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Bitcoin and the Dangerous Fantasy of ‘Apolitical’ Money

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

By Yanis Varoufakis

(Page 2)

2. Bitcoin as a Digital Simulation of Some Precious Metal (e.g. gold)

What is the great merit of gold? Its scarcity! The fact that, once humans, for some strange reason (most possibly related to gold’s perpetual glitter and scarcity) started using it as (a) a means of exchange and (b) a store of value, gold became a currency and its smallest possible, meaningful, quantity became a currency unit. The designer of Bitcoin’s algorithm tried his damndest to emulate gold. Just like gold, which one presumes to be in fixed supply under the Earth’s surface, Bitcoin is also limited, artificially (through the design of its algorithm) to a plateau of 21 million units. And just like gold, there are two ways in which bitcoins can be acquired: One is to buy them using dollars, chickens, silk, honey, whatever… The other is to ‘dig’ for them like 19th century gold diggers dug for gold. To that extent, Mr ‘Nakamoto’ designed his brilliant algorithm in a manner that allowed for ‘bitcoin digging’. This is how he did it:

The uniqueness of Bitcoin, as alluded to earlier, is that no centralized institution (private or public) is the custodian of the Bitcoin transactions’ Ledger. So, who is? The answer is a spectacularly liberal-cum-communitarian: “We all are!” By that, what I mean is that the Bitcoin algorithm is written in a manner that makes it possible (indeed demands) that the whole community of Bitcoin users has access to, and polices, the Ledger of Transactions (which ensures that I cannot cut and paste my one bitcoin a large, or indeed infinite, number of times).

In this sense, bitcoin users must make computing power available to the Bitcoin users’ community so that everyone can ‘see’ the Ledger, in order to ensure perfect community ownership of the transactions’ record, as opposed to trusting some government agency (e.g. the Fed) or some private corporation that may have its own agenda. Naturally, as the Bitcoin economy, and the number of transactions grows exponentially, the amount of computing power that is necessary for one individual to devote to the ‘Bitcoin community’ in order to ‘mint’, or ‘unearth’ a new bitcoin rises exponentially with time. This increasing complexity also acts as a legitimizer of the notion that new bitcoins are delivered to the accounts of the users that put increasing computing power at the Bitcoin community’s disposal.

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3. Bitcoin’s Two Fundamental Flaws

As with all things digital, there are a number of concerns to do with security; namely with the fear of hackers and e-spivs (traditionally, slickly dressed men selling purportedly authentic goods at bargain prices). Imagine a world that has shifted entirely to Bitcoin. Would we not live in fear that some ingenious hacker will get the better of Nakamoto’s algorithm and manipulate it to his benefit? Would it be wise for humanity simply to assume that the Bitcoin algorithm is un-hackable (especially so in the absence of some authority that can intervene and save the day if something horrible happens to the algorithm)? Besides, even if the algorithm is safe, there is always the danger of waking up to the realization that one’s bitcoin stash was e’looted during the night. And if one entrusts one’s stash to some company with better firewalls and computer security, what happens (in the absence of a Bitcoin Central Bank) if that company goes broke or simply disappears into the Internet’s darker crevices (along with its customers’ bitcoins)?

These concerns would probably suffice to put a dent in Bitcoin’s prospects. But they are not the main drawbacks of the currency. No, there are two insurmountable flaws that make Bitcoin a highly problematic currency: First, the bitcoin social economy is bound to be typified by chronic deflation. Secondly, we have already seen the rise of a Bitcoin aristocracy (a term ‘coined’ by Greek blogger @techiechan) which, besides the issues of distributive justice which it raises, evokes serious fears about the capacity of very few entities or persons to manipulate the currency in a manner that enriches them at the expense of financial instability. Let us look at these two problems in some detail.

First, deflation is unavoidable in the Bitcoin community because the maximum supply of bitcoins is fixed to 21 million units and approximately half of them have already been ‘minted’ at a time when very, very few goods and services transactions are denominated in bitcoins. To put simply, if Bitcoin succeeds in penetrating the marketplace, an increasing quantity of new goods and services will be traded in bitcoin. By definition, the rate of increase in that quantity will outpace the rate of increase in the supply of bitcoins (a rate which, as explained, is severely constricted by the Nakamoto algorithm). In short, a restricted supply of bitcoins will be chasing after an increasing number of goods and services. Thus, the available quantity of bitcoins per each unit of goods and services will fall, causing deflation. And why is this a problem? For two reasons: First, because an expected fall in Bitcoin prices motivates people with bitcoins to delay, as much as they can, their bitcoin expenditure (why buy something today if it will be cheaper tomorrow?). Secondly, to the extent that bitcoins are used to buy means of production (land, labor and capital) that are used to produce goods and services, and assuming that there is some time lag between the purchase of these means and the delivery of the final product to the Bitcoin market, a steady fall in average prices will translate into a constantly shrinking price-cost margin for firms dealing in bitcoins.


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