Response to Karl Denninger’s BitCon

Karl Denninger wrote a post back in April called BitCon, which was about why he believe that bitcoin won’t work. Jon Matonis offered a great response, but I wanted to elaborate in more detail on a few places that Jon may not have addressed.

Time preference and money supply

First let discuses time preference and social time preference. As Karl stated in his essay below:

“Time preference is the ability to choose to perform a service or sell a good now but obtain and consume the other part of the transaction for yourself later.  With a perfect currency time preference has no finger on the scale; that is, the currency neither appreciates or depreciates over time against a reasonably-constant basket of goods and services.”

Generally this is true. If we want an ideal currency for all economic functions we would want a currency that no matter where we are in time 1 unit of perfect currency will always get us 1 unit of the same goods and services at a later date. So one piece of gold will always get you 3 cows and a bull–today or in 50 years, it does not matter when the good are bought. This allows for there to be an unbiased time preference—that is, it does not matter if we buy it now, or later. The thing with Bitcoin is that it is a commodity that acts like money–so you are not using it for all of the same functions as money. Specifically, debt with a deflationary commodity is a poor idea considering that it is just going to become more valuable over time, thus increasing the real value of the debit over time. So bitcoin has a time preference that is skewed towards savings due to the restricted, fixed supply. Whereas, fiat currencies have a bias toward debt because of it’s inflationary features.

Now Karl seems to think that Fiat currencies violation of time preference to bias it towards spending (investing) today, rather than saving for later, is beneficial—and for his world view, it is. To the creditors of the world, and thus 95% of the entire economy, inflation is good because they can lend out money today, and know that it is going to worth less when it is repaid, so they may charge interest to make up for that. Furthermore, very large amounts of capital can be created using debt because it money that doesn’t exist yet today–your social time preference helped you make the choice that you would rather have a large amount of money today, in exchange for the promise that you will pay off more money that you borrowed overtime. The benefit of this model is that you are skewing time preference towards today, in the assumption that through lowing lending rates, people will borrow more money today, invest it, and thus spur the economy today and create more wealth later down the line when you are repaying that original loan. And because the government really wants growth today, they will smudge the interest lower than what it really is to try to spur the economy.

The issue with this is that the fundamentals of the market are the same–nothing has changed except for the capital within it. That means that people that are taking advantage of low interest rates are not actually investing smarter, they can just lose more because there is less interest to pay back over time–so their risk is lower, but the investment is not smarter. When the economy is already struggling, investors are not making smarter investments–they are simply making more risky investments, who’s risk has been mitigated for the time being by the government. This then causes for what we saw in the 2008 sub-prime mortgage crisis–lots of seemingly low-risk investments (because of governmental guarantees in the housing market) that are very profitable for a year or two, but then become disastrous when no one can pay.

This is all caused by the government’s hand in monetary policy that distorts the interest rates and lending, and thus time preference, which causes for poor decisions because of these distortions. 

Why bankers and government fear deflation.

Deflation can be worse than anything, and that is not because deflation is bad, it’s because deflation and debt together are very, very, very destructive. The deflation we saw in the 1930s was caused by the velocity of money collapse, and thus the value of the few dollar circulating increasing in value, increasing the value of all money—INCLUDING DEBT because the monetary base shrunk. So when deflation occurs your $400,000 mortgage is now getting more expensive over time, so you are fighting a losing battle. In these cases, many people give up, default, and pass the buck on to the bank. The bank now has a piece of property that is getting more expensive that it already cannot sell–and this is happening with many mortgage holders at the same time, and so the bank is put in a position where it will most likely fail–unless it is bailed out.

So the trade-off becomes that if we NEVER want deflation, particularly from the collapse of the velocity of money, than we will need to expand the money supply by the same ratio as the percentage drop in the velocity of money. Then as the velocity increases again, we can contract the money supply. Put some money out there, pull it back in later, and we’re all good, right? The problem is that the velocity of money isn’t exact—it’s a guesstimate. All of this expanding and contracting isn’t going to be right on the money, so there is going to be some degree of deflation or some inflation. Because the current monetary model favors debt by having inflation, the Fed world rather error on inflation, rather than deflation. The problem with this is that sucking in the money supply can create serious problem such as a spike in interest rates, which then means that current short-term debts can’t be serviced and we are into an economic crisis all over again.

Why governments and banks love inflation

Most people do not understand that money is a mode of exchange, NOT storage of wealth. This is why 50% of all stocks are invested in by the top 1% of wealth holders—because they understand this idea, and have money to invest—the other 99% does not. In fact, 3 out of 4 people in the United States today live paycheck to paycheck, and so biasing money to lose value over time is effectively a way for the government to create a hidden tax through inflation—or as Karl put it, to steal from you.

This creates a system where the poorest people have the least amount of opportunity to exit the poverty trap. Because of the educational and economic barriers towards investing—the poorest people cannot even accumulate capital to then invest, nor do they have the educational resources to do it well.  This puts them at an inherit disadvantage that makes the startling growth in the wealth divide much more expected. This is a very serious issue considering labor earnings are at an all-time low, corporate profits are at an all-time high, food stamps are at an all-time high, and all of the economic gains of the last 50 years have vanished in the last five. This is creating a system where the poor get poor and the rich get richer by design. It is getting so extreme that people cannot exit the poverty trap from generation to generation. And it has a lot to do with the money in their pockets becoming worth less every day.

As being a society that exists within this inflationary system has taught people to waste money and be consumers, rather than to save for tomorrow. This is because throwing your money away today on a shit investments, rather than to save and wait for the right opportunity to come, is less profitable because you are not allowed to have your own time preference. If you try to hold fiat money, you’ll simply watch it evaporate away from inflation. Damned if you do, damned if you don’t.

