Month: June 2021

Bitcoin Excitement

Interest in bitcoin is growing. Its promotors are generally good guys wanting to provide the world a better payment system. Its users are often bad guys happy to move their ill gotten money pseudo anonymously (though the Feds tracked down and recovered some of the ransomware paid in bitcoin by Colonial Pipeline). 

Ezra Fieser reports in Bloomberg on a fascinating effort in the El Salvadorian village of El Zonte to expand the use of Bitcoin for making payments.  [“World’s biggest bitcoin experiment is a surf town in El Salvador”]  On June 9th, El Salvador approved President Nayib Bukele’s proposal to add Bitcoin to the U.S. dollar as legal tender in the country (El Salvador does not have its own currency).  El Zonte has no bank, thus storing money and making payments of it from a smart phone wallet would be very attractive.

Michael Peterson is the acknowledged father of efforts to establish bitcoin in El Zonte. The requirements for its use are apps for acquiring, storing, and paying bitcoin on smart phones and the proliferation of people and merchants with such apps willing and able to deal in bitcoin. Peterson “used Wallet of Satoshi, one of the many existing smartphone apps created for small transactions using Bitcoin, which is notoriously impractical—expensive and slow—for everyday purchases.  As more stores began asking how they could accept Bitcoin, Peterson decided El Zonte needed its own app. The Bitcoin Beach Wallet, which launched in September, similarly uses technology that allows for small transactions.” [Bloomberg, ibid]

Bitcoin ownership and transactions are recorded on blockchains that are replicated thousands of times around the world and publicly accessible. Blockchain is a slow and expensive approach to record keeping, but avoids the so called “trusted third party” of, say, a bank account ledger. Thus, work arounds have been developed for small payments that can be spent without the slow and cumbersome mining that prevents double spending for digital currencies on distributed ledgers (e.g., blockchain).  Despite the touted attraction of avoiding a “trusted third party”, most bitcoin users hold them with exchanges such as CoinDesk. These exchanges also facilitate finding sellers for those wishing to buy bitcoin and buyers for those wishing to sell them. Bitcoin traders no longer gather in park meetings that brought buyers and sellers together. [“The future of bitcoin exchanges”]

But the value of bitcoin has been highly unstable. On April 15 Bitcoin traded at $64,829.14, rising unevenly from virtually nothing starting in July 2010. On May 23, it traded for $31,248.42 and as I write this it is trading at $34,616.24, not exactly a stable value.

Thus, bitcoin has not been used to fulfill one of the key functions of money, i.e., to set prices. Though a growing (but still relatively small) number of establishments in El Zonte will accept bitcoin, they all price their goods and services in U.S. dollars. Thus, before bitcoin can be used for payment, an exchange rate (bitcoin equivalent of the required dollar amount) must be agreed. 

To succeed and be widely accepted and used as a currency, the value of bitcoin will need to become much more stable. In fact, to be competitive with the dollar or other sovereign currencies, bitcoin will need to become more stable than its competitors. Improving payment technology can be used for the dollar or any other currency, so the issue is the currency itself rather than the technology for paying it.  See the very successful example of M-Pesa in Kenya. That technology is very unlikely to rely on the clunky blockchain. Even Facebook’s Libra (now called Diem) only pretended to use blockchain, stating that it intended to switch to blockchain in the future. [“Bitcoin, cybercurrencies, and blockchain”]

As explained in my first article on bitcoin written over seven years ago [“Cryptocurrencies-the bitcoin phenomena”] the value of bitcoin or any other currency results from the matching of its supply with its demand at a particular value. Achieving that equilibrium requires either an adjustment in its supply or in its value. Widespread use of bitcoin for payments (rather than just speculative investments) will create demand to hold it for future payments. Bitcoin’s supply is totally predictable. It is growing gradually to a maximum of 21 million units by the year 2040. The supply is currently 18.74 million. Thus, its value depends on what happens to its demand for payments.

While the demand for money (dollars or whatever) tends to be relatively stable in relation to income over moderate periods of time, it is subject to seasonal and other temporary short-term fluctuations.  In the search for a rule based monetary policy, Milton Friedman proposed that the money supply should grow at a constant rate (e.g., 3 to 5%) over time to match the increase in the demand for money as income grows.  But short-term (even day to day) fluctuations in money demand would have resulted in very volatile interest rates in order to keep money demand in line with the steadily increasing supply. Central banks around the world have generally targeted interest rates instead to allow short run adjustments in supply to short-run changes in demand. But setting and adjusting the policy interest rate can be tricky as well.

The ideal monetary regime is to fix the value of currency to something (such as gold, or a basket of currency as in the case of the IMF’s SDRs, or a small basket of widely traded commodities) and then allow the public to adjust the supply to match its changing demand for that fixed value. Such a system follows currency board rules. The central bank passively supplies or redeems its currency in response to the public’s demand at the fixed price. Such a system has been adopted by several countries as is described in detail in my book on the creation of the Central Bank of Bosnia and Herzegovina.  [“One Currency for Bosnia-Creating the Central Bank of Bosnia and Herzegovina”]

Even under the most favorable conditions of widespread use for payments, bitcoin would suffer the weakness of the Friedman rule. With no elasticity to its supply, a holder of bitcoin wanting to sell some would have to offer a price that another holder would be willing to accept and visa versa. Its value would remain volatile (though less so). It is hard to imagine bitcoin ever succeeding as a widely used currency. https://www.economist.com/finance-and-economics/2021/06/10/cryptocoins-are-proliferating-wildly-what-are-they-all-for?frsc=dg%7Ce

Do what we say and not what we do

In his meeting with President Putin, President Biden is thought to have proposed red lines against the use of cyber weapons such as ransomware. The idea of shutting down something like Colonial Pipeline with a computer hack is surely repugnant. I seem to remember that many of us cheered when the U.S. (and Israel?) damaged the Iranian uranium enrichment facility at Natanz with a malicious computer worm called Stuxnet. Nor were many of us much bothered when U.S. financed coups topped unfriendly governments, or when we attacked Afghanistan, Iraq, Libya, Haiti, Nigeria, Syria, to name but a few.

“The supreme international crime according to 2017 U.S. media reporting is interfering nonviolently in a democratic election — at least if Russia does it. William Blum, in his book Rogue State, lists over 30 times that the United States has done that. Another study, however, says 81 elections in 47 countries.”  https://davidswanson.org/warlist/

While this is hard to swallow, our bad behavior differs from that of Russia’s or of other autocrats. I will not go to jail for writing this. Most Americans (I like to believe) condemn such behavior contrary to our founding principles when they learn of it. Our press is happy to expose such breaches when they discover them. In short, while our government often violates our principles of individual rights and the rule of law and lies regularly about it, public scrutiny and outrage tend to check bad behavior and move us back toward conformity with our principles. We never get there but it is very important that we keep trying.