Happy New Year, Everyone.
It’s hard to believe that I went all of 2012 and 2013 without writing a post about Bitcoin, considering how much I was talking about it in the analog world. As the calendar turns over though, I think I’m finally ready to put some thoughts on paper, in part to address some of the more persistent misconceptions and logical fallacies that still seem to infect the discourse, from both supporters and detractors. This will probably have to be a series, so I will try not to disappear for weeks between posts, as I often have in the past.
Since I haven’t written about the subject in this forum yet (given the very slim connection to marketing), I think that a little context on my own backgrounds and biases is certainly in order, in the interest of full disclosure. So a few stipulations:
1.) I am a Bitcoin supporter, an enthusiast, even. I own some, so that bias exists.
2.) Unlike many of the most vocal Bitcoin enthusiasts however, I have some reservations, and my skepticism will not allow me to overlook either current or potential flaws.
3.) I am not a programmer. I can read/write a very little JS and HTML and have some fundamental understanding of programming, but that’s it, so I can’t look at the code itself and get anything from it, despite it being open source. I trust the community for my information there.
4.) I am not a cryptographer, and while I have a pretty good grasp of the fundamentals of how Bitcoin and the SHA-256 implementation work together, and how the hashing function works, etc., it is an imperfect understanding even after a year or two of study by a novice. I like to think that I am a pretty smart guy, but this stuff is complicated, so once again, I tend to trust smarter people than myself on the details here.
5.) I am not an economist by training or trade officially, but I am on more solid ground here than programming or cryptography. I have made a long-time hobby of the subject, have read a fair bit of the major primary and secondary sources, and keep up with the various schools of thought.
6.) I like liberty, but I am not a libertarian. This also sets me apart from a lot of Bitcoiners.
That should do it, but if I think of anything else as I write this I will make sure to include it. I just want everyone to go into this knowing approximately how large a grain of salt they will need at various times.
One of the issues that has been at the forefront of the public discussion lately has been the opinion of the popular economist Paul Krugman, who writes for the New York Times, which is generally negative towards Bitcoin. While we mainly focus on him, and his back and forth with the Bitcoin community, he serves as the face of what is a broader group of traditional public economists, which tends to share a number of his views on the matter. Now for a bit more disclosure, I will say that unlike the vast majority of Bitcoiners, I often like Krugman’s work and columns, and respect his intellect and the body of both scholarly and popular writing on recessionary/depressionary monetary policy that he has produced in particular. I don’t hate quantitative easing, I don’t fear the imminent collapse of the US fiscal system due to rampant inflation, and I generally subscribe to what are considered “liberal” economic theories, so we have all of that in common. That said, I respectfully disagree with him on the subject of Bitcoin, for a number of reasons.
I think that he is in part unable to separate, despite his claims to the contrary, his own political and moral beliefs from the debate, which has often lacked in civility from both sides. In discussing the “normative economics” of Bitcoin here, he allows a logical leap to be made from the features of an inherently apolitical computing process to the aims of its users relying on no more than assumption. He sees the Bitcoin community at large as a single mindset dominated by libertarian motives and thought process. While that is undoubtedly describes a large number of Bitcoin enthusiasts (spend any time in the forums and you will see it), I am living proof that there is a more diverse ecosystem below the surface, and that it is possible to believe in the protocol without espousing a particular set of political beliefs. To paint with such a broad brush is damaging, and seems to cloud his judgement a bit at times. To be fair, the abuse heaped upon him would ruffle almost anyone’s feathers, but that’s the unfortunate reality of a debate played out entirely over the internet between one public individual and a legion of anonymous opponents. The price you pay for the vast reach of the digital realm is the lack of a filter, so you have to take the polite, well-reasoned argument with the… less so.
There does seem to be a disconnect with traditional economists and the source of Bitcoin’s “intrinsic” value, which ignores the fact that this is largely an irrelevant argument. The comparison to gold which is often drawn, while overly simplistic and imperfect, is apt enough to be commonly used in this debate, so for now I will gloss over those imperfections and keep to the analogue that everyone is comfortable with. For those who aren’t familiar with the article that I linked above, I’m going to quote a relevant section:
Underpinning the value of gold is that if all else fails you can use it to make pretty things. Underpinning the value of the dollar is a combination of (a) the fact that you can use them to pay your taxes to the U.S. government, and (b) that the Federal Reserve is a potential dollar sink and has promised to buy them back and extinguish them if their real value starts to sink at (much) more than 2%/year (yes, I know).