Now not only is this model reinforcing poverty, but it is also systemically unsustainable because of crony capitalism. When the money supply is expanded, some gets that new money for free, and those happen to be those who are closest to the Fed. These are companies like Goldman Sachs, HSBC, Barclays, and UBS just to name a few. Not only are these companies afforded extra-judicial powers that essentially make them immune to the law, but they are also given free money for it. I cannot think of a more perfect example of crony capitalism and corruption.

 

Self-validation

Karl continues his rant stating that the properties of a good currency should make it self-validating. As bitcoiners we can tell pretty quickly if someone sent us a coin or not—as we know how the software works, unlike Karl. Furthermore, we understand it is impossible to forge. It cannot be done—that is part of the beauty of the system. We also understand that the record in the blockchain is protected with cryptography, so getting proof that someone ‘owned’ the address is next to impossible–you’d need the private key. This means that security and privacy are features of the currency, rather than protections it needs to be afforded from the State.

New $100 bills. They cost a little more than 12 cents to produce.

This has a very, very, very important implication. It means that the total utility of the monetary system never bleeds it value from security risks, as the United States Dollar does. Bitcoin has 0% counterfeiting, while the U.S. has about $55 million worth of counterfeit bills floating around. This also does not factor in the cost of needing to replace bills, as the U.S. had to do with $100 bills because of Super-Ks. In fact, the new $100 bills cost about 60% more to produce, a direct cost that users of the currency must bear. Bitcoin will always expend 0 on fraud combating, whereas the U.S. and other Nation-States will always have to spend money on combating fraud.

Karl also points out how waiting for block confirmations currently takes too long, and hence it cannot work because no one wants to wait for 10 minutes. As true as this may be we are already seeing entrepreneur resolve this issue with green addresses, and other entrepreneurial developments. It is an issue, but it is being resolved by market forces. This is in addition to that all of the points that Karl makes about double spending can just as easily be applied to a checking kiting. People can write several checks from one account with no money, and because there is time between when the check is cashed, and when it clears the account, they are ‘double spending’. And just like with banks, as much as an issue as check kiting may be, several procedures have been put in place to mitigate it as much as possible.

State-sponsored theft and terrorism

Karl believe that State-sponsored theft and terrorism is a good way for the economy to work. Several times throughout the article he lets it be known that he thinks anyone who evades the tentacles of the state for any reason, deserve to have violence inflicted upon them, their wealth stolen from them, and their liberty seized from them. Unlike Karl, I understand that the State must justify its power—Power does not justify the State. Simply because the governments can ‘legally’ threaten me with death for refusing to use their shit currency, does not mean I should use their currency. Quite the opposite—I should question why they need to use violence to make me use their currency.

Here is the difference between myself and Karl: I know that violence is wrong. Period. Karl believes that it is justified when it comes from the Fist of his Master, The State. Men like Karl do not need to understand why the State is all-powerful—they simply believe it and lick the boot heels of their oppressors, without even a thought towards if what they are doing is right, wrong, or otherwise.  These are the same men that will say nothing when people are being dragged to the gallows. They are the cowards that enable The State by refusing to acknowledge that they can refuse participating in deplorable, detestable, disgusting, and illegal acts.

The panoptical world that Karl lives in is so powerful that he cannot even see that societies exist outside of the state, and they are growing rapidly. In fact the stateless economy, also known as the black market is the second largest economy in the world with more people participating in it, than in the ‘official’ markets. It also poised to grow faster, and more robustly, and include more people than any other economy by 2020. Karl won’t even see this as being legitimate economic activity that could have a use, so he just rejects it, as he rejects the idea of non-violent currencies.

Karl is so concerned with money laundering and illegal transactions that he fails to see that these are concepts made up by The State, for the State’s benefit. A transaction can’t be ‘illegal’ in and of itself—it is just a transaction. Same with money laundering, it is just the movement of money, nothing else. Karl doesn’t even think about this, the State says it’s bad, and Karl says yes.

This is the problem with many experts like Karl. He would rather tell you how it is, while dismissing the facts, rather than to have facts explain what is occurring. Instead of acknowledging that bitcoin is a very real currency (because it can be used for real exchange todayand has been for years), and that it is functioning despite being stateless, he simple dismisses it. No explanation required if you just shove your head in the ground.

Ponziing and Preference

Karl also points out that early bitcoin adopters are rewarded the most like a pyramid scheme. This is true, but this is how technological innovation works! Someone invents superior technology that outdates the old, then they create a business destroying the old model; this is how Apple, Facebook, and Google all became successful—by creating economic efficiency that outdates the previous model. Furthermore, Karl forgets to point out that in state-based monetary systems, those closest to the state, profit the most despite doing nothing to earn it. They just lobby and then take their 5,900% to 77,000% return on investment in lobbying.

Karl continues on his diatribe with nonsense about entropy. In seeing that bitcoin is a successful currency with deflationary features, the entropy that Karl speaks of is simply part of the deflationary aspect. In fact, most bitcoin have never been moved, or are ‘lost forever’, and yet bitcoin is still working as a currency and storage of wealth.

One of the points that really grates on me is this:

“the benefit of seigniorage comes with the responsibility for it as well, and it is supposed to be bi-directional.”

Yes! This is 100% true and why bitcoin is succeeding.

The federal government benefits from seigniorage, which many people in this country do not like, and so they are choosing to disengage it. There is punishment for not using the dollar, so until recently there has been no opportunity to compete with the governments monopoly on currency. Until now.

Government have not responsible managed our currency and economic system, and people are no longer trust the government and are opting-out of their monetary system. That is a choice that people can make because they can avoid the Fist of the State coming down upon them through the pseudo-anonymity that digital currencies offer.

People are making this choice because they no longer trust their governments–people see them for the tyrants that they are. Again, and again, and again, we see that government lie to their populations about how the money supply is managed. And again, and again, and again we see inflation destroy the middle class of nations around the world. How many times must they reduce us to absolute poverty and despotism until we realize that is just what States do. Steal from the weak and give to the powerful—that is what they do.

