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Getting Bitcoin Wrong

The new VOX looks excellent.  I’m excited for Ezra Klein and Matt Yglesias and the rest of the team working there.  But I wasn’t a huge fan of this article on Bitcoin.  In fact, I think there are some serious misunderstandings in it.

The first error is the idea that Bitcoin’s decentralized model is its ultimate strength.  The author writes:

“Bitcoin’s detractors are making the same mistake as many Bitcoin fans: thinking about Bitcoin as a new kind of currency. That obscures what makes Bitcoin potentially revolutionary: it’s the world’s first completely open financial network.”

This is simply not consistent with the role of money in modern financial systems.  Modern money is denominated in a unit of account established by specific governments (the US Dollar, the Yen, the Euro, etc).  It is regulated by that government.  And it is distributed through a system either controlled by that government, a public/private partnership or a privately managed system with government oversight.   But notice that government and any credible form of money go hand in hand there.

In the case of the USA and most other modern payment systems the banks control the issuance of money and the government oversees how this system is regulated.  This strikes a nice balance by allowing private entities to compete for money issuance (loans create money) and utilizes the various strengths of government to support this system.  As the entity with taxing authority over private production as well as control of the legal structure of the system the government has an extraordinary amount of power to secure and stabilize a payment system.  After all, when the banks blow things up they don’t turn hat in hand to one another.  They usually turn hat in hand to the government to stabilize everything.  And the government is happy to help because governments know that the stability of their payment system is central to the health of, well, just about everything in the financial system.  To separate government ENTIRELY from money is to separate money from one of its most integral features.

But the credibility a government contributes to a currency is only one component of this relationship between money and governments.  Another important component of money as a credible and valuable medium of exchange is in its use for public purpose.  A government must be able to tax money in order to be able to generate revenue for public purpose.  And in order to properly tax it must maintain some level of government oversight.  This means that there is simply no such thing as having a fully decentralized monetary system.  In other words, to separate “money” from a government is to create a mythical world where government does not exist since, by definition, a government cannot exist if it has no taxing or legal authority within a monetary system where it exists.  Therefore, to create a currency that is fully decentralized is to create a currency that serves ONLY private purpose.  This is totally incompatible with the existence of modern human society and the interconnected social systems in which we live.  So no, decentralization is not Bitcoin’s greatest strength.  In fact, as I highlighted over a year ago and prior to the massive Bitcoin fraud, this decentralization is Bitcoin’s greatest weakness.

A more minor misunderstanding has to do with Bitcoin and its comparison with other modern funds transfer systems like Paypal or credit cards.  The author says:

“MasterCard and PayPal payments are based on conventional currencies such as the US dollar. In contrast, the Bitcoin network has its own unit of value, which is called the bitcoin.”

This isn’t quite right.  Credit card companies like MasterCard facilitate electronic funds transfers. Banks and finance companies use MasterCard branded cards to allow these transfers to be processed in the money they issue. To discuss credit cards or Paypal without discussing banking is missing the point of the “money” used in the means of transacting business through those funds transfer systems.  So let’s be clear – these payments are occurring inside the banking system and represent what is essentially a short-term dollar denominated loan by a bank (or, in the case of Paypal, a deposit transfer).

Further, the value of a Bitcoin is not like a “currency” at all.  It’s more like a financial asset issued by a private/decentralized system whose value is fluctuating up and down like a stock or bond based on what speculators think it’s worth at any given moment in time. And just like stocks or bonds this financial instrument called “Bitcoin” is denominated in local currency and can be exchanged into deposits.  But make no mistake – when you want to go buy 99.9% of goods and services you must convert that financial asset into good old fashioned bank deposits denominated in USD.  The reason why is because, control of money is about controlling a trustworthy payment system.  And for all its flaws, the modern banking system is extremely trustworthy.  That’s a big part of the reason why a system like Bitcoin, being decentralized, simply can’t compete with modern banking (not to mention, the banking system’s lobbyists are bit more powerful than anyone associated with Bitcoin).


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