Significant Day for Crypto

13 Mar

I haven’t posted in quite a while, but the news this morning seemed significant enough to stir me to start typing.

The first thing I saw on my phone this morning was that ether, the token (or crypto-currency) of the Ethereum Blockchain, was trading at $27. When I yelled this news to my wife, she responded with “twenty eight forty three”. Thus far the high on the Kraken exchange has been $29.98 but right now fallen back below $29.85. This is a 100 to 1 increase in valuation, from $.29 in August 2014.

This certainly got me excited, so as I sat in front of CBS Morning while reading Ethnews.com on my phone I saw this headline: New Gold Backed Cryptocurrency Introduced (https://www.ethnews.com/new-gold-backed-cryptocurrency-introduced).

The story reports that a new crypto-coin, OZcoinGold, is being launched on the Ethereum blockchain, but rather than a mined coin, it is a limited edition of tokens, 100 of which grant ownership in 1/3 oz. of 24 karat gold in a vault at the Perth, Australia mint, and 2/3 oz. of gold in certified reserves in a gold mine regulated by the Australian government. The issuer of the coin is backing it with 100,000 oz. of gold, at the mint and in reserves at the mine. After March 1st, 2022, holders of the tokens will be able to redeem them for certificates from the Perth mint, which are then exchangeable for gold at gold dealers throughout the world.

The coin was launched at SXSW on March 10.

This means that with only two more pieces of the puzzle in place, the unregulated free market in ideas will have provided the world with an unshakable gold standard. It will then be up to the market in currencies to use this mechanism to supplant the corrupt central bank/creeping world bank fiat money regime that siphons our wealth to fund the eternal war.

I plan to write further on what the two remaining pieces of the puzzle are, but I am also thinking about starting a new blog under a pseudonym. If you are reading this and would like to know where to find my future posts (if that change does come to pass), please email me at gmautry@gmail.com and I’ll reply with a link to the new blog. And please let me know if you found anything on this blog useful or interesting.

Walt, here’s why you’re wrong about the Fair Tax.

2 Sep

Walt,

I have a great deal of respect for you as a noted Libertarian activist and the founder of Nolanchart.com. However, you were completely wrong about cyber-currencies, as I explained in my blog posts here and here. And although I heartily agree that taxation is theft, I believe that your objections to the Fair Tax are also somewhat misguided.

I am no gradualist. If you brought me a magical button, and said “Push this, and no tax will ever again be collected, and no monopoly of coercive force will ever again exist.”, I would push it in a heartbeat. But try getting that bill passed in Congress. I support the Fair Tax because I believe clear distinctions can be made between the effects on the economy of one tax policy over another. Specifically, I disagree with your assertions that the Fair Tax merely enforces the status quo, and that it shifts the tax burdens onto the poor and away from the rich. I continue to insist that reducing state expenditures to zero, which I don’t know how to do, and reducing the harm to the economy imposed by the tax regime, which I believe can feasibly be done by enacting the Fair Tax and repealing the 16th amendment, are separate issues. I believe that one can advocate for the achievable mitigation of an evil, while simultaneously desiring the much less achievable total elimination of that evil.

So first, let us consider whether the Fair Tax merely perpetuates the status quo. I will assume that your justification for this argument is the well established fact that the Fair Tax is designed as a revenue-neutral proposal, that is, its enactment will not (in theory) increase or decrease federal revenue. However, the amount of federal revenue is not the only factor in the status quo.

1. In addition to the drain on the private economy represented by revenue extracted, there are tens or maybe hundreds of billions of dollars in compliance costs associated with the existing tax regime. These costs do not benefit anyone other than accountants who sell tax compliance services to taxpayers. But these costs are not simply waste, they actually enable the most intrusive and anti-liberal bureaucracy of the American Imperial State. No other institution in our society has a greater on-going impact on otherwise peaceful and honest citizens than the annual tax return imposed by the IRS under the existing tax regime.

Under the Fair Tax, these costs would almost entirely disappear and be returned for productive investment in the private economy, and the tax compliance bureaucracy would entirely devolve from the federal to the state level, and cease to intrude into the private affairs of citizens in any way. This is a real change in the status quo that I can support even though it falls short of reducing state expenditures to zero.

2. The existing tax regime exists primarily to serve the interests of politically connected parties. Practically every word in the countless thousands of pages of the federal tax code can be traced to a specific objective of some lobby.