Conclusion 

Karl Denninger is a statist who can only see the world from that perspective. He cannot even imagine that people could be intelligent enough to organize outside of the state and create a monetary system that is far superior to anything the state can provide. This is because of the natural functions of the state, and what it does. Karl believe in that vision, I do not.

Hayek’s Promise

In his final treatise on economics, titled “The Denationalization of Money” Fredrick Von Hayek wrote about his idea of what a world with ‘Free Money’ would look like. He believe that money that if money was independent of nation-states (like BTC) that it could fundamentally change the world for the better, and liberate people from the oppression and tyranny of the monopoly on money. He based these ideas off of some of the principals of Silvio Gesell–radical economist and anarchist. His principals were the bases of the ‘Worgl Miracle’ which essentially reversed the depression in the town of Wörgl, Austria in the 1930s. One of the concepts that Hayek wrote of based on these theories was the ‘Swiss ducat’ theory of how to operate a free-money bank in a fiat currency system. This is about the possible function of how a bank like this could work in the bitcoin economy.

This is not a bank for bitcoin, but a competitive economic mode that facilitates the purchasing power of different currencies and leverages them against one another using free-market principals. Essentially, these are bitcoins and alt-coins. They forces free-market functions on to the economy by allowing one currency to hedge against one another (BTC/LTC), and digital currencies against fiat currencies using their deflationary properties to their advantage.

How?

As the bank what I do is I sell shares, or ‘bits’ as I like to call them, at their current market value. So today, you come in and buy a share for $120–the market price of what bitcoin is trading at today. In exchange I offer you an IOU for 1 BTC, and you will pay this loan back over the course of however long you choose–here is the kicker–you pay back the loan in dollars at the amount that you paid for the IOU with 1% in USD.

What this does it it offers the same possibility as buying a home back in the 1980s. For example, my mother paid $68,000 for our family home in 1982–today it is worth $425,000. Now, if we are looking at only purchasing power we’ll see that the the house should only be worth $178,000. It is worth more because of the additional intrinsic value of the property, along with the limited, finite supply of property in this desired area.

The intrinsic value of real estate is defined as the net present value of all future net cash flows which are foregone by buying a piece of real estate instead of renting it in perpetuity. These cash flows would include rent, inflation, maintenance and property taxes
BTC is a more extreme case of this because unlike property, we can know the exact number of BTC in circulation, and how many more bitcoins will be added to the economy and when. We can use these facts to leverage Bitcoin’s future purchasing power against its purchasing power today.

The reason this can work is because of BTC deflationary effect of having a predictable, fixed supply, but has limitless economic capacity. When we look at the value over time for bitcoin, one can see that the long time span one looks at the more likely it is that bitcoins value will gain against fiat currencies. This is because of the fundamental functions of both Bitcoin and fiat currencies. Bitcoin has a fixed 21 million coins EVER. Fiat currencies can guarantee that over time, they will expand the money supply, mean that there will be MORE dollars at a later date no matter what. Currently the Fed has announced their plans to devalue the dollar by 33% over the next 20 years . Due to these facts, the longer of a time span that we look across, the more likely we are to see bitcoin gaining value against all fiat currencies.

Bitcoin’s USD value will increase as long as there is growth in the BTC economy outpaces the supply–and that supply is fix. We know that only 25 new coins can enter into circulation every 10 minutes. We also know what the approximate market value of those 25 new coins will be when they are introduced into the economy.

The purpose of the bank–to assume the risk for holding the assets that are Bitcoins. Furthermore, through watching the blockchain, the volume of transaction, and the velocity of transaction over time, and historic gains and losses over time, along with the knowledge of how many coins are in circulation, how many coins will be added in the future, means that we can have pretty good projections about whether the value of BTC is going to go up or down based on its real economic value, and not just speculation.

So how does it work?

You come in and we sell you an IOU for one bitcoin. This ‘bit’ is $120–the market value of bitcoin today. Over time, you repay that loan to me. For the sake of this, let us say $10 a month. So when May 2014 rolls around, you have paid off your IOU for the Bit, I give you your bitcoin in return. The difference is now that bitcoin is worth $500–which you paid $120 for one year ago. And the way that the bank profits is through assuming the risk of holding BTC in case the price ever does go down, and for whatever gains are taken, the bank will take 1%. So we get 0.01 of your bitcoin for holding it (our profit), and you win for taking out the IOU because your $120 IOU is now worth $495.

Furthermore, if upon the completion of the payment, or hell, even partial payment, one could ‘refinance’ their loan with The Bank. So because the bank is holding the BTC, we can refinance at the market value at the time of refinancing. So if you have paid 50% off of your IOU (so 6 months have passed–it’s DEC 2013) and now the value of BTC is say, $240. One could refi, and now as the bank I give you $240, and the 12 month cycle starts all over again. One is using the equity in their bitcoin and its deflationary nature to hedge against fiat inflation, and the lost of purchasing power of the dollar.

More importantly, is that we can build applications that create these financial instruments for automated, program-oriented banking. Similar to Bitcoin’s protocols, that means that no one can cheat at banking! If you lock yourself into a 12-month CD, the program application is what locks you in—not a person. The program can also have you pay a penalty to exit the deal, if you choose to do so, or other functions. And this is just one of many examples; there is a whole world of financial instruments that we can build that function off of programs that both yield profit and ensures security, safety, and most importantly, no one can cheat at it! This works because it functions on the same trust as bitcoin–trust in the programming and protocols that ensure no one is cheating at, or rigging the system for their gains and others losses through corruption.

These are simply my own thoughts and ideas, and I could be wrong about some of this. But please, tell me your thoughts on this and if my logic is correct. Because if I’m right, we are in for a radical new way of doing finance and commerce.

