The Limited Use Case for Bitcoin and Crypto Currencies

In this commentary, I focus on the fundamental concepts of commodity money (Precious Metals), Fiat currencies (Dollar, Euros etc) and memory money (Bitcoin).  Thus, I will avoid the technical aspects of the fiat currency system and blockchains.  Money is a human concept or idea.  When we discuss the technical details, we can lose our way.  I will begin this non-technical commentary by making the following opening assertion.

Bitcoin and Crypto currencies are incremental technologies attempting to leverage old third rate concepts of money.

To use a sporting analogy – Bitcoin and Crypto currencies are division three money.  I will go into further detail to explain why they are third rate concepts a little later in this commentary.  But for now I will state that Bitcoin is an attempt to use a memory system as money.  This has been done before.  Crypto currencies can be issued by anybody at zero cost.  This too has been done before.  But before we examine third division money we should take a look at first and second division money.

 

The Best or Preferred Money – Division I

Money is a very human concept.  By this I mean that money caters to our instinctive needs to gather and store wealth.  Historically, in truly free markets for money, people generally chose money that doubled up on its utility.  In other words, it delivers value twice.  First, it can be used in exchanges for other goods.  Second, it has its own inherent value.  In ancient Ireland, cows along with Gold and Silver were used as currency.  Any commodity that could be easily stored could be used as a savings device.  In turn any commodity saved could be used in exchange for other goods and services.  Precious metals proved to be the most popular commodity money due to their portability and divisibility.  The durability of Gold as money is often not very well understood by Bitcoin promoters.  Bitcoin enthusiasts habitually confuse fiat currencies with real money.  The quote and accompanying chart below are from Bitcoin Magazine:


“If the last 700 years are any indication, reserve currencies have a shelf life of roughly 100 years. The U.S. dollar (USD) officially became the world reserve currency 77 years ago (Bretton Woods, 1944). Arguably, USD was the reserve as far back as the late 1920s.”

 

Bitcoin – The People’s Money?

The paper scripts issued by the legacy empires presented on the chart above were little more than Gold / Silver redemption notes.  The coinage of these empires were Gold and Silver coins stamped with an empire logo.  The flags in the chart above do not represent ‘reserve currencies’ or fiat currencies, they were just the logos stamped on Gold and Silver coins.  Even if the given chart went back 3,000 years, it would still show Gold / Silver as real money.  Empires come and go. But Gold / Silver stays.

To illustrate the point, look at the currency note below.  Twenty Dollar = 1 ounce of Gold.  The twenty dollar bill is actually a Gold certificate.  The holder / bearer of this twenty dollar bill is entitled to receive 1 ounce of Gold from the US Treasury on presentation of the bill.

When Dollars were ‘as good as gold’

The Bitcoin Magazine chart above is claiming that the reserve currencies from different empires are distinct from each other.  That is nonsense.  They may have different writing on their currency notes, but they all entailed the same thing – pay the bearer a specific weight of Gold or Silver on demand.  The premier world currency since the dawn of civilization is Gold.  The world moved firmly off the Gold standard in 1971.  Since then we have operated primarily with division 2 money – Fiat Currency.

Fiat Currency – Division II Money

Government money is often called Fiat currency – money by decree.  Another name for Fiat currency is ‘Legal Tender’.  Fiat or legal tender is a type of ‘coercion money’.  It is not backed by government.  It is enforced by government.  It is legal tender.  All commercial vendors in Ireland must accept Euros as payment.  All taxes must be paid in Euros.  ‘Coercion money’ is a provocative term for legal tender.  Nevertheless, it is accurate. We have become so accustomed to government money that we find it hard to imagine anything else.  We are somewhat unaware that we are forced to use it.

In order to keep this commentary non-technical, I will gloss over the details of how the fiat / legal tender system works.  It is suffice to say that the government controls the currency and can print more currency if and when it needs it.  It is much harder for government to borrow and spend if they are not in control of the currency. Ironically, it is the very fact that they control the currency that renders them bankrupt in the end!

Fiat currency has a symbiotic relationship with its government.  When a country’s political or economic system collapses its fiat currency collapses with it.  The table below illustrates the point. These 42 countries include most of central and southern America, much of Africa, eastern Europe, and central Asia.

99.9% is a lot to lose

I have only included ‘wipe out’ stories from the last 50 years and I have ignored cases where a country suffered more than one collapse.  During periods of collapse government generally steps up its enforcement of its currency’s usage.  It is at this point that the ‘coercion’ aspect of fiat currency really comes into focus.  Black markets for goods in foreign or alternative currencies flourish.  Businesses forced to accept payment in the ailing currency quickly disappear into the ether and generally economic chaos ensues.

The biggest takeaway from the table above is that all of the above fiat currencies have been replaced by another fiat currency.  Not Gold / Silver.  Gold has been out of the picture for 50 years.  This is a unique epoch in history.  Never before has the entire planet operated on pure fiat.  We are living through a remarkable period of history.  In the last 50 years, the US Dollar has generally acted as a substitute in a currency crisis until a country reintroduces another newer fiat currency and stability is restored.  The big question is – what happens if there is a Dollar crisis? Will this ‘division II’ money be replaced by ‘division I’ money?  Will Gold resume its position as the dominate form of money or will Bitcoin usher in a new monetary standard? I have previously written on the Dollar here.