Under the Fair Tax, the unfair advantages in the tax code obtained by lobbying disappear. Future lobbying efforts will be restricted to obtaining federal contracts for the provision of goods and services, and obtaining regulatory advantages, but not tax advantages, over competitors. This represents a significant reduction in lobbying activity and the attendant potential for political corruption. Perhaps not an earthshaking change in the status quo, but still one that I can support.

3. Under the existing tax regime, U.S. businesses are harshly disadvantaged in global commerce. Putting aside tariffs, foreign producers have no embedded costs imposed by the U.S. tax code in the prices of their goods sold here, while domestic producers are burdened by onerous tax costs on goods sold abroad, including not only corporate income taxes, but also innumerable other taxes that may or may not add to a producer’s costs under the tax code, depending on that producer’s success in currying political favor, as noted in the previous point.

Under the Fair Tax, all producers, foreign or domestic, will have exactly the same embedded cost imposed by the tax code, 21% included in the price of new goods and services sold to end users in the domestic market. Domestic producers will have no embedded costs due to U.S. taxes on goods and services sold in foreign markets. This is a total reversal of the injurious policies affecting domestic business competitiveness in the current tax structure, and a huge change in the status quo which I support, even though it does not amount to total strangulation of the state.

4. Under the current tax regime, the state asserts the right to extract taxes on the income of American citizens earned anywhere in the world, and uses the implied threat of (either using or withholding) its coercive military power to impose its intrusive financial reporting requirements on foreign financial institutions. This is one of the clearest indications of the essential nature of the American Imperial State. Not surprisingly, this has made it increasingly difficult for American citizens living or investing abroad to obtain necessary financial services.

Under the Fair Tax, the issues of U.S. tax compliance will be restricted to the borders of each of the individual States, and American citizens will be free to pursue global financial opportunities with no interference from federal tax farmers. Another significant change in the status quo which I support.

I could go on, but now I would like to turn to your second objection, that the Fair Tax is unfairly burdensome to the “lower classes” and more advantageous to the “higher classes” than the existing tax code. I am assuming that you are using the term “class” to denote income level, not net worth or social status predetermined by the circumstances of birth. My refutation of this assertion is somewhat involved, and I hope it does not prove too tedious.

Rather than try to analyze the impacts of various tax schemes at differing income and spending levels, I will approach the question from a somewhat deeper level. One way of classifying tax schemes is by establishing two major categories, which I will call transactional taxes and recurring taxes. In the first category, a tax liability is triggered (i.e. a theft occurs) when a specific change in status, such as ownership or location, occurs. Examples are income taxes, where a change in ownership of wages or capital goods occurs; sales taxes, where a change in the ownership of a consumer good, or compensation for the provision of a service, occurs; and tariffs, where the status of a good changes as it crosses a border. A recurring tax is a liability imposed periodically. Examples are property taxes, licensing fees, and mandatory insurance premiums. For this discussion, I will ignore the second category, since virtual all of the federal tax regime that would be eliminated and replaced by the Fair Tax falls into the first category.

The Fair Tax is typically characterized as a sales tax or consumption tax, as opposed to an income tax, implying that it is the buyer, and not the seller who pays the tax. But in reality, both are simply transactional taxes imposed on the seller, when a sale occurs. In the case of the income tax, the seller is the wage earner who sells his or her labor to an employer, or a self-employed producer who sells goods or services. In the case of the capital gains tax, the seller sells an appreciated capital asset. In each of these examples, it is clear that it is the seller who is compelled to surrender a portion of the funds received in the transaction to the tax authority.

In the case of the Fair Tax, as any sales tax, it is commonly asserted that the buyer pays the tax. This is incorrect. The buyer pays the price set by the seller (even though the full, tax inclusive price is typically not on the price tag), the seller receives the money and remits a portion of that money to the taxing authority. The buyer does not remit a portion of the shirt or the hamburger that he bought to the tax man. It is always the receiver of money, i.e. the seller, who ultimately pays the tax.

Viewed in this light, the shift from income tax to the Fair Tax represents a shift from taxing the income of wage earners to taxing the income of producers of goods and services. Since the “lower classes” earn the bulk of their income from wages, while the “higher classes” typically earn the bulk of their income from the production of goods and services, it is difficult to see how this shift could be considered disadvantageous to the poor vis a vis the rich.