Next: The Revolution of Bitcoin Banking

Facts about Bitcoin and the world you should know

Bitcoin’s market capitalization (the total worth of coins in USD) is about 1.64 billion—that’s about the size the yearly GDP of the Belize economy.

ALL forms of currency and assets can be seized by the U.S. government–no law needs to be broken. In 1933 Executive Order 6102 made holding gold illegal, and the U.S. government seized people’s gold under the threat of prison time if they did not. Bitcoin, unlike gold, cannot be seized.

The median age of currencies in circulation today is about 39 years, and about 20% of the 755 currencies that have come into existence in the last 300 years died from hyperinflation. (lots of good info here)

The federal government adds about $40 billion dollars to the economy each month. That’s brand new money that makes your money worth just a little bit less.

Corporate profits and the stock market are at an all-time high, and wage earning are at an all-time low.

Banks operating in the U.S. get to commit fraud and not be punished.

E-commerce sales topped 1 trillion this year.

The average cost of an e-commerce transaction is about 2%

Bitcoin make the same transaction fees about 0.1% (that is a high bitcoin transaction fee)–a 2,000% savings over using traditional e-commerce methods.

Sending a wire internationally can take weeks, can get lost, will be subject to substantial fees, and you will face at least a 1% conversation fee. Also, if the amount is in excess of $50,000 you will have to jump through quite a bit of paperwork. With Bitcoin it takes about 10 minutes. You can also transfer as much money as you would like and there are no hoops to jump through.

The shadow economy is one of the largest economies in the world ($10 Trillion) and none of it is done through banking. It’s all cash and unofficial—to bitcoin and other digital currencies, this is a new market that can be empowered IF bitcoin can get to them.

M-PSEA, a mobile banking program in Kenya captures 30% of all commerce and more than 90% of Kenyans use it.   And Kipochi now directly links bitcoin and M-PESA.

Today, there are more than 25 nations that are facing more than 10% inflation annually.

All of the above needs to be taken into consideration when we consider the future of bitcoin. Bitcoin’s success will not be because of its own greatness, but because of how terrible the fiat banking system is. People don’t need a totally private, cryptographically secure currency–they need a government that does not spy on them. Because people do not have faith in the later, the former is needed.

Keep in mind as well that the guarantee of privacy is just one of the many features that makes bitcoin great. There is also the near friction-less mode of exchange that it offers, in addition to being a digital storage of wealth–features that make it truly revolutionary and completely out-dates the old model of banking.

This has huge implications global south. Why would someone in Zimbabwe trust the government currency after a bout of hyper-inflation? Or Argentina where inflation is about 10.5% per year? We have to keep in mind that global south consist of some of the poorest people in the world, in some of the most corrupt nations in the world. Though it may be several years before anyone even adopts bitcoin in these places, it can offer a powerful mode of wealth protection and storage against corrupt national governments with poor monetary policies.

As we move forward into this brave new world of free money, we have to ask ourselves, have our national governments and their monopoly money out lived their purpose?

The Intrinsic Value of Bitcoin

gold_mining_rocker_boxThere are several features that create the intrinsic value of bitcoin, but the primary one is its production cost. Bitcoin is a commodity money like gold, sliver, or copper which means that the energy cost to extract these raw materials creates their base value. The actual exchange between two people is totally subjective, as the subjective theory of value shows us, but we can assume that practically no one would sell their commodities for a price below what it cost them to extract the commodity. Today, the cost of mining bitcoin is getting to be quite difficult, which is part of the reason for the increase in price we have seen.

The Base Value of Bitcoin

Let us take a moment to think about how mining for bitcoin is similar to mining for gold. If you go into your backyard and try to see how much gold you are going to find, you’ll probably come away empty handed. That’s because you are using a pick and shovel, and it is no longer the 1850s–someone else got that gold (if it was there) long ago.

That just like how bitcoin mining is today–well more like 95 years ago when gold was about $20 to the ounce. Check and see how many bitcoins you could make with this mining calculator. Most likely it’s not a lot. This is because just like with gold mining, someone developed a better way to mine for bitcoins, making mining with a normal computer unprofitable today. This is because the newest bitcoin miners use energy more efficiently to mine bitcoin.

Keep in mind that the commodity value is just the base amount–that is just the production cost. Bitcoin, like gold, is a special commodity–it’s a commodity AND money at the same time. These special commodities are appropriately called commodity money. Commodity monies are special in that they have an inherent value by being a commodity, but because of their traits, they make great money too.

It is this secondary value of being good form of money that creates the secondary social value of bitcoin and other commodity monies. It is both the production cost of bitcoin, along with the properties of good money that it exudes which creates the total value of bitcoin.

Commodity money creates a secondary value as a mode of exchange through the base production value. It is because of this trait of being made from a real commodity that commodity-monies can ‘bootstrap’ their way into becoming a mode of exchange. Once this happens it allows for market mechanisms to decide on the price of the commodity money beyond its production value. This is how commodity monies become more than just commodities, and become modes of exchanges and in some cases a storage of wealth. This is why gold became the most sought after commodity during the mercantilism era: it met the four qualities of good money better than any other object in the world, and was by far the best storage of wealth. This was not because it was shinny, but because it was incredibly rare. This is also why gold and silver have 3,000 years of history as being used as money and a storage of wealth–due to the intrinsic qualities they hold because of their scarcity.

The Value of Fiat Money

Where Fiat money eventually ends up: An arm full of Zimbabwe money that is worth nothing.

So than why is fiat money valued at all? Fiat currencies are not independent, nor is there any value contained in the money itself–it’s just paper. So how do these worthless pieces of paper have value?

Through the governments guarantee that it will accept fiat currency as legal tender, and that all transactions within its economy will meet this basic minimum standard of the law. This is what allows the government to bring violence to anyone who challenges the legitimacy of government’s monopoly on money. The power of fiat money is derived from the government’s legitimacy–that is why they can just make new money up out of thin air.

