Bitcoin And Central Banks
Bitcoin enthusiasts often claim that Bitcoin intrinsically decentralizes control of the economy. This belief is false; if anything, the reality is the exact opposite. An open, distributed, ledger-style payment system ultimately gives central banks more power than ever before. In fact, the whole idea that Bitcoin, or a similar payment network, confers advantages beyond the operating cost of the network itself, is based on a profound misunderstanding of economies in general, and currencies and payment networks in particular.
Let’s start with the purpose of currencies and, more generally, payment networks.
The total value that exists within a given economy has little to do with currency, payment networks, or the monetary policy of central banks. Market inefficiencies can sap an economy of its value, but that doesn’t mean the value wasn’t there to begin with. To put this another way, the total value of goods and services that can be produced at a given time doesn’t change because, say, interest rates go up. However, higher interest rates may make it more difficult to buy or sell some of these goods or services.
It is the market value of an economy that determines the value of its currency, not the value of some asset that may be employed as security. The confusion on this point appears to stem from the historical use of precious metals to mint or underwrite currencies. The purpose of this was to encourage the use of the currency in trade, to boost confidence in the currency, not to establish the value of currency itself. Modern economies typically don’t need to rely on such measures, since the value of the economy, and the confidence in the associated currencies, is well-established.
Bitcoin is no different in this regard. There is no store of gold or other precious metal that supports its value. The irony is that many so-called “gold bugs,” who believe that a currency must be secured, are also Bitcoin enthusiasts, and a significant part of their criticism of existing currencies and payment systems is the very fact that those systems are unsecured.
But Bitcoin is supported with far less security than any of the G8 currencies. If push comes to shove, I can’t trade Bitcoin for mining equipment. Bitcoin only has value because the value of the Bitcoin economy—the aggregate value of the goods and services that I can buy and sell using Bitcoin—has value. If anything, Bitcoin is actually secured by the central bank currencies that its advocates criticize. Most merchants using Bitcoin simply convert it immediately into dollars. If they couldn’t do that, they wouldn’t accept it.
There’s nothing wrong with bootstrapping a currency by using another currency to secure it. Developing economies do this all the time, and the so-called cryptocurrencies collectively form a developing economy. But if your "currency"Bitcoin is not a currency; it’s a payment network. derives its functional credibility and practical usefulness from another currency, disparaging that other currency doesn’t really make much sense.
Which brings us to another point—the idea that a given currency or payment network is intrinsically inflationary or deflationary. Bitcoin zealots will sometimes tell you that Bitcoin is superior to fiat currencies controlled by central banks, because the supply of Bitcoin grows in a predictable fashion. Some central bank can’t decide to issue more currency, consequently devaluing it and causing inflation. However, in the real world, inflation (and, more generally, fluctuations in the value of a currency) are affected by a large number of variables, which, except in extreme cases, dwarf the supply of the currency itself.
Again, ironically, Bitcoin has itself been subject to these very forces, with the value of Bitcoin dropping precipitously in 2014 in spite of the fact that the supply didn’t change much. All that happened is that short-term speculators left the market. And that’s just one of dozens of equally potent variables. Another is simply the growth of the economy itself, which is actually a very good reason to issue more currency. Ideally, in fact, you want to keep inflation or deflation aligned with the people’s expectations, otherwise you discourage long-term investment. A currency whose supply cannot vary in response to economic growth (or recession), investor confidence, and so on, is more, not less, likely to lead to instability and speculation.
Furthermore, the rules governing the supply of Bitcoin are not, in fact, fixed mathematically (another mantra of Bitcoiners). They can quite easily be altered by the collective agreement of the miners. We’ve already discussed the potential for the ledger to be effectively hijacked by a large mining conglomerate. Such a conglomerate could simply decide to increase or decrease the rate of new Bitcoin being introduced into the world. And unlike the fiat currencies that are so widely disparaged, there is nothing to prevent the introduction of a virtually infinite number of Bitcoins.
In fact, because Bitcoin is, for all intents and purposes, infinitely divisible, massive increases in supply are actually a more viable tactic than with fiat currencies. Most financial systems don’t have a way to deal with arbitrarily small fractions. Your bank balance is not precise to a thousandths of a cent. If the Fed decided to write off its debt by massively devaluating the dollar, it would be difficult to do so completely without everyone rewriting all the software that runs our financial systems.