While this may seem counter-intuitive, it should be obvious that production is the only real source of value available for extraction by taxes. And given that the Fair Tax is designed to be revenue-neutral, the total cost imposed by taxation of goods offered by producers under the Fair Tax must be less than or equal to the total cost under the current tax system (actually less than, because of the tremendous reduction in compliance costs). This, in turn, implies that the general price level of consumer goods will remain the same, although there will surely be some price variations across different classes of goods depending on whether these goods are relatively subsidized or penalized by provisions in the existing tax system. In other words, the cost of all revenue generated under the current system, plus all of the cost of compliance, is already embedded in the prices of market goods, albeit in a bewildering variety of guises. Under the Fair Tax, the same cost of extracted revenue, but almost none of the compliance cost, is applied to all consumer goods in a perfectly uniform fashion. So although the relatively poorer wage earner will find the prices of subsistence goods equally affordable under either regime, his income in the form of wages will no longer be taxed at all. Meanwhile, relatively richer producers will continue to surrender taxes on same level of production as before. Nothing in this strikes me as a shift of tax burden from the rich to the poor.

So yes, Walt, everything I have written here simply refers to two different methods of conducting a criminal enterprise. Yet I still contend that one method injures the crime victims less than the other, and should therefore be implemented if possible. I look forward to your response.

Government’s Role in the Bitcoin Universe

19 Nov

With bitcoin hearings before a Senate committee underway today, plenty is already being written about what the government is or is not likely to do and how its actions could affect the future of bitcoin. That is not what I want to discuss. This post is about what the government should or should not do, and how its actions will impact the world economy and the prosperity of its citizenry.

I will make clear at the outset, that my own intellectual bias is Austrian (primarily relying on the work of H.H. Hoppe), anarcho-capitalist, and post-statist. In my view, the best thing the government could do would be to shut up shop, abandon all of its assets to homesteaders, and sink into the ash-heap of history. However, I am also a realist. I recognize that the solutions I will propose herein represent a compromise with evil, and I hope that my fellow anarchist readers can forgive me for that. I would not propose them if I did not believe them to be within the realm of reasonable possibility, and that if enacted, they would shift the balance of power within society away from the political and toward the economic means.

To begin, I wish to establish a few points of agreement with my readers. If the following statements strike you as false, you should probably not waste your time reading further.

1. If government has any legitimate functions, one of these functions is the protection and restoration of justly acquired property.

2. Bitcoin is property. All bitcoin acquired through mining is justly acquired, as the means of production may be freely obtained by anyone (freely in the sense of being without arbitrary restriction such as patent or licensing law, rather than of being without investment cost). All bitcoin acquired through voluntary, honest exchange, like any other good so obtained, is also justly acquired.

3. The existence of property in bitcoin resides in the physical integrity of the bitcoin network.

4. Ergo, it is the duty of government to protect the physical integrity of the bitcoin network, and to work to restore bitcoin obtained by force, theft, or fraud to the rightful owner.

5. It is not the duty of the government to protect the value of bitcoin, but any government policy explicitly intended to decrease or destroy the value of bitcoin, such as a ban on bitcoin software, or confiscation or punitive taxation of bitcoin balances, would constitute a crime.

These points summarize what I believe to be the level of consensus today between the actors in the bitcoin community, the broader financial community, and the American federal and state governments. The more extreme stance taken by the law enforcement and anti-terrorist elements of the federal government, that bitcoin is a threat and should be actively suppressed, does not seem to be gaining a critical mass of support. At the same time, most of the major players in the bitcoin economy seem to be advocating detente with the regulatory state rather maintaining the radically anarcho-capitalist position of the early years.

Here is how I see the concerns and objectives of the key interests:

The government’s largest concern is how to tax the bitcoin economy, and it should be assumed that all proposals coming from that side will have tax enforcement as the primary goal but will be couched in terms of anti-terrorist and anti-fraud protections in order to muster public support.

The largest concern of the banks and Wall Street is the protection of the ability to manipulate credit through the fractional reserve system anchored in the Federal Reserve. They will maintain a publicly neutral stance but will covertly and frantically lobby against any proposal (such as the one that I offer) that threatens their corrupt power.

The core concerns of the bitcoin community are the maintenance of the physical integrity of the bitcoin network and its surrounding infrastructure, including enhancement and maintenance of security measures to deter theft, and continued viability of the software as the network scales upward. There are also significant concerns arising from externalities, such as the public perception of bitcoin and the policies of the regulatory bureaucracy. These include raising public awareness and understanding of the bitcoin economy with the aim of deterring fraud, and defense against unwarranted restrictions on the free production and exchange of bitcoin.