Statists argue that seigniorage from the state is not only needed, but is desired. For the State is the law, and the law is a means to an end in itself–that is why the state has the legitimacy of violence to decide if a person deserves to live or die. It is through this power of that the State can redistribute, protect, or harm their own citizens–for the benefit of all, or for a few. It is from this base of power that states create the laws to conduct economic transactions within their sphere of influence. This is why fiat money is only valid within particular nation-states own sphere of influence, and not that of other nation-states.

Philosophy of Value

The intrinsic value of bitcoin far beyond its commodity value. What creates its real value is the mathematical assurance that the bitcoin ecosystem cannot be predicated upon force, unlike fiat money. This is because of the cryptography that bitcoin is built on top of allow for two very distinct things:

For this to work, a robber would need to know all of the wallets that you have, and the amounts you have in them.

1. It assures that the vast majority of transactions within the bitcoin economy are based upon voluntary participation, which in turn ensures:

2. Almost all transactions must be non-violent, unlike state-based currencies, where the legitimacy of the currency comes from the state’s ability to bring violence to you for not complying with their laws or legal structure.

These qualities result from the privacy function of Bitcoin. Privacy, within the context of an economy is what allows for a fair, voluntary economic system to be created. Bitcoin exchanges ‘the protection’ of the law, for the mathematical assurance of cryptography.

Bitcoin has made a new economy in which the categorical imperative is not the law; but privacy. We prefer to have no laws, because privacy allows for us to build the voluntarily social contracts without the threat of violence from the state, or anyone else because our true identities are unknown. We understand voluntary transactions ultimately lead to a lower transaction cost for both parties because policing and enforcement does not have to be paid for.

Conclusion

In another age, fiat currencies and national governments were tools that we needed to evolve technologically. This economic mode was an excellent model for the growth and development of an advanced industrialized society, and all that came with it. Today however, both national governments and fiat currencies are anachronism that keeps greater humanity from advancing itself to its next stage of societal evolution: Anarchism.

Next: Understanding The Economic Functions of Bitcoin

Bitcoin and Liquidity Preference

“Why would anyone outside of a lunatic asylum want to hold money? What an insane use to put it! For it is a recognized characteristic of money as a store of wealth that it is barren; whereas practically every other form of storing wealth yields some interest or profit. “ –John Maynard Keynes

This is how Keynes understood the functions of money. He believed that individuals should be self-interested enough to want to maximize the utility of money. Keynes believe that ‘the public’ held money for three purposes:

  • to have on hand for ordinary transactions
  • to keep as a precaution against extraordinary expenses
  • to use for speculative purposes.

This is called liquid preference, and it is the idea that we would rather have a dollar that can purchase anything now, in our hands (as it is the official mode of exchange and legal tender), than to have a bar of gold that is subject to storage fees, a house that is deteriorating, or food that is rotting. Because physical items that are subject to physical decay cannot be immediately exchanged as money can, everything become more illquid than money. The more illiquid something is, the more ‘risk’ that is taken on in holding it; which creates the need for a higher dividend yield, or ROI for holding that object when comparing it to money today. This preference for money today is due to the special properties of liquidity that money has. When two monies are compared side by side, Gresham’s law take effect, with the bad money driving out the good.

In order to understand how bitcoin operates as a payment system, we must first understand how governments created money. This is a very long and esoteric topic which I explain in some detail in bitcoin and the history of money. Essentially over the course of several centuries, governments have changed money (i.e legal tender) from being backed by commodities, like land, gold, or silver; to being backed by nothing except for their own legal force (which is why you cannot exchange your dollar for gold or bitcoin down at the bank). This allows for governments to augment the money supply to attempt to change the velocity of money–this is the equivalently of change exactly how much more ‘liquid’ legal tender is, then any other commodity.

So how is bitcoin different? Well, Bitcoin is not money

Bitcoin is a commodity money. 

Bitcoin’s intrinsic value is derived from its ability to act as money, while still having an independent commodity value.

So in reality, bitcoin is not a ‘money’ in the most traditional sense of the word–it is not recognized as being an official form of legal tender, nor is it created in the same way that money is created by the state. What this means is that if bitcoin is not created by any state entity as a legal tender, then it must be a classic form of money: commodity money. This is something like gold, silver, bushels of wheat, cigarettes–really anything you can imagine, it just has to be something that is of value to society, and is plentiful enough to be readily exchanged, while still being divisible, portable, and difficult to counterfeit.

What happens when we understand bitcoin from Keynes perspective (that money is a barren storage of value)? We can see that his statement is true–but then, why is bitcoin worth something? Because again, bitcoin is not money–it is a commodity that acts like money. This means that the whole payment network of bitcoin while still working, acting, and functioning like money, it distinctly is not money.

Bitcoin is a commodity which is used primarily as storage of value that is readily exchangeable–more so than any other form of legal tender, or commodity-money that has ever existed. What happens when we do a side-by-side comparison of bitcoin-as-money, against all other forms of money, is that bitcoin will always be a superior form of money. Always.

Bitcoin flips the idea of liquidity preference on its head because bitcoin not technically money–it is a commodity-money with a built in payment system. Bitcoin has all of the features of sound money, with the extra twist of living on the internet, which inherently makes it superior to all forms of legal money. Over time, as people come to know and understand, how and why bitcoin is a better form of money, people will start abandoning fiat money causing for both hyperinflation and hyperbitcoinization.

Next: Bitcoin’s Creative Destruction

The Political Fork

There is going to be another fork with bitcoin, and it is going to be odd and obscure–as politics always is. The fork is not one that is chose by the community, but rather is something that will be forced upon them. This is how government regulation within the bitcoin community on a whole will be preformed. I believe that over the next few year we will see a large national security apparatus that will start ‘mapping’ bitcoin addresses, where they are associated, and with whom they are associate with.