Which is exactly what we’re doing with cryptocurrencies.
If I’m a central banker, it gets even better, because the ledger is, in fact, public. No more suitcases chained to the bad guys’ wrists, full of unmarked bills. No more armies of forensic accountants pouring through the shredded receipts we grabbed out of the trash and painstakingly reassembled. Nope. All I need is a simple program that crawls the ledger, tracing the history of every transaction you’ve ever made, and I’ve got you cold. All I need to do is make sure every institution that deals in cryptocurrencies complies with existing fraud prevention laws, so that whenever value leaves or enters the network, it’s tied to your identity.
Which is exactly what Bitcoin startups are already doing.
Bitcoin enthusiasts have tended to treat these issues as minor details, when, in fact, they are the most important aspects of a distributed ledger approach. They want to believe so badly that cryptocurrencies will overthrow the existing system controlled by central banks that they’ve overlooked the fact that it will, in all likelihood, strengthen those systems.
Governments and megacorps will take the part of Bitcoin that makes sense — a distributed ledger system where clearing transactions is done by consensus — and create a verification system for participants, in place of the very inefficient proof-of-work model. They will do this because it removes a massive inefficiency from the economy. Clearing payments is very expensive, and introduces massive drag on the economy. This puts central banks in a gatekeeping, rent-exerting position, which is the kind of position they like to have. However, participants in networks run by central banks will operate according to the rules set by the central banks. Among other things, this will give them absolute control over monetary policy and complete traceability for all financial transactions. Since they no longer have to be concerned with a physical money supply, the potential for abuse will be far greater than it is today.
Cryptocurrencies are no revolution; they’re Big Brother’s third eye.
The fact that you and I can start an underground payment network to subvert those operated by large corporations and or central banks doesn’t buy us much beyond what was possible before the advent of cryptocurrencies. Creating new currencies or payment networks has always been possible. In fact, many small developing economies have attempted to issue their own fiat currencies.
You and I could declare ourselves Kings Of Infinite Space and launch our own fiat currency right now. In principle, it’s no different than launching our own distributed ledger-based payment network, except that, since we’re programmers, that’s more appealing. And it’s more efficient if we want to invite others to use our underground currency.
But even as Kings Of Infinite Space, we’d need to be careful. If we made our network too open, the next thing we know, the government could take control of it, possibly without our knowledge. And once they’ve done that, they can track every transaction, and, whenever it becomes convenient, seize the associated funds. So if we’re doing something illicit, we’re probably better off using untraceable fiat currency in physical form. Which really tells you all you need to know about whether central bankers are shaking in their Italian loafers at the prospect of decentralized payment networks. They aren’t, or at least they won’t be, once they fully understand the topic.
Greater financial transparency would probably make it easier to prosecute and/or prevent bribery, corruption, organized crime, and terrorism. That could be great. But a lot of corruption goes unprosecuted already, and, if you consider that many cancer survivors have to rely on illicit trade to secure their pain relief, a system which makes that more difficult is not without its downsides. And, since a lot of the enthusiastic early adoption around Bitcoin was driven by illegal drug markets, it’s kind of comical how incredibly bad cryptocurrencies are for that use case.
So: here we have a technology that allows us to build highly-efficient, completely transparent payment networks, using an almost infinitely flexible store of value, ultimately controlled by whomever can aggregate the most computing power, and somehow this is supposed to lead to the decentralization of our economy? To the contrary, if I was a systems architect for a central bank, and I was trying to come up with the best possible design to please my employer, this is exactly the kind of system I would design.
The only exception would be the proof-of-work scheme, since central banks can simply restrict participation in the network to trusted partners, i.e., banks and other regulated financial institutions. But they’re going to figure that out, sooner or later. It’s a pretty obvious modification, and it would make crossing the chasm much easier.
In the end, the only positive effect that this technology will really have is that our markets will be about 5% more efficient (that’s the going cost of clearing a transaction today). Five percent of a multi-trillion-dollar economy is a lot of money, so freeing it up will drive a lot of economic growth and new prosperity. But it’s not going to change the role of central banks, or at least, not in the way Bitcoin libertarians want it to.