And finally, the key concern of the public at large is to be secure in their private property rights, that is, the right to justly acquire, exchange, or use for any peaceful and honest purpose, any property, including bitcoin.

My proposal provides what I believe to be a reasonable compromise between the competing concerns of the government, bitcoin community, and the public, which although not fully just (as involuntary taxation is never just), is at least as just as the current regime. (I can find no way to reconcile this proposal with the interests of banks and Wall Street, nor do I wish to do so.)

Here is the proposal:

1. Congress should enact the Fair Tax Act of 2013 (HR 25, Wikipedia, http://www.fairtax.org) This measure repeals all federal income taxes (personal, estate, gift, capital gains, alternative minimum, Social Security, Medicare, self-employment, and corporate), replacing them with a single broad consumption tax collected on the sale of new end-user goods. The tax rate is revenue neutral. A monthly “prebate”, in the amount of the tax that would have been paid on expenditures equal to the federal poverty level, is remitted monthly to each registered family. The clause in this bill relevant to bitcoin is Section 103 paragraph (d), “Barter Transactions- If gross payment for taxable property or services is made in other than money, then the person responsible for collecting and remitting the tax shall remit the tax to the sales tax administering authority in money as if gross payment had been made in money at the tax inclusive fair market value of the taxable property or services purchased.”

The enactment of this bill would satisfy the government’s objective of facilitating tax enforcement by eliminating the need to track bitcoin incomes or capital gains and instead to simply collect the sales tax in dollars on items purchased with bitcoin. The capability of calculating the tax based on the exchange rate at the time of the transaction would be a trivial addition to the functionality of already available bitcoin payment processing platforms. This single step would eliminate a huge source of uncertainty on the part of both the government and users of bitcoin. Step two would extend this benefit even further.

2. Congress should enact legislation authorizing the optional distribution of any portion of Fair Tax prebates in BTC. Taxpayers should be permitted to designate the portion to be remitted in BTC at any time more than one month prior to receiving a prebate. The prebate amount would be denominated in dollars, and the exchange rate for determining the BTC amount would be the Average Federal Bitcoin Acquisition Rate (AFBAR) for each monthly period, where AFBAR is defined as the sum of the cost in dollars of BTC purchased by the federal government during the month plus the amortized value of the GH/s employed by the government to mine BTC during the month, divided by the number of BTC distributed in prebates at the end of the month. The government would be prohibited from acquiring more, during each month, than 105% of the BTC required for the next prebate. In order to smooth the impact on market exchange rates, it would be required that purchases or sales of BTC or GH/s to make up any projected shortfall or overage in mining production be made in nearly equal daily increments, such that the total bitcoin surplus after each monthly prebate distribution would not exceed 5% of the amount distributed.

This part of the proposal is (I believe) being set forth here for the first time, and deserves some explanation. The purpose is twofold – to facilitate the acceptance of bitcoin as an alternative currency, by establishing a mechanism for widespread distribution of bitcoin throughout the populace; and to achieve rapid equilibrium in the market exchange rate between dollars and bitcoin, with minimum volatility, by making a significant fraction of the demand for bitcoin highly predictable and constant. It makes the government a significant stakeholder in the success of bitcoin, is neutral from a taxpayer perspective, and moderates the concentration of bitcoin wealth, reducing the attendant risk of market manipulation, bubbles and crashes.

Assuming these two measures are implemented while the bitcoin price in dollars is still rising, I predict the following results. Initially, few households will opt to accept the prebate in BTC, both due to unfamiliarity and to the risk that the exchange rate on the date of the prebate will be lower than AFBAR. My analysis of price data from the MtGOX exchange beginning on July 10, 2010, shows that this was the case 45% of the time. Thus, risk averse families who do not intend to save a large percentage of the prebate would be very unlikely to opt to collect in BTC. However, the data also show that if the prebate is held in savings, the risk of a negative monthly return by saving bitcoin versus dollars decreases as the period that the savings are held increases. At 22 months, the risk of a negative return by choosing bitcoin vanishes.

Under these conditions, within a few months, most families will have adopted a strategy of collecting increasing percentages of the prebate in BTC, selling BTC for dollars immediately if the exchange rate is favorable, and holding BTC in savings in the months when the rates are unfavorable. Within another few months, the most common strategy will shift to collecting 100% of the prebate in BTC, and holding these as savings as long as possible. This means that the quantity of BTC that must be acquired by government monthly will steadily increase toward a maximum, and that citizens will have a highly liquid market for selling their bitcoin prebates, at a steadily rising price.