We are already seeing the Bitcoin Foundation leading the charge into regulation.  As much as I would like to think that regulation could be a good thing, I simply cannot believe it when it is coming from a government whose actions can only be defined by that of a tyrant. I believe that a deal shall be struck with the devil that allows for bitcoin to be used for commerce, but there will be a tax at the point of purchase, along with some sort of ‘logging’ of what  bitcoin address it may come from. This will then be used to create a map of the bitcoin ecosystem to go after larger tax resisters, and operations like the Silk Road.

We must take into consideration that these companies are already sharing data and executives with the government spy agencies. Palantir Intelligence, which seems to have had a hand in building PRISM, is funded by and has several ex-PayPal executives at it. This is on top of several of the major tech giants already sharing untold amounts of data with the NSA–for us to believe that the government would not try to map bitcoin and rob it of its privacy capabilities is silly. They will try to map it, and they will most likely be successful.

I believe that this will lead to a sort of political forking. I think the most viable solution would be for the creation of Zerocoin alt currency that people could simply mix into, but there could also be an evolution of more sophisticated mixing services, similar to the one on BlockChain.info.  Anyway about it, I do not suspect that this cat and mouse game with the government and crypto-anarchists will end simply–I think that this is the start of a very sophisticated game of building a better internet, and currency on top of privacy that is assured by math, and not the political promises of corrupt men.

A Bit of Math: The Equation of Freedom

John gray is a premier political philosopher, and formerly a lecture at the London School of Economics. His erroneous essay on Bitcoin deserves a philosophical reply. In the following I will refute John Gray’s assertions on the functions of money and benevolence of the state, in addition to displaying that he speaks from a place of anointed authority with a misunderstand of what the concepts of digital freedom and liberty mean. It is my hope that through refuting John Gray that I can offer a framework for understanding the maxims of Digital Freedom and thus digital currencies themselves.

In his essay, John Gray States:

“While the policies that were adopted in the wake of the financial crash may have saved the world from a rerun of the 1930s, they also mean that money is steadily losing its value as a store of wealth. With near-zero interest rates, small savers are robbed as surely as they would have been if the original Cypriot plan had been implemented, just more slowly.”

A Golden Dawn, the neo-nazi part of Greece, having a rally.

His error is in assuming that crisis has been averted.  It is clear when looking at the big picture over the last five years, we can see that crisis has not been averted, but rather it has been mitigated for the current point in time. The Bank of England’s Governor stated that he believe that the current depression is worse than the Great Depression of the 1930s, and the data supports this. Greece unemployment is greater than the U.S. had at the peak of the great depression, and they also in the 6th year of their Great Depression. It is no wonder that just like in the early 1930s that we are seeing the rise of Fascism in Europe again with Gold Dawn–the Neo-Nazi Party of Greece–which is now the third largest party in Greece.

Many other European states are not fairing much better. Italy is clearly floundering, with a -2.4% economic growth for 2012, bail-out being likely in the next 6 months, and having their prime minister convicted of tax evasion, and then evading even the very ruling banning him from politics–corruption is an issue that cannot be understated. This is also an issue in Spain where the prime minister and his People’s Party are under fire for allegedly accepting cash payments from construction firms. This is on top of the economy having a projected unemployment of above 25% until 2018, the largest protest ever for an independent Catalonia, and 20% of the economy going black. Let me remind you that this is a nation that tore itself apart in a civil war during the 1930s because of economic problems, it is not fantastical to think that it could happen again.

Perhaps the only accurate part of this statement is that money is steadily losing it’s value. This is due to the policies of Japan, The U.S., and The E.U. all engaging in ‘quantitative easing,’ which is a sophisticated word for expanding the money supply. Japan is trying to double their money supply to achieve a rate of 2% inflation ‘as soon as possible,’ and the U.S. has tripled their money supply since 2008. This may have helped combat the obvious deflationary forces that have been present since 2008, but this is akin to jumping out of the frying pan only to find yourself in the fire later on. I believe that we will see stagflation starting 2016, and with the global economy already doing this poor, it shall create massive political pressure that will go unheard again.

Moving forward, let’s look at more of the erroneous statements of Mr. Gray:

“The currency has been criticized as a tool of speculators and money-laundering and its value has oscillated wildly as a result of hacking.”

This is an assumption that should display Mr. Gray’s rudimentary knowledge of how Bitcoin and the internet functions. It has not been ‘hacking’ itself that has caused for the volatility of bitcoin prices, it is simply with the market growing and trying to establish itself. Some of the major bitcoin heist did temporarily effect the price, but to believe that it is the cause of volatility would be inaccurate.  When you have such a small pool of wealth that is being dealt with (the market cap today is around $1.1 billion total–not just in circulation), it means that any shift of more than a few $100,000 is going to move the market quite a bit.  If you moved more than $10 million into any currency on the ForEx market it would not even be noticeable–it would be a drop into the financial ocean.

Later in his essay Mr. Gray displays his lack of understand about the functions of the internet:

“[Cyberspace is] a site of unceasing warfare – abounding in worms and viruses, vulnerable to attack and decay, and needing scarce resources and energy to operate – the virtual realm of the internet is a projection of the human world with all its conflicts.”

His whimsical notions of how cyberspace functions should be more than enough to inform us that he does not understand how the internet works. First, war is an act of violence in its totality–violence simple cannot exist on the internet. Period.  Calling viruses, worms, and hacking ‘warfare’ is a disservice to those that have died under the bludgeon of warfare, and creates a fundamental misunderstanding of what is occurring–violence is not one of them. Through allowing this ignorant idea that ‘war’ exist on the internet, Mr. Gray has endorsed the violence that the state brings to people like Pvt. Manning and Edward Snowden who have done no actions of violence whatsoever.

