Sunday, November 24, 2013

How bitcoin is going to fail and why it is not a gold equivalent.

Being a libertarian means I often get into discussions with other libertarians that non-libertarians simple do not have. Lately many of those discussions have been about bitcoin. In case you are normal and don’t know what a bitcoin (or BTC) is, it is a cryptocurrency that acts as digital cash and allows for easier more anonymous payments for goods across the internet. It was promoted by libertarians from the early days, nobody knows the true identity of the original creator. It has had a meteoric rise in value, less than a dollar a few years ago and recently had a high of over $900 before falling again, and there is an amazing amount of volatility.

There are a lot of great things about bitcoin, and that’s what makes it popular to those who know about it. Having a digital cash for the internet is probably the best thing about it.

Some people like to claim it is anonymous, but that is only partially true. Each bitcoin transaction is traced through the bitcoin network and each user has one or more “bitcoin wallets” and the transaction from one wallet to another wallet is tracked, this can be anonymous as long as the owner of the wallet remains anonymous.

Here is why I don’t think BTC is as good as gold and why it will eventually fail. The claim that bitcoin is limited is misleading. It is true that bitcoin itself has a limit of about 21 million bitcoins. However, it is not true that cryptocurrencies as a whole are limited. Bitcoin was invented by a person or persons and can be recreated by other people making competing versions of the cryptocurrency and this is why it is not like gold. Gold is gold, it is not man made and although many alchemists have tried to reproduce it, they have been unsuccessful. There is also always a true cost in mining gold, it is never free or easy to obtain more, this limits the new production automatically, even if there were some new vein found, that would not make it available until someone could extract it.

The fact it is man made and reproducible is why bitcoin is destined to fail. If the idea of a cryptocurrency gets popular enough, governments will create their own versions and will make their version easier and more legal to use, they will tie the digital currency to their own currency and will make it legal tender to pay taxes with. They will allow seamless transactions between whatever the regular currency is and the cryptocurrency and this will be done through the banking systems that are so regulated as to almost be an extension of the government already in most countries and are controlled by the government in other countries. Imagine this: The federal reserve comes out with their own version of the bitcoin, let's call it the “USDcoin”, they make a .001 (or some other arbitrary number) USDc the equivalent of $1 and they make it very easy to use. You can have these deposited into your existing bank account and they are immediately converted to dollars and when you send dollars out of your account they are immediately converted to USDc. Then the government also implements anti-bitcoin laws that make using bitcoin difficult or impossible to use. Of course they will claim bitcoin was being used for illegal purposes and money laundering. This will be the end of bitcoin. I do expect in the process some of the privacy aspects will be lost, but other positives will occur in the end the USDc will win out by a combination of making it easier and more attractive to use than BTC and by forcefully making it impossible to use other cryptocurrencies. Other countries will follow suit.

USDc or BTC won’t be a store of value and people who desire such a thing will go back to other options to retain their purchasing power. Since I am not truly talking about a separate currency and only a digitized version of the USD that operates on a diversified peering network that would be obvious to the banks and the federal reserve, but is transparent to the end user, the federal reserve and the banks could do this on their own without the government. It would operate like bitcoin on the network, but to users it would look like they are transferring USD directly without fees. Bank accounts that are already used would double as "wallets" for digital cash on the network and those accounts would be insured by the FDIC. If you don't think the government is thinking about this, you have to admit that the bankers must be thinking about this at the very least, they do not want to see bitcoin become a competitor.

Who knows what the final product would truly look like, but the basics would be that a new system would be created with the backing of the banks and the government and it will get adopted and not BTC as the digital currency of choice. BTC might still be in existence, but it would not matter and for all practical purposes BTC would be dead.

Backers of bitcoin often ask the wrong question, they understand the virtues of bitcoin and they hope one day it will be a widely circulated currency, but what they often fail to see is that it is reproducible and the if the federal reserve ever decided to make their own version, that would end the dream of BTC ever becoming a currency in the united states at least.

Would the fed have as good of a product as bitcoin? Probably not, but history is filled with inferior products winning out if they have enough backing (public education). There are also benefits the fed and the banks in conjunction with the government could implement that would offset some of the negatives. By tying the digital currency directly to the dollar it eliminates the wild fluctuations BTC has, they could make it legal tender and it would get used at all stores if it were tied into existing bank accounts as well as debit cards and allowed for transaction-fee free money movement as it would be a digital version of existing cash, the cost savings of not paying a fee to Visa or Mastercard on debit card transactions would be the incentive to widely adopt for business. The elimination of competition would be the incentive for the banks and the fed to adopt and the government wants the visibility of digital cash transactions for taxing purposes.