Placing a ceiling on the value of gold is mining technology, and the prospect that if its price gets out of whack for long on the upside a great deal more of it will be created. Placing a ceiling on the value of the dollar is the Federal Reserve’s role as actual dollar source, and its commitment not to allow deflation to happen.
Placing a ceiling on the value of bitcoins is computer technology and the form of the hash function… until the limit of 21 million bitcoins is reached. Placing a floor on the value of bitcoins is… what, exactly?
I have had and am continuing to have a dialogue with smart
technologists who are very high on BitCoin — but when I try to get them
to explain to me why BitCoin is a reliable store of value, they always
seem to come back with explanations about how it’s a terrific medium of
exchange. Even if I buy this (which I don’t, entirely), it doesn’t solve
my problem. And I haven’t been able to get my correspondents to
recognize that these are different questions.
So the argument being made by Krugman here is about Bitcoin’s usefulness as a store of value (or lack thereof), and comparing it to gold as a counter-example. However, citing the ceiling value of gold says nothing about the floor value of Bitcoins. Additionally, there seems to be some conflation here with ceiling on supply and ceiling on value, and they are not the same thing, which begs the question of whether he really doesn’t see the distinction, or whether he is just being sloppy.
Regardless, the factors that affect the upside price opportunity (and make no mistake, the factors that he cites are simply several of many that determine price, not actual fixed limits), are not the same as qualities that make a good store of value, nor do they confer a special “intrinsic” value upon the medium. What he is getting at with that mining business is scarcity, which IS one of the qualities you look for in a store of value, along with fungibility, divisibility, etc., all things that bitcoins have in common with gold. However, when push comes to shove critics of BTC always come back to a.) gold has value because people have long agreed that it does, so basically credibility, b.) gold has some industrial applications that make it useful and will provide a minimum of demand (it is a good semi-conductor), and c.) that gold is pretty and jewelry/aesthetics will also provide a minimum level of demand.
Here is where the argument that Krugman is making falls apart. He specifically complains that supporters of BTC use its utility as a medium of exchange to explain why it is a good store of value, and he is saying that they are different questions. But in fact, when trying to explain something like “intrinsic value” (which we shouldn’t bother with, but the critics insist), that utility is exactly the same as citing gold’s utility as a semi-conductor or jewelry material as reasons that it is a good store of value. You can’t have it both ways.
As to the credibility argument, this in part gets back to why any discussion of “intrinsic” value is a waste of time. Quite frankly, Bitcoin is a good store of value because right now tens of thousands of people in the world are willing to pay upwards of $700 for a bitcoin. As long as some people think that they are worth more than nothing, they can store value. Not to mention the fact that price stability isn’t a valid argument in a year that has seen gold price fall so substantially. You can say that this means that gold is also not a good store of value, but it’s both or nothing. Now the argument of gold/bitcoins vs the dollar is one worth having, because there you are basically trading stability with slow depreciation vs volatility with a chance of appreciation. Like bonds vs equities, it is simply a matter of personal risk tolerance, but that’s finance, not economics.
Another part of the issue here, is that Krugman keeps thinking about what makes Bitcoin viable/valuable as “money,” which is near-sighted when looking at Bitcoin as a whole. It can function as money, certainly, but in viewing it as an equity or a commodity, you have to look at the whole, rather than specific parts. When someone talks about, or invests in, Google, they aren’t simply referring to the search engine. There is an entire suite of products and services that make up Google, from the ubiquitous e-mail service to analytics, social media to hardware like Google Glass, and a million other things. Sure, the search engine was the foundation for their empire, but it is not the only facet that a valuation is based upon, and the same is true of Bitcoin and it’s function as money. The features that make it a great payment protocol are part of what make it a good medium of exchange, and that utility in turn provides some basis for its “floor” as a store of value.
Up Next, BTC Deflation & the Economic Schools at Play: Keynes vs. Hayek!
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