The internet in itself is a place of intangibility and human expression–that is the bases for the very code the the internet is written upon, and the functions that the internet carries out. Ideas, intangibilities, concepts, exchanges of information, and knowledge–that is what the internet is in all of its forms–nothing more and nothing less.  It is from this very place that programmers of the 21st century have found themselves asking the same questions as the legal philosophers of the 16th century–in a very different light however.

The freedom of the internet is derived from the freedom of actions which one can do on the internet through the functions of the code that one is using–the code itself is a tool, a tool to help create these expressions and communications over the internet. Programs based upon this same form of logic that philosophers are subject to, hence why it is called logic. It is not surprising then to discover that with the building of the foundation of the internet that small community of cypherpunks found themselves discussing  principals and values like freedom, privacy, and sovereignty.

It was from these discussions that the question of assurance came up: How can we be assured that our privacy is safe? We cannot trust someone else with our privacy, or else it would not be private, so how to we negotiate that? The answer to this question was math. Mathematics offer us statistically assurances that if we are to use a cryptosystem, such as a PGP key, or Bitcoin, that the statistic capability to break hash function is very, very, if not impossible hard to do. Thus, we arrive at a system of privacy that offers the mathematical assurance of privacy–not the lies of men sworn to protect these privacies. Armed with this knowledge, this same community that was just a bunch of ‘punks’ became the vanguard of the internet privacy and freedom.

From their deep thoughts to the question of liberty and government violations of that that The Declaration of Independence of Cyberspace came from. It was clear almost 20 years ago that the Internet was too powerful for megalomaniacs of governments to let it be. It was also clear that the defense of the internet was going to be needed and it is for the same reason that the Electronic Freedom Foundation was founded. Even back in 1995 it was clear that the freedom of the internet could not co-exist with the oppressive governments of the world–either the internet would be free along with the world it connects to, or it would be limited, choked, and exist only at the whims of those in the halls of power–just as our societies exist today. With the true extent of NSA spying today still unknown, I believe it is clear to see who is winning. As nation-states are clamping down on the freedom of their citizens and the internet across the globe, people are finding solidarity within that principal itself: The freedom of the Internet.

As a man that has called himself as a liberal, it is sickening to here such dribble as this be written from any man that calls himself a scholar:

“[Crypto-anarchy is] a philosophy that shares the fatal illusion of anarchism in all its varieties, the notion that most human beings actually want freedom from government. Invading personal freedom in times of crisis isn’t always unpopular – far from it. Not only during the 20th Century but throughout history, human beings have turned to governments, and often to tyrants, for protection and security. The safety they are looking for may be just a mirage. That hasn’t stopped them wanting it.”

I am shocked and horrified to hear a scholar advocate for the tyranny of governments–popular or not.  Simply because Adolf Hitler and Benito Mussolini came to power through legitimate means and because a majority of citizens would willing have other citizens taken to the gallows for false promises of liberty does not excuse such actions in any way, shape, or form. Totalitarianism, Fascism, and Authoritarianism all have a deep and powerful appeal, particularly in times of great uncertainty. It is akin to the power of having Demi-God come to you and say, “Give me the power to kill and work outside of the bounds of the law–for I shall give you peace in our time.”  It was these very feelings that caused for the the untold deaths of tens of millions of innocents during World War II–a horror that we cannot, must not, and shall not ever experience again.

What men like John Gray and his masters do not realize is that this is the beginning of the final push for a global liberated single humanity. Those that are Digital Natives understand the power of the internet and how it has, and shall continue to change the world. Digital Natives see how much closer we are to one another than we are to the elites that run run own respective nation.  Our counterparts in Greece, Egypt, China, and the world over, that are struggling with the political oppression in their nation is the same struggle as our own. They are our brothers and sisters of the world, and fellow citizens of Cyberspace. It is with them, not the John Gray’s of the world that we shall find liberty together.

He concluded his essay with the following statement:

“Whatever happens, this will surely not be the last attempt to find freedom in cyberspace. While the freedom Bitcoin promises is an illusion, it’s one that will always have a grip on the human mind – the dream of finding some kind of talisman, a benevolent tyrant or a magical new technology, that can shelter us from power and crime and protect us from each other.”

It is tragic to see that Mr. Gray understand the human heart’s most basic yearning to find freedom, yet refuses to acknowledge that technology may have brought this within our grasp. I believe that this is where there is a fundamental difference in the world view of my generation and his generation.  To take from the Declaration of Independence of Cyberspace:

“You are terrified of your own children, since they are natives in a world where you will always be immigrants. Because you fear them, you entrust your bureaucracies with the parental responsibilities you are too cowardly to confront yourselves. In our world, all the sentiments and expressions of humanity, from the debasing to the angelic, are parts of a seamless whole, the global conversation of bits. We cannot separate the air that chokes from the air upon which wings beat.”

We have moved into a world where those who hold economic and political power do not understand that which we are creating together in the Great Common known as Cyberspace, and so they seek to destroy the freedom we have created here. Because they do not understand us they have sent swarms of regulators to eat out our substance and subjugate us to laws that far outside of our jurisdiction. Because of their own stupidity and certainty of that stupidity that they have doomed themselves to fighting a war which they cannot win.

That is a war with freedom itself. This is not the glistening banner of shinny, pretty freedom that American politicians speak of, but true, unadulterated, messy, freedom. The freedom that is not just a promise, but a rule. One that is blind and unbiased, that functions from maxims and not opinions, and is of rules, not rhetoric. It is from this idea of advancing economic freedom from a categorical imperative that we are able to see the power of the federated cryptosystem that Bitcoin is.

Bitcoin, Bootstrapping, and the Black Market

One of the most powerful features of bitcoin is that it is a simple, and unbiased money.  When I say unbiased, what I mean is that bitcoin is owned by no one, and favors no one state over another–it’s not American money, European money, or Chinese money–it’s just money.