Bitcoin and Crypto Currencies – Division III Money

Bitcoin is memory money.  It is a technological service that ensures all accounts (wallets) are maintained publicly, accurately and that those records are incorruptible. The open ledger is really quite public.  The records are here for all to see.  As we shall see, this is not a new concept.  For example, Yap Stones were used as money in the Yap Islands in Micronesia.

No hand bag is that big!

Given how big they could be they couldn’t be carried around as pocket change.  Ergo, Islanders maintained an oral public ledger of all the large transactions pertaining to the bigger stones including who was the latest owner.  Yap stones served as a recording system, but they were less useful as money.  I am willing to bet that Yap Islanders had very little success buying merchandise from passing trade ships with ‘memory stones.’  Nevertheless, Yap stones acted like money in much the same way as Bitcoin.

Another, and indeed more popular memory money, was Tally Sticks.  These memory sticks were quite popular in the medieval period.  This system worked by marking notches on a stick to denote the amount of money owed.  The stick was then split length ways into two.  Each party to a transaction held on to their part of the stick. Thus an independent and verifiable record of a transaction was held separately by the two parties to a transaction without the need for a middle man or banker.  In time these tally sticks were used as collateral and in turn as money.  Tally sticks were accepted as payment for taxes in England in lieu of Gold / Silver.

Tally Sticks

We can see that Bitcoin is a new technology applied to an old concept.  While it may be used as money from time to time it will probably be no more successful than Yap Stones or Tally Sticks.

A Bitcoin Fallacy.

Bitcoiners spend too much time comparing Bitcoin to the Dollar.  This is a mistake.  Government money has always had a limited lifespan.  History tells us that the world reserve fiat currency, the US Dollar, will inevitably end up worthless. Therefore, there is a sporting chance that a Crypto currency would be worth more than a collapsed Dollar.   However, anything is worth more than a collapsed Dollar, including jam jars, whether they are empty or full.  Almost any tangible good or service is superior to a collapsed currency.  Remember a collapsed currency has exactly zero purchasing power.

In a Dollar collapse, Gold is the traditional replacement money.  Bitcoin promoters need to convince the public that a Crypto currency should replace the Dollar. Therefore, they need to explain how Bitcoin is superior to Gold.  The beauty contest is not Bitcoin V Dollar. It is Bitcoin V Gold.

If Bitcoin wants to be the new world money, it needs to be superior to the old world’s money.  Gold has competed with and defeated, various fiat currencies time and time again.  The present fiat system is unique in that it is truly worldwide.  It is 50 years old.  It will be consigned to the dustbin of history like all previous fiat attempts.  Why would we choose a piece of digital code (Bitcoin) to serve as money instead of Gold?  This is the question that needs to be answered.

 

A Humble and Open Mind

It is easy to critic Bitcoin and blockchain technologies.  They are inefficient and expensive to use and subject to regular government confiscations, https://news.yahoo.com/irs-seized-3-5-billion-194403091.html .  However, before I pen my concluding remarks, let us take at a look at the most recent revolution in the transport industry.

The Horseless Carriage

The first horseless carriages were huge hulking beasts driven by steam.  Even as they evolved to internal combustion engines, cars remained unreliable and impractical compared to actual horse-power.  You almost needed to be a mechanic just to drive one and you needed to bring drums of petrol (gas) with you to refill if you were brave enough to chance a long journey.  How many times did early car enthusiasts have to endure the humiliation of sitting in their ‘broken down’ new contraption while being towed home by a horse

Original Horse Power

Imagine telling the people in the photo that, within their lifetime, horseless carriages would be mass produced in factories.  They would run on rubber tyres filled with air on paved roads.  Those paved roads would run to and from every city, village, and household in the land.  That there would be petrol (gas) stations everywhere.

The people in the photo would rightly ask: Where will all the money and material come from for such a brave new world of paving bricks, petrol, rubber, and metals.  They would probably commit you to an asylum if you mentioned flying train carriages that would transport hundreds of people across the oceans!

As a bitcoin skeptic this little reflection on the past can help us look at Bitcoin and its potential future with a little humility.  We know no more about the future than the people in the photo above did.

Bitcoin is based on blockchain technology.  The blockchain is simply a chain of packets of information.  In the case of bitcoin, each packet of information is related to a transaction.  But the blockchain can be used to maintain other packets or chains of information – and herein lies the blue sky potential of the blockchain.  Although I remain skeptical toward Bitcoin as money, I do believe that blockchain technologies offer a lot of potential.  I like to think of Blockchain technology in much the same way as electricity or the internet.  In my view, its use as money will be limited.  Nevertheless, it may serve as a great enabler of human progress.

 

 


 

The Great O’Neill is a Commodity Trading Advisor who writes a regular blog here 

 

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