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Bitcoin and the Dangerous Fantasy of ‘Apolitical’ Money

Posted on Dec 26, 2013
btckeychain (CC BY 2.0)

By Yanis Varoufakis

This article first appeared in April at the website of Yanis Varoufakis, an economist who holds professorships at the University of Texas and the University of Athens. Hear him discuss Bitcoin in a December interview with RT here.

1. What is Bitcoin? What Makes It a Very Special Form of Digital Currency?

Bitcoins are digital units of currency that one can use, on the Internet, to purchase a limited number of goods and services. The digital nature of Bitcoin is not what makes it novel and unique. There are, indeed, a large array of digital currencies, including dollars, euros, frequent flyer points, Amazon points etc. Starting with standard (fiat) money, more than 90% of dollars, euros, yen etc. are, indeed, digital. When your bank gives you a loan, for instance, it appears as digital money in your bank account. And when you use debit/credit cards or Internet Banking in order to transfer it to someone else’s account, from whom you are buying a good or service, your dollars, euros and yen come and go as mere digital currency units. Only a tiny portion of standard money takes a paper or metallic form.

Similarly, when an airline grants you frequent flyer points, that you can add to by using a particular credit card or redeem on some flight, upgrade or duty free item, it is creating a digital currency that you are accumulating for the purposes of using it in the future in order to purchase goods or services. Similarly, when the European Union created its carbon trading scheme, to be used by corporations and traders, it concocted a digital stock of carbon dioxide, divided it up in small bundles, distributed them to corporations (attaching to each such bundle or unit a quantity of carbon dioxide that the bundle’s owner could emit) and then set them free to trade these bundles (or pollution rights) amongst themselves in the hope that this digital market would generate a price for carbon dioxide such that corporations would have an incentive to produce less of it and sell (to less efficient firms) the balance of their bundles. Had this scheme worked, these bundles of carbon dioxide would emerge as a digital-only currency.

So, Bitcoin is not novel because it is a digital currency or because it is a ‘made up’ currency. Digital, ‘made up’ currencies are everywhere. What is, however, genuinely novel and unique about Bitcoin is that no ‘one’ institution or company is safeguarding the so-called Ledger: the record of transactions that ensures that, when you have spent one unit of currency, there is one less unit of currency in your (digital) wallet.

Put differently, take gold sovereigns as an example: By their physical, metallic nature they constitute a private and excludable media of exchange, in the sense that if I use one to pay Mary for a car that she is selling, I shall end up with one less such unit in my wallet. The great challenge of creating a non-physical, wholly digital, currency is the pressing question: If a currency unit is a string of zeros and ones on my hard disk, who can stop me from taking that string, copying and pasting it as often as I want and become infinitely ‘moneyed’? If I can do that, then it is as if all of us have a printing press in our living rooms, in which case we would have the makings of instant hyperinflation.

Until Bitcoin’s emergence, the conventional wisdom was that to make a non-hyper-inflationary digital currency possible, a Ledger of Transactions, keeping track of each unit that you and I spent, must be kept by some Central Bank or corporation. E.g. the Fed or the ECB or indeed Visa keeping track of our digital dollars, or euros. Or British Airways or Lufthansa or Amazon maintaining a Ledger of the ‘frequent flyer’-like points that they administer. Bitcoin, quite audaciously, broke the back of this assumption.

Bitcoin was born the day in 2008 some anonymous computer geek using the unlikely Japanese pseudonym Nakamoto posted an algorithm (on some obscure listserve website) that made something remarkable possible: It could generate a string of zeros and ones that was unique, ensuring that, before it could be transferred from one computer or device to another, a minimum number of other users had to trace its transfer and verify that it left the device of the seller (of some good or service) before moving to the device of the buyer. Moreover, the algorithm was written in such a way as to guarantee a steady ‘production’ of these strings—or bitcoins—over time, which, along with the computing power devoted by users in order to help track transfers, could collectively to maintain The Ledger. Lastly, to cap the supply of bitcoins, and thus safeguard their value, the algorithm guaranteed that the maximum number of these strings could only grow (given the algorithm’s structure) to 21 million units by the year 2040. Once it reached that quantity, its ‘production’ would cease and the users of bitcoins would have to do with these 21 million units. Meanwhile, before that date, and before the maximum bitcoin supply is reached, the ease with which users could ‘mint’ or ‘dig up’ fresh bitcoins (by making computer power available to the bitcoin community) would be inversely related to the total quantity of bitcoins already ‘created’ or ‘extracted’ from the algorithm.

In a sense, the designer of the Bitcoin algorithm (who has, by the way, dropped off the radar some time ago) seems to have designed the new currency on the basis of faith in the crudest version of the ‘monetarist’ Quantity Theory of Money—the idea that the value of money depended solely on the quantity of money supplied to the public. Thus, they aimed at creating the digital equivalent to… gold. Come to think of it, Bitcoin was, indeed, modeled on gold.


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