The independence of money is directly linked to the independence of commerce, so when you have a 100% free, uncontrolled money, that means that any and all forms of commerce can be undertaken.  This is everything from the angelic to the satanic–from being able to send activist funds behind authoritarian lines to be used for life-saving medical treatments, to purchasing drugs or other nefarious items–bitcoin includes all of these transactions because it is a non-discriminator money. It does not need the approval of the powers that be in order to work–two parties that want to do an economic transaction is all that is need for bitcoin to work. This is critical to understanding how the bitcoin market managed to bootstrap itself passed a fun hacker currency and into the real world of finance, economics, and commerce.

Black market bootstrapping

One of the questions that has been discussed little is how? How did some anonymous hacker’s pipe dream of a crazy, digital currency living on the web and protect by sophisticated cryptographic algorithms come to fruition? Well, outside of being a very sound mode of exchange, bitcoin can do transactions that very, very few other monies can do at this point in time–create a (almost) totally anonymous transactions between two private parties online. This allows for bitcoin (and other digital currencies) to build markets where others could not do so because of authoritarian restrictions.

It is with this niche area of service (illegal products and services) that bitcoin managed to bootstrap its way from being a play currency to being a real currency. It is specifically the ability to facilitate commerce that could not occur otherwise, or would be very difficult to occur. And thus, because commerce can occur with it, and two or more parties are willing to accept it, it becomes a currency.

Lets think about this for a minute–so bitcoin bootstrapped itself beyond, well nothing, into currency by facilitating black market transactions. Furthermore, the value of bitcoin increased because it was recognized that bitcoin could facilitate the transactions very well, safely, and anonymously. Who else, other than drug dealers could use this?

Well anyone in System D (the unregulated markets of the world) could use bitcoin.  Jon Matonis, the director of the Bitcoin Foundation wrote a great article on bitcoin and what it can offer for those in System D. I would go one step further and even suggest that in the same way that then first black markets of bitcoin (Silkroad) bootstrapped bitcoin towards more acceptance, it’s use within System D will help bootstrap it towards global acceptance.

It is going to be very interesting to see how bitcoin is going to break into developing markets. I personally hope that we will see an adoption curve similar to that of M-Pesa, The Kenyan mobile currency. Having started only in 2007, more than 30% of all commerice is done through Kenyan cell phones! With huge portions of the population being able to easily and quickly adopt bitcoin, I see a bright future for it and the developing world.

Theory of Digital Currencies

It is obvious to me and many of my peers that contemporary models of economics simply do not apply to the brave new world that we are entering into.  With the advent non-state currencies that are based upon decentralized, federated protocols that are guaranteed by cryptography, math, and privacy, we need a new economic paradigm to move forward. In this blog I will attempt to build a theory of digital currencies that can explain their functions and rise within a global economic system of state-based currencies.

Ultimately, it is my hope to thoroughly explain on a economic level the failures of state-based currencies, and the solutions that digital currencies offer. It is also my hope to start a philosophical dialog about economic liberty, what it means in the world of today, and what sort of moral, ethical, and societal expectation come with economic freedom. It is my hope that this will help explain the horrible distorting mechanism of state involvement in economies that entirely destroys the concept of a free market and replaces it with some notion of national socialism.

Please feel free to leave respectful comments and critiques on any theory that I may present in this blog.

Protecting yourself from legalized theft

Believe it or not, government official can steal from you whenever they really want to. All that they need is some sort of excuse to justify the theft, it doesn’t really matter what, as long as there is something ‘illegal’ to accuse one of.  Once an accusation has been leveled, the police are free to steal whatever it is that they like. And with more than 2.8 billion dollars seized in 2012 alone, it’s hard not to think that some innocent people were pulled in. That’s what happened to James Lieto when the Feds seized close to $400,000 dollars of his money. When your business takes a $400,000 loss–even if it is in the short-term and the funds are returned later, your business is simply going to fail because you do not have the needed capital to run your enterprise. The police can take your money for practically any reason, and there is little you can do about it.

Now many would retort with, “But not all cops are bad–we need them to take the bad things from the bad people.” Sure, but that is not what is being discuses, we are talking about people who use their roles as police officers and outdated laws to steal from people innocent people. I don’t care if guns were taken from 10,000 criminals–the good cannot outweigh the bad. That is why we were entitled with the fourth amendment to protect us from overarching authority. Sadly, the most of the bill of rights and constitution are wholly ignored in this country today, so there is little recourse. So what can one do?

Protect yourself with bitcoin and other digital currencies because they cannot be seized.

Digital currencies are protected by cryptographic algorithms like SHA-1 which means that there are two ways that you can take the money without authorization: through cracking the private key–which on a good day is about 2^63, which would take years to crack, or you can know the password. Because digital money exist exclusively on the internet, you simply cannot seize the funds. The protection that this can offer cannot be overstated when you are looking at your life’s work and savings being taken from you.

This also has far reaching ramifications for when tyrannical governments use their over reaching authority to restrict capital flows to defend their fledgling economies. In places like Venezuela, Argentina, and Iran–all of which have capital controls and rampant inflation (10%+), their citizens are getting poorer by the day because they cannot exchange their money for something stable and worthwhile. What we are seeing with digital currencies are market adjustment according to country and the currency that is being exchanged. Despite bitcoin being the same thing in the U.S. and Argentina, there are very different prices between where you are buying from. Currently it cost about 60% more to buy bitcoins with Argentinian Pesos over USD because of the inflation that the Argentina peso is seeing today, along with the capital controls that are in place. Bitcoin offers protection to people that want to flee from a currency that is clearly losing value, while also being able to get around capital controls.

In concluding, digital currencies offer protection from illegal government seizures. If you have any reason to fear government seizures, or even if you handle large amounts of cash regularly ($5,000+) you may want to consider putting some of your money into digital currencies to hedge against government seizures before you find yourself with no money, and no recourse to get it back.