So, Bitcoins

by: Jeffrey Snider

Bitcoins are a remarkable bit of innovative technology. When they were first introduced quietly at the end of October 2008, nobody noticed it or the fitting timing. The design paper for the cryptocurrency was published anonymously at the very same moment the dominant global currency, the eurodollar, was undergoing its severe reckoning. The latter is in many ways like the former, since the eurodollar is not a thing just like Bitcoins. In many respects, it, too, is a cryptocurrency and as such confounds a great deal of "expert" analysis.

The price of a Bitcoin, meaning its exchange rate, has exploded more recently, though not for the first time. If we reckon it as a currency, then the other side implication of this price action is that the dollar has fallen in value relative to it. That it has survived and in some places thrived after eight and a half years is meaningful, but what we don't know is whether it is that because of the potential for Bitcoins or because of the constant malfunction of the "dollar."

There is more than a fair hint of Gresham's Law at work. For those unfamiliar, Gresham's Law is a stated maxim on currency, thought up in 1858 by Scottish banker Henry Dunning Macleod and named for 16th century English financier Sir Thomas Gresham. Ironically, I suppose, Macleod's thoughts on 19th economics mirror what would become of this idea.

I can hardly express the disappointment I felt at reading them…for the purpose of describing the actual principles and mechanisms of commerce they were absolutely worthless. They were merely a chaos of confusion and contradictions…In fact, they were in no sense a science, but the butchery of a science. I saw that the greatest opportunity that had come to any man since Galileo had come to me, and I then determined to devote myself to the construction of a real science of Economics on the model of the already established physical sciences.

The "them" Macleod referred to were Adam Smith, David Ricardo, and John Stuart Mill, among others. Intending to establish economics as actual science, his concern was as the whole of it was about exchange, where value was specific to only supply and demand. Therefore, in the case of multiple currencies artificiality would lead to drastic inequalities as a matter of self-evident principle. Or, as Gresham's Law is commonly stated, bad money drives out good money.

Throughout human history there was rarely a single form of currency. In most cases, any economic system would often run with several concurrently. The early Colonial United States was practically fixed to Spanish gold doubloons, often short were English guineas or French Louis d'Ors. It was messy but in so many ways very elegant; a system of checks and balances beyond the reach of governments.

Are we seeing something similar here? Is the Bitcoin so undervalued, the "dollar" so overvalued, that the former are being hoarded while the latter discounted toward oblivion? Not quite, but, again, there is the suggestion.

The issue is purely acceptance, meaning that those exchanging Bitcoins north of $2,000 are betting on wider recognition and therefore the cryptocurrency increasingly supplanting other forms, including maybe the eurodollar itself. This is not specific to Bitcoin, as the blockchain technology behind it is what really drives the relentless interest. To put it simply and bluntly, the world's leaders have all failed in monetary terms, so should anyone be surprised that alternative means are occasionally, if not consistently, sought?

Here is where it gets sticky, though, as there are tremendous barriers to that possibility. The biggest is, of course, the US government who after appropriating a coinage monopoly is not going to so easily relinquish it (though I should point out this is also true of replacing the eurodollar). Several years ago, they made that amply clear when the IRS ruled Bitcoins within its taxing authority, and not as money. I wrote at the time:

In other words, you cannot avoid taxation by paying employees in Bitcoins instead of dollars. Further, the IRS is subjecting merchandise trade to its $600 filing limitation - if you paid two Bitcoins to for a new flatscreen you are supposed to issue Overstock a 1099 (this is not a joke)…

When you paid two Bitcoins for that flatscreen from Overstock, you are supposed to calculate the value of the Bitcoins at which they were attained and compare that to the fair value of the flatscreen. If the latter is greater than the former, the IRS has ruled it a taxable gain. And that subjects you to a further taxation test about whether that gain is "capital" or "ordinary."

This is no trivial matter, for what ultimately will guide any currency to full establishment is its acceptability to the public. The modern person is a creature of convenience, a fact established by almost every facet of modern life. The chartalists were right on that count, as what matters for currency is no longer value but expediency, a factor over which the government unfortunately holds enormous sway in this regard. We may lament this state of affairs, the loss of money as property, but it does us no good to ignore it or wish it wasn't so.

And so the balance under Gresham's Law, as it were, is one of possible inconvenience under Bitcoin versus the inertia of the eurodollar though it doesn't work. If the latter rises past some critical threshold, then we would expect this element or corollary of Gresham's Law to increase exponentially (a run on "dollars" converted into Bitcoins?). Though I am as pessimistic about the state of the eurodollar system as anyone, if not more so, I'm not sure it will get that far as anything more than a true "tail event." In other words, the entire system would have to break down catastrophically and with no alternate form of viable money on the horizon. The first part could happen, but I just don't see the second part.

For Bitcoins, however, if there is a path to full currency status it is likely in future generations of the technology that address version 1.0's weaknesses, including anticipating how the government will surely intervene to block it. Until you can whip out your phone and pay in Bitcoins without issuing a 1099 and calculating the capital gains tax on the transaction (or maybe there will be an app that will do both?) the potential is limited to largely the specific forms of commerce currently open to them (more so black market or darknet).

I doubt that is what the current "price" of $2,800 is anticipating, so it is a fair question to ask whether recent price action invokes the word bubble. I can't answer it mostly because my interests are almost all on the other side, meaning that I can't help but be encouraged that entrenched dissatisfaction over the state of global money is driving it. That said, I continue to believe we are a couple blockchain generations away from true viability, though if nothing changes we could get there sooner than you might think.