If these measures are enacted, the economy will experience a short period, three to five years at most, of a dual currency regime. Every family will have a small, guaranteed income in a relatively deflating currency, which will significantly increase their ability to discharge debts and increase savings. At the same time, a moderately inflating currency will continue to provide the unit of account. This will moderate the shock of the transition to a truly stable currency, as dollar denominated prices and wages remain relatively steady.

In my next post, I will describe the end state of this scenario…

Saving for Retirement? Bitcoin safer than a CD

16 Nov

Yesterday I made the bold statement that there is zero chance that anyone who really understands the true nature of bitcoin believes that the dollar price will decline in the long run. Today I thought I would analyze the data to see just how long a run we are talking about. I downloaded the complete set of MtGOX BTC price and volume data from Bitcoincharts.com, beginning on July 17, 2010 through November 15, 2013 (1213 days). I wanted to find the shortest period during which a person could buy BTC at the daily high on the first day, sell at the daily low on the last day, and not lose money.

The answer… 633 days. If you bought bitcoin on any day before April 9, 2012 and held it for at least 633 days, you made money. And not just a little money. The worst return came from buying on June 8, 2011 at the high of $31.91 and selling on March 1, 2013 at the low of $32.92, giving a total return of 3.17%, or 1.83% annualized. I just did a quick web search and the best rate I could find on a 24 month certificate of deposit was 1.45%.

On the other hand, the average annualized return over all 633 day periods was 178.72%, and if you happened to be the lucky guy or gal who bought on September 28, 2010 at $0.06 and sold on June 21, 2012 for $6.56, you bagged an annualized return of 5,979.28%.

And of course, if you bought BTC at MtGOX on day one at $0.05 and are still holding on, with the price at $475.00 (just below the all time high of $478.50 set moments ago), your unrealized annualized gain as of right now (November 16, 2013; 10:05 pm EST) is 284,649.30%. This is how that Norwegian kid with 47 krone became a millionaire.

And this ain’t over yet, folks. If you read my post yesterday, you have seen the rationale for my prediction of least 2 to 4 orders of magnitude in price rise before bitcoin finally levels off.

In my next post, I will speculate on whether or not the Feds really want to get in front of this juggernaut.

Is gold worth its weight in Bitcoin?

15 Nov

A question for my American readers: have you ever been watching a British drama on PBS or BBC America and wondered what the difference is between a guinea and a pound sterling? I used to think that “guineas” was just a nickname for pounds, like “bucks” and dollars. Turns out that the difference between guineas and pounds provides an almost perfect real world demonstration of Gresham’s Law (the subject of my last post) in action.

During the colonial era in America, Great Britain defined the weight of the shilling as 86 troy grains of pure silver, and its legal tender law established this coin as the basis of the British monetary system. Twenty shillings made a “pound sterling”. Britain also minted the guinea, a gold coin weighing 129.4 grains of .9135 pure gold. The valuation of the guinea relative to the shilling was set by British law, but was adjusted from time to time as the relative market prices of gold and silver fluctuated; for the purposes of this tale, we will look at the 1717 guinea, which was set by statute at the value of 1 pound 1 shilling (21 shillings).

Doing the math, we see that 118.21 (129.4 x .9135) grains of gold was set equal to 1806 (86 x 21) grains of silver. Thus the price ratio of silver to gold was established by British law at 15.28/1. All well and good, but unfortunately, the actual ratio of the market prices of gold and silver in the foreign markets where British goods were traded was somewhat less than this figure, meaning that gold was overvalued in Britain (and in America). In turn, this meant that Britain’s trading partners wanted to be paid in silver, and wanted to pay for British exports in gold. The result, bad money (gold) drove good money (silver) away from British shores.

So what accounted for this mismatch in prices? After all, gold and silver coins issued by an imperial government both function in exactly the same way. They are equally recognizable, equally portable, equally exchangeable, equally storeable. You need more shillings than guineas to make the same purchase, but that factor exerts a negligible effect on the relative demand for the different coins. The fundamental driver of the ratio of the free market prices of gold and silver coins was the relative supply of the two elements. When the combined weight of all of the silver in the British sphere was less than 15.28 times the combined weight of all the gold, the result was a drain of silver coin from the British isles. As a result, the empire switched from silver to gold as the currency standard in the nineteenth century.

