Tuesday, March 28, 2017

Bitcoin & Theory of Money

I was asked by a friend to write about bitcoin.

Not that I have been following bitcoin closely. I haven't.

But from what I have gathered from some headlines, it goes something like this:

Bitcoin is a computer algorithm, supposedly complex and is on its own after its creation and nobody can control it nor modify it. Its supply is created by some random successes in operations which is supposed to mimic the randomness of the success of mining. In other words, its supply is sporadic.

The key to getting this bitcoin scheme going is to create a demand for it. It has its own ecosystem whereby people with a hoard of bitcoin can exchange it with others. There is no point exchange it with another bitcoin unless of course you want to go into debt by borrowing. You want to try to exchange the bitcoin with other non-bitcoin items, so that from there, it is supposed to behave like money.

The other way to hip the demand for bitcoin is to create an exotic story out of it, like the Mona Lisa, in order to get people to desire bitcoin for its own sake. Or, to stimulate demand by creating a speculative fervour for it about its rising value in the future. All these things could be stimulated out of an environment of complete nothing better to do and boredom. One must just as well try to cultivate the black tulip.

In the bitcoin ecosystem, of course, by definition, the rule is to use bitcoin as a unit of account and a medium of exchange. Anything can be used to fulfill these two functions.

We can think of isolated places now or in the place where all kinds of stuff are used as a unit of account or medium of exchange - but in small doses. It could be favours (of a lady or man), graces in heaven, cows, shells, stones, metals, dusts. The most famous was salt which was used to pay Roman soldiers as "salarium" which becomes in English "salary".

The test of money as we now know it as money is the size of the ecosystem in which the item functions as money. If we think of the ringgit or any other national currencies, each ecosystem may not be very large. But if we think in terms of paper money or electronics money, it covers the entire earthly universe, almost literally - except for those few isolated places that still trade in wives or some other unfortunate creatures.

So a unit of account or medium of exchange is not sufficient a quality to be considered as money.

The store of value is also a necessary function but not sufficient. In Malaysia today, the ringgit is not considered a good store of value. People who are clever enough are proud that they are fully in debt and in possession of bricks and mortar called houses and condominium units. Better still, gold.

But however lousy the ringgit may be as a store of value, it is still the only means of final settlement.

No matter how rich you may be, but if you do not have the cash, you cannot buy anything. This is here that the banks do a roaring business, exploiting the difficulty of ensuring sufficient liquidity by people at very inconvenient times - only of course when you have collateral assets in real estate. Banks know from hundreds of years of operations that real estate is the only way to hold value because people cannot help but procreate and they all want to live in city centres.

What I am getting at is that the current economic theory despite the Keynesian revolution is still stuck in medieval times in the barter economy where unsold goods can be considered as savings and hence investment. Keynes got stuck at the savings equals investment and could get out; he insisted that there is hard truth no matter what. He was still stuck in the barter economy.

In the monetary economy - ie, a money-using economy, like we all are in the world today - no money, no talk. We all have debts and we must have the cash to pay the debts - you can ask the unfotunate wives of gamblers who borrowed from loan sharks as lenders of last resort. They just want their cash back.

So if you set up a company to produce apples, you have to have capital in cash to hire workers and machines. You have to pay the workers cash first before they would work. There are no apples to give them in the first place. But after you have produced the apples at the end of a production period or harvest, you want cash back for your apples. You are not happy if you sell all the apples to your workers and they give you back all the wages you pay them. You have your initial capital in cash back and have no more apples. If you keep back some of the apples for profit, and sold some apples to your workers, you do not have cash. Your profit must be in the form of cash.

The only way of is to sell your apples to your foreign friends for foreign curreny or your political friends who print money or your rich friends who have savings from their parents.

That why, all merchants clamour for exports rather than feed their workers. That's why governments print money. Or people spent their inheritance or borrow to the hilt. This is the way our modern monetary world works.

So, I don't think bitcoin is any bit a coin, not just yet.


walla said...

Just as linux is to software, bitcoin is to internet currency; it's just an encrypted digital currency on peer-to-peer open space with the advantage of transaction speed and lower processing costs for cross-border transactions.

It is its bigger institutional brother - blockchain - which will shift the paradigm of traditional financial services, especially in the capital markets and such wholesale payments as securities settlements, cross-border forex and correspondent banking.

Given the potential for multiple reconfiguration of its transaction networking, blockchain can be envisioned as the financial matrix of the future.

Right, Neo?

etheorist said...

Right, walla.

I had had some education on blockchain at a conference this week and sure the technology promises great disruption to the world as we know it.

The digital world is certainly a dimension on its own. But it is at best just another dimension.

There are also parallel dimensions that can exist and be non-digital even in the future.

But I could feel the great excitement among the believers. Captivating.