% debate. Let us briefly allow that the Reddit post is accurate and that by 2026, the bitcoin has, in some unspecified way, become more important than the dollar. What happens? That is making a very large change to the global economy very quickly. It is very hard to predict what effect that will actually have. It may be that it establishes universal love, but the recent financial crisis has acted in favour of those who already have money. Predicting the effects of a major change to the global financial system a decade in advance seems ambitious.
This is not to say that I am enamoured of the current financial system. I would like to see change to it; as is probably obvious, I would like that change to be gradual. This shouldn’t detract, I hope, from the critiques I’m making.
Viability and credibility
Questions have been raised over whether the viability and credibility of this aspiring money supply has been established. So let us examine these doubts.
The total supply of bitcoins is capped at 21 million. This is, so far as I understand it, an absolute constraint and is not a bug but a feature; a gold-standard libertarian means of dealing with inflation. Even under the gold standard, new discoveries could increase the money supply. Once all bitcoins have been mined – predictions suggest between 2030 and 2040 – the money supply, assuming no bitcoins are lost, is fixed. That encourages hoarding; that worsens the problem we are trying to address.
I would add here that we may have some confusion about terms; bitcoins are often referred to as a money supply. Money supply is usually understood as a measure of liquidity of a currency; it is not the same as a currency.
Bitcoins are not stable; the value against the dollar has fluctuated wildly. Speculation makes up a significant part of that volatility. I would venture that the failure of Mt Gox shows that bitcoins are still vulnerable.
The total market capitalisation of bitcoins is on the order of US$10bn. That is approximately the same size as the estimate of the contribution made to UK GDP by drugs and prostitution. Promiscuous and profligate as Brits may be, I don’t think that a currency whose total value is equal to our appetite for hookers and blow is a threat to the dollar. The highest ever daily trading volume of bitcoins was slightly in excess of US$70 million; in the last 180 days, it has not risen above US$35 million. By way of comparison, the Bank of England’s estimate for currency trading in London – admittedly one of the world’s main financial centres – was US$2.4 trillion per day.
Remember, the original Reddit post suggested that very conservative growth estimates were being used. I do not think that growing several orders of magnitude in around a decade can be considered conservative.
It is also operating under an uncertain legal situation, being discouraged by the EU, a unit of account in Germany, banned in China and so on. That has real and serious implications for the adoption of bitcoin. This is also one of the major problems with the original Reddit post, even if we accept it: it is hard to model how states will react to any rise in the use of bitcoin. Finance is not just about economics; it is about politics.
Please don’t take from this that I am opposed to bitcoins; I don’t have a particularly strong view on them one way or the other, but some clearly do not like fiat currency. While I would grant that bitcoin is not a fiat currency in the sense of a currency backed by a state’s promise, it is not backed by a commodity. It is based on trust that the code works – that code has already had problems. It may be a new form of fiat currency, but it is a fiat currency.
The decentralised nature of Bitcoin, it has been said, means that any abuses can be quickly identified and acted upon by exclusion from ‘the club’. Given Mt Gox, this is simply untrue.
Nor is decentralisation a panacea; G Hash is the dominant bitcoin mining outfit, currently accounting for just under one-third of all new hashes. If G Hash, or anyone else, were to have more than half of bitcoins, they would effectively be able to double spend bitcoins. They are sufficiently worried about it that they’ve sought to address it, promising never to launch a 51 per cent attack. Someone else with the resources, determination and decent hardware to reach that position might not be so nice.
“Whilst there may be abuses by users, abuse by the purveyors of the service is scant compared to what we have experienced with our current baking system. Over the last decade this abuse has led to a severely impaired monetary system now awash with debt.”
In Yes, Minister, Sir Humphrey mentions the Politician’s Syllogism
1. We must do something.
2. This is something.
3. Therefore, we must do it.
Just because the current system is bad does not mean this is good.
As I said above, I do not like the way the world is. I would venture, though, that states, companies and individuals will still run up debts, whether they’re denominated in bitcoins, dollars or giant stones.
We’ve been told that our current evolutionary progress means that bitcoin could rise within five years given what has happened in the last ten years. But what has really happened since 2004? The US and the dollar are not as overwhelmingly dominant as they were, but they are still the single biggest players.
If we take the evolutionary comparison, we would expect to see change, experimentation, failure and extinction before success. To pin one’s hopes on the first cryptocurrency to be “the right answer” is going to lead to disappointment.
Nor can we predict evolution’s future paths. Technology has moved on at a remarkable rate and shows no sign of letting up. The cryptological function used to generate bitcoins is a computationally hard problem. What happens if and when someone develops a quantum computer, and that problem is no longer hard? If the rest of the blockchain is deciphered almost instantly, you would have a sudden rush of all the rest of the possible bitcoins – massively deflationary – and then a complete drying up of supply, as well as allowing the 51 per cent attack we mentioned above. Equally, it may be that future developments render the existing security built into bitcoins obsolete.
Above all, the lessons to be learned here is not to take anonymous, unsubstantiated posts on Reddit as anything other than for entertainment purposes only. You shouldn’t base your opinions on single news sources and you should question why people say what they say.