In the twentieth century, gold and silver coins were abandoned as circulating currency (i.e. as a medium of exchange) by the nations of the world in favor of fiat paper currencies and base metal coinage. Once the United States defaulted on its obligations under the Bretton Woods agreement and later changed the statutory definition of the dollar to remove all reference to a fixed weight of gold, neither gold nor silver served as the unit of account in any part of the global financial system. Of the three defining functions of money, this left only the storage of value. Because of its lower price, silver came to be valued more highly in industrial applications than as bullion, so that most silver coin and bullion has disappeared. Today, the only remaining monetary role for metal is gold as a store of wealth, either in central bank reserves or in private hands.

For this reason, the traditional the price relationship between gold and silver, based on the relative quantities of circulating coins, which had varied in a narrow range for centuries, has now completely broken down. Silver today would probably command a higher price than gold if the price ratio depended on relative quantities of bullion. Some interpret this fact to be extremely bullish for silver, assuming that the price ratio must inevitably move in the direction of alignment with the ratio of physical bullion, or at least with the traditional ratio of around 15 to 1. But since silver is no longer in demand in any monetary role, there is no clear basis for predicting any particular ratio between gold and silver.

Let me pause to recap a few facts. We know that the price of anything is a function of supply and demand. We know that prices can only be comparable against a unit of account. We know that historically, at least for most of the last 3 millenia, the ultimate means of balancing financial accounts was by the exchange of quantities of an easily measurable characteristic of a scarce commodity, usually the weight (mass) of a precious metal. We know that when a specified weight of one metal is used as the unit of account, the market price of an equal weight of any other metal used in coinage stays very close to the ratio of the total available weight of that metal to the total available weight of the reference metal. We know that when an attempt is made to constrain the price of one metal relative to another, for example, by statute, the metal that is undervalued will either be exported or saved and will cease to circulate (Gresham’s law).

We also know that the policies of central banks supported by states have overthrown this regime and replaced it with a system of accounts maintained on bank ledgers, using paper tokens exchanged by hand or digital tokens exchanged electronically in the place of metal specie. Each major state establishes its own unit of account and its units of currency are the primary means of exchange within its borders. These major currencies are freely traded on global markets, and so a fluctuating exchange rate exists between each pair of currencies. And finally, the US dollar is the de facto unit of exchange for most international trade, primarily due to the relative strength of the US economy and the relationship with the Saudi Kingdom establishing the dollar as the single currency used to settle international trades in petroleum.

What can we glean from these historical facts to guide us in predicting the future dollar price of bitcoin? Obviously, neither dollars nor bitcoin are metals. However, bitcoin simulates the properties that make metals useful as money to a far greater extent than dollars. The main difference is in the limited and predictable supply of bitcoin. In addition, although bitcoin is exceptionally well suited to provide all of the essential elements of monetary utility, (unit of account, medium of exchange, and store of value), its level of acceptance at this stage allows it to compete in only one area, that is as an incorruptible and indestructible store of value. This is because the dollar is far too ingrained as the unit of account in the world’s financial systems to be overthrown on any time scale less than decades. And bitcoin is severely undervalued, not due to government fiat, but due simply to the lack of widespread acceptance. This undervaluation is precisely what makes bitcoin problematic as a medium of exchange but almost unbelievably valuable as a store of wealth.

So we have the following situation: despite the replacement of precious metals as money, there remains a vestigial demand for gold bullion, and to a much smaller extent for silver, as a store of wealth. There are estimated to be around 3 billion troy ounces of gold in the form of bullion or coins. At today’s market price in dollars, this comes to a little less than $4 trillion of demand for the utility of gold as a store of wealth. I personally see no reason why this demand for a secure means of storing and protecting wealth for future needs cannot be met by bitcoin as readily as by gold. You can refer to my earlier post (here) for my explanation of why the basis of the value of bitcoin is exactly the same as the basis of the value of metal bullion.

Right now, I could buy all existing BTC for a little over $5 billion (well, I couldn’t, but there are a few folks who could). This reflects the fact that practically none of the 7 billion plus people on earth have even heard of bitcoin, and the majority of those who have think it is a scam, a bubble, a money laundering scheme, a hack waiting to happen, or else they are simply too busy or too dull to make the effort to understand what it actually is and to grasp its potential. However, the tiny fraction of humanity who have taken the time to study and really understand what bitcoin is all about are grabbing it with both hands as fast as they can.

