The Transaction Cost of Bitcoin

Bitcoin and other cryptocurrencies have create a new monetary system that relies privacy and pseudonymity to conduct economic transactions, rather than governmental laws and regulations. This monetary structure has several distinct advantages over fiat money that makes cryptocurrencies fundamentally superior to all fiat money.

The current economic paradigm using fiat money creates a system in which transaction costs shall always be higher than those found within the bitcoin ecosystem. This is due to the costs that are associated with the creation, maintenance, and enforcement of laws within the fiat currency system that allows it to function. The privacy and anonymity functions of bitcoin allows for it to function as a money system, while not needing to pay for the legal structure, or enforcement cost of normal money systems.

What Creates Transaction Cost?

According to Ron Coase, who originally theorize about transaction costs in his work the Theory of the Firm, there are three types of transaction cost:

1) Search and information cost

2) Bargaining and decision cost

3) Policing and enforcement cost

These are features that all transactions have and are built into the cost of the transaction. For example you want to buy a loaf of bread, first you need to know where to buy bread (search and information cost). Then you need to decided what a reasonable cost is, and to see if you can get bread at that cost (bargaining and decision cost). And finally you need something to pay for that loaf of bread (policing and enforcement).

Now all three of the above features are ‘cost’ that are associated with any kind of exchange; legal or illegal. The largest key difference with illegal transactions is that third type of transaction cost (policing and enforcement) is replaced with evasion and extralegal cost.

Evasion cost substitutes the policing and enforcement cost. So if one wanted to avoid paying $25,000 in taxes, they could pay a lawyer $10,000 to save $25,000 in taxes. So part of the $25,000 is going towards paying the policing and enforcement cost, where as $10,000 is the alternative evasion cost that one can pay to assure they get away with their full $25,000. So if one pays the evasion cost of $10,000, they will save $15,000 in total.

This $15,000 is a special type of profit because it is derived directly from NOT paying the full transaction cost. This is called risk profit and is only experienced when one takes on evasion cost, or the cost of doing illegal business.

All transactions consists of the three above associated cost. What crypto-currencies offer is a fundamentally different paradigm for how to deal with legal and enforcement cost. Instead of needing violence to enforce the rules of the money system (like fiat money), bitcoin embeds ‘the legal system’ directly in cryptography, merging law and mathematics. This allows for an economy to be built directly on top of the non-aggression principal. Cryptocurrencies have no policing and enforcement cost whatsoever, which shall always create a lower transaction cost.

The Law and what it offers

Today, the law is what offers us financial protection within our current economic system. This is why you can challenge or dispute transactions that you do not recognize on your credit card or debit card. This is also why the Department of Homeland Security can seize your banking accounts and all of your money without notice. Both of these situations arise because of the laws that govern the current economic system. Though laws offer a distinct way of protecting actors within their economic system, and are sometimes of great necessity, it can also be at great expense to the general populous, and to the determent of the economy on a whole. Police stole more goods than all burglaries combine in 2014–if you haven’t already, it might be time to rethink the majesty of the law, and what it means to be governed.

Detriments of the Law

Utilizing laws as a bases to create an economy system has two distinct detriments: The cost that is needed to create and enforce laws, and biases of those involved in the legal system.

When we look at the cost of legal economic enforcement, we must look at all aspects of the law and the expenses associated with them. Breaking down these cost is almost impossible when we look at the breadth of lawsuits, permitting procedures, various licensing, taxation, and various government entities that are funded through taxation. These cost are rolled into all economic transactions that one does within a fiat economy, as the burden of police and enforcement cost are forced on to the consumer, producer, and the sum total of society. Thus, through simply having laws that must be enforced, the transaction cost associated with that money will increase.

Legal bias

Another hidden expense that comes from a economic legal system is the inherent bias that those involved within the legal and political system are going to have towards themselves. Or in another word, corruption.

Those who are closes to the centers of power are the ones that will benefit the most from the law, or the corruption of the laws. This is why the most profitable investment that can be made is lobbying. This is also why no criminal charges have been brought to those responsible for the 2008 financial crisis, no charges for the NSA spying scandal, and why the average congressperson is a millionaire. This is because of the corruption of the legal framework that they operate within and control, and the way that they allow for the corruption of the legal system to favor themselves and their cronies.

The corruption of our legal system is not an error, but occurs by design. Those who are closest to the centers of power are also the ones with the most agency within this system. They have varying degrees of control within the legal system that correlates with how close to the center of power they are. Thus, the closer to the center of power, the higher degree of agency they have within this legal system, which creates the conditions for manipulation and corruption of the legal system. This creates a two-tiered legal system in which those who are closer to the center of power shall have more economic opportunity than those more removed from it.

Over the last century, the corruption of the legal, economic, and political system has resulted in the economic state we are in today: a broken political system that is beholden to the interest of bankers, oligarchs, capitalist, and members of the legal system before all others. This not only is unethical and morally reprehensible, it is also very, very expensive.

Free Markets and Their Functions

People enter into economic agreements because they are just that: agreements. These are natural transactions that occur because of our own subjective interests for ourselves.  This is why we enter into social contracts in the first place; because we freely and naturally agree with the stipulations of the contract and proactively make the choice to be part of the contract. A transaction like this does not need anyone to enforce anything–both parties are willingly entering into a transaction because they both are getting something they desire from the transaction. Both actors have utilized free-choice to choose to enter into this agreement. This is the natural state of economic affairs, and there is no actual need for policing and enforcement cost in transactions that are entered into within free agreements. Thus, for voluntary agreements, there is not need to pay for policing and enforcement cost, which in turns creates a lower total transaction cost within a monetary system.

With bitcoin, people are making exchanges via the internet where there is no need for a legal enforcer to ensure that transactions are conducted fairly–that is what the bitcoin software does. Because of this feature–where bitcoin can allow for private individuals to preform economic transactions without needing a centralized enforcer–means that bitcoin does not have to pay policing and enforcement cost. This means that if we are to look at the economic cost of transactions within a monetary system, fiat currencies will always have a higher total transaction cost because of the need to pay for a policing and enforcement cost.

Conclusion

When observing any contemporary economy system we can see that there are three types of transaction cost: search and information cost, bargaining and decision cost, policing and enforcement cost. Because bitcoin uses software to create a secure form of money, there is no policing and enforcement cost that are associated with bitcoin. This means that when we look at the total transaction cost across an economy, an economy using bitcoin (or another digital currency) will always have a lower transaction cost than a fiat economy that must pay for policing and enforcement cost.

Next: Bitcoin and Liquidity Preference

11 thoughts on “The Transaction Cost of Bitcoin

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s