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    Cryptocurrency Enthusiasts vs. Central Banks

    June 2021

    After a volatile week, a Bitcoin was still worth about 40,000 USD last month. That is still quite valuable, something Bitcoin enthusiast have been eager to point out. I would like to weigh in as well on Bitcoin and other cryptocurrencies, whose fluctuations have dominated a lot of market news, especially over the past weeks.

    Well, I can try to tell you what it’s about…

    What’s going on is harder to explain…

    The story is so far: Bitcoin, the first and biggest cryptocurrency, was introduced in 2009. It uses an encryption key, similar to those used in hard-to-break codes – hence the “crypto” – to establish chains of ownership in tokens that entitle the current holders to… well, ownership of those tokens. And nowadays we use bitcoin among other cryptocurrencies to for example buy houses, cars and coffee, pay our bills, make business investments, and more.

    There is nothing in the code that governs the cryptocurrency, however, that provides an answer to the question: How can Bitcoin become money if it becomes so valuable that you don’t want to spend it?

    It is certainly true that even with last month drop, over the long run the value of a Bitcoin has appreciated. In 2008, it was nothing more than a PDF that contained an idea. The PDF traded in 2009 at a spot prize of zero, considerably lower than current levels. That’s in my opinion an impressive 13-year performance for any asset. It is an Amazon or Apple level shoulda-got-in-on-the-ground-floor performance. But Bitcoin isn’t supposed to be just some asset, though. It’s supposed to be a global money. Depending on whom you ask, it will either become the standard medium of exchange for all transactions, or a final medium of settlement for other kinds of money, a bit like the dollars that banks can hold in reserve accounts at the Fed, which means that it can’t just gain in value. It also has to become more useful, as money, to more people. That’s for sure not a quality you have to ask of your Apple stores.

    If normal, law-abiding people so far don’t use cryptocurrency, it’s not for lack of effort on the part of crypto boosters. Many highly paid person-hours have been spent trying to find the luller app, the thing that will finally get the masses using Bitcoin, Ethereum or some other cryptocurrency brand daily.

    Investors continue to pay huge sums for digital tokens. The values of major cryptocurrencies fluctuate wildly as Bitcoin for example fell 30% last month at one morning, then made up most of the losses the same afternoon. Their collective value has, however, at times exceeded 2 trillion USD, more than half the value of all the intellectual property (IP) owned by U.S. Business.

    So, why are people willing to pay large sums for assets that don’t seem to do anything?

    The answer, obviously, is that the prices of these assets keep going up, so the early investors made a lot of money, and their success keeps drawing in new investors.

    On the other hand there’s also a strong element of libertarian derp-assertions that fiat currencies, government-issued money without any tangible backing will collapse anytime soon. True, Britain, whose currency was still standing last time I looked, went off the gold standard 90 years ago. But who’s counting? So when John Maynard Keynes called the gold standard a “barbarous relic” way back in 1924, he wasn’t wrong. But the metal’s mystique, and its valuation, live on. It’s in my opinion therefore conceivable that a few cryptocurrencies will somehow achieve similar longevity.

    Whether Bitcoin is a money is an exercise in scholasticism. It is money now, for some people. There are transactions for which it’s appropriate and already being used. In 2011 there were only 12,000 transactions per day. By May of 2017, that number had risen to 300,000 transactions a day. Since then, it has moved in a band around that level – volatile, but moving sideways. The value of a Bitcoin, however, has continued to rise from just under 2,000 USD in 2017 – volatile but, you know, up to more than 40,000 USD currently. As a money, Bitcoin is becoming more valuable, but not more useful.

    It’s in my opinion possible that its usefulness is limited by design. People who argue for Bitcoin as the future of money like to say that, unlike the dollar for example, there is no central bank that can answer for Bitcoin or screw it up. But there is a governance structure behind Bitcoin, as real and as clear as the one at the Federal Reserve (Fed).

    The Fed follows a code it calls a “statement on Longer-Run Goals and Monetary Policy Strategy”, which it updates, about once a decade, when its internal culture of MIT, Harvard, and Berkeley macroeconomists starts to think differently about money. Right now, both the code and the culture of the Fed believe that dollars should lose value against other goods over the long-term and at an average of 2 percent a year.

    The code that generates Bitcoin has capped their total number of 21 million. That means they are supposed to become more valuable, forever, by design. You can change the code, but just like at the Fed, to change it you have to change the culture – you have to convince a lot of people to use the new code. Here, too, the culture of Bitcoin is fixated on the soundness of money, convinced that the best money only becomes more valuable overtime. People encourage each other to hodl, to hang onto their bitcoins. If you hodl, you have diamond hands. If you sell, you have paper hands. If you hodl nothing, you are encouraged to have fun staying poor.

    When you hodl, you are becoming richer, but you are not transacting. That is good for Bitcoin the asset, but it’s problematic for Bitcoin the money, because you are keeping what you hodl out of markets. This is in my opinion a challenge as old as money. Theognis, a Greek poet from the 6th century BC, wrote that shrewd men know bad gold and silver, and that no one will “take in exchange worse when better is to be had”. Aristophanes, the Athenian satirist, pointed out that “full bodied coins that are the pride of Athens are never used while the mean brass coins pass hand to hand”.

    Short: poor-quality money drives high-quality money out of circulation. Because why would you spend something that is becoming more valuable?! Both the code and the culture of Bitcoin are designed, over the long term, to drive it out of circulation. This leaves hodlers stuck with a collective action problem. Sell, or change the code, and your asset drops in value, becoming more useful as money. Hodl, and keep the code, and your asset appreciates.

    Monetary culture is monetary policy.

    Diamond hands are holding hands.