As one of these people, I can unequivocally state that there is zero chance that any significant fraction of us will ever be persuaded that bitcoin’s value as a savings vehicle is likely to decline in the long term. These are people, for the most part, who not only have an understanding of bitcoin, but also have much greater than average understanding of the current financial system and its weaknesses, particularly the utter worthlessness of the fiat dollar, under current Fed policy, for savings. There is some finite positive probability, given bitcoin’s exponential explosion into the world’s consciousness, that some of those learning about it for the first time, or those currently rejecting it, will also come to embrace it. So the demand for bitcoin solely in the role of digital bullion can only stay at current levels or increase. Thus;

Worst case – the demand for bitcoin as digital bullion remains about where it is and its dollar value fluctuates in the range of $100 – $1000 (in 2013 dollars)

More likely case – bitcoin splits the demand for bullion with gold at some level near parity and trades between $50,000 and $500,000 (in 2013 dollars)

Best case – the continuing spectacular increase in the price of bitcoin ultimately leads to total acceptance, so that it splits or captures the demand not only for bullion but for a medium of exchange, and becomes the defacto global unit of account. At that point, the dollar price becomes meaningless. If this has occurred by 2040, when the supply of bitcoin will be stable at under 2,100,000,000,000,000 Satoshi, and world population is estimated to be around 9,000,000,000, the per capita share of BTC will be 233,000 Satoshi.

Today, anyone on earth can purchase that amount of BTC for a buck, but the price is going up. I’d get started if I were you.

Gresham’s Law and Bitcoin

14 Nov

“The course our city runs is the same towards men and money.
She has true and worthy sons.
She has fine new gold and ancient silver,
Coins untouched with alloys, gold or silver,
Each well minted, tested each and ringing clear.
Yet we never use them!
Others pass from hand to hand,
Sorry brass just struck last week and branded with a wretched brand.
So with men we know for upright, blameless lives and noble names.
These we spurn for men of brass…”

Aristophanes, “The Frogs”, circa 405 B.C.E.

Gresham’s Law states that “bad money drives out good”. When the price of a currency is artificially constrained, for example by a legal tender law, then the constrained price may be higher, the same, or lower, than what its price would be on a free market. If the currency’s constrained price is lower than it would be on a free market, it will tend to be exported to be resold where the constraint does not operate, and thus will disappear from circulation. If there are competing currencies in the constrained market, the currencies that are relatively undervalued will also disappear from circulation. This will be true, even if the constrained price of the most undervalued currency is still greater than or equal to its true free market price. If creditors are compelled under legal tender laws to accept one or more currencies at a fixed price, debtors will always tend to pay with the cheapest currency available, that is the currency whose constrained price has the greatest positive (or smallest negative) spread from the free market price. The currencies with a narrower spread, even if they cannot be resold on a foreign market at a profit, will tend to be retained as savings.

What does this have to do with Bitcoin? Bitcoin actually does trade on a truly free and global market. Thus its spread is, by definition, zero. No national fiat currency can make this claim, at least in its home country. Thus, by applying Gresham’s law, we can see that given a choice, debtors will tend to pay their debts with their national currency, and retain any Bitcoin that they acquire as savings. They will exchange their Bitcoins for other currencies only if they have no other means of paying a debt or purchasing a necessity.

This means that the adoption of Bitcoin for commerce directly will be slow, or in other words, even if Bitcoin becomes commonly used as a payment system by merchants, prices for consumer goods and interest rates on loans will continue to be denominated in the national currency, and will be quoted in Bitcoin at the prevailing free market exchange rate at the time of payment. During the current phase of Bitcoin’s adoption, as it becomes increasingly clear that demand continues to rise steadily, I would actually expect that Bitcoin prices will be quoted at a discount to the instantaneous exchange rate.

So, as a unit of account, Bitcoin will not become the standard anytime soon, although it probably will at some point in the future, when demand for Bitcoin reaches equilibrium with other currencies, and in particular, gold and silver bullion, which also trade globally on a fairly free market. However, as a store of value, I believe that it is already the standard.

In my next post I will explain at what price I expect that equilibrium to occur.

What backs Bitcoin?

12 Nov

In several earlier posts, I implied that the Imperial Government of the United States might be actively hostile to Bitcoin, which could certainly tend to complicate its widespread adoption. In this, I believe I was in line with the conventional wisdom (a position I have seldom fitted into comfortably). However, in the interim, several indications have arisen which suggest that the IGUS is maintaining a neutral stance vis-a-vis Bitcoin. Most notably; last month’s Federal bust of Silk Road was not accompanied by a frenzied government call for the abolition (as if that were even possible) of Bitcoin, and last week, François R. Velde, senior economist at the Federal Reserve Bank of Chicago, published Bitcoin: a primer in the Chicago Fed Letter. This is a balanced piece which includes a good technical explanation of Bitcoin. It concludes with the statement that, “[Bitcoin] represents a remarkable conceptual and technical achievement, which may well be used by existing financial institutions (which could issue their own bitcoins) or even by governments themselves.” I have long believed that the most rational response of the state to Bitcoin would be to embrace and profit from it along with rest of us, and this paper suggests that at least one of the court intellectuals agrees.

However, Dr. Velde makes a common mistake when he states “Fiduciary currencies” (including Bitcoin) “—in contrast with commodity-based currencies (such as gold coins or bank notes redeemable in gold)—have no intrinsic value…”. This touches directly on a criticism I answered briefly in a previous post, which is that “Bitcoins are backed by … well … nothing. It’s fiat money issued by ‘the market’…”. In that post I addressed the mischaracterization of Bitcoin as fiat money, since this designation requires the imposition of a state fiat or decree to support the value of the currency. Dr Velde correctly points out that fiat money, including the US Dollar and all other major national currencies, is also a fiduciary currency, and has no “intrinsic value” derived from its status as a commodity.

So what is the error that Dr Velde has made? You might expect that I would argue that Bitcoin has some sort of “intrinsic” value, perhaps deriving from the fact that it requires an input of energy to create new Bitcoins. I have seen this argument before, in Bitcoin forums and articles. Dr Velde alludes to this when he remarks that “The term ‘mining’ may lead one to think that bitcoin is not fiduciary.” However, this is nothing more than the Marxist labor theory of value, and holds no water in a serious economic discussion.

My argument is not that Bitcoin has intrinsic value. It is quite the opposite – I maintain that no form of money, fiduciary or commodity-based, has intrinsic value. In fact the term “intrinsic value” is an oxymoron. Things have intrinsic characteristics; gold is dense and malleable, Bitcoin is decentralized and cryptograpic, water is wet, etc. One of the intrinsic characteristics of the concept of value is that it always and everywhere is a subjective ranking reflecting the goals of a human actor and the options available to him for achieving those goals. To argue that gold has intrinsic value is to assert that there is some minimum level in the rankings assigned by every living human to every option available below which gold (in some specified quantity) can never sink. This is clearly ludicrous. A drowning man in possession of a kilogram of gold will be more likely to find positive value in letting it sink to the bottom of the sea than in maintaining his hold on it.

What is really being said by incorrectly applying the adjective “intrinsic” to the value of gold is that gold has a long established history of being relatively highly valued by many if not most people. In fact, it is so highly valued that its market price cannot be even remotely accounted for by its utility as anything other than as (primarily) a store of value and (secondarily) a medium of exchange. This explains why the vast majority of the gold currently in the hands of humanity consists of bullion bars or coins, or chains, rings and amulets that may also be used for exchange in a pinch. Only a tiny fraction is employed in such uses as decorative gold leaf or as an electrical conductor.

To quote Dr. Velde again, “a currency that has value only because of the belief that it will have value may have no value at all (for instance, if I believe that no one will accept it, I will not accept it either)”. Quite true, and applicable to gold as much as to any other thing on earth. What is at issue here is not some intrinsic value that gold can never lose, but rather the strength of the belief that gives gold as well as Bitcoin its value. I am certainly not suggesting that the strength of the general belief in the exchange value of gold is likely to be diminished anytime soon. I am merely asserting that the fact that Bitcoin is not “commodity-based” or “gold-backed” has no rational bearing on its value whatsoever.

The only difference between Bitcoin and gold, or any other currency, is that the demand for Bitcoin is 100% derived from its utility as money (that is, a medium of exchange, a store of value and a unit of account), whereas there does exist some modest demand for non-monetary gold. Gold has a history of demand spanning 5 millennia, Bitcoin has a history of demand spanning 5 years. But based on that brief history, there is no reason to think that the belief in the value of Bitcoin is in danger of vanishing.