|
In this post I address issues of competing
government currencies, competing private currencies, gold, silver, bitcoin and
alternative “crypto-currencies”.
We all know that variety and competion is a good thing. We all want slightly
different things, value the same things differently or make different
trade-offs. That’s why we have a wide variety of products, prices, quality,
colors and materials on the market. Interestingly, money is different. We
all want one single universal money. It may not be obvious to many people, so let me explain.
How money is different from everything else? On one hand, money is just an
asset. You can produce, buy, sell or hold it. On the other hand, money is a
medium of exchange. It allows you to trade your 8 hours in the office for a
new iPhone. It also allows you to delay consumption decision. You can spend 8
hours of work today, but then be free to decide when and for what to spend
your salary. If suddenly you need to buy a ticket to Hong Kong, you can do it
without working extra couple of hours to earn it.
The function of money is to exchange the widest variety of products
between each other. iTunes credits allow you to choose between many
songs. This make them money to some degree. But dollars are even better money
because they can buy all those songs, but also a myriad of other things as
well. Therefore, people tend to keep savings in dollars, not in iTunes
credits.
It seems obvious that the best money is the cheapest and the most widely
recognized and accepted one. Cheapest in a sense of handling it. If your
money is a huge stone you have to carry around, it is more expensive than a
small gold coin (provided they both have the same price in terms of goods
they can buy). Piece of paper named “gold certificate” could be even cheaper
than gold itself, but carries a risk of fraud, so in some cases it could be
even more expensive to hold than the gold itself.
For a huge part of the civilized human history we used two metals as money:
gold and silver. They were not perfect, but universally accepted and
recognized. All other things like seashells, diamonds, IOU papers were less
universally recognized, so they were naturally used in some very niche
markets while everyone was keeping cash in gold or silver.
Both gold and silver were durable, easy verify, easy to cut and melt
together, compact enough to be stored and moved around cheaply. And they were
very hard to obtain, so there was very low inflation cost (every new gram of
gold created eats into everyone’s savings because it increases purchasing
power of its owner comparing to everyone else around). Other things were
either easy to produce, or not durable, or hard to split in arbitrary parts.
Why gold did not outcompete silver? Or vice versa? That’s because they both
had weight. For small purchases gold would have to be split in tiny
difficult to handle pieces, while to make big purchases one would need to
move several kilograms of silver comparing to much smaller amount of gold.
This naturally created two parallel global markets: one for small purchases
where the silver was used (and small droplets of gold would be impossible to
handle) and another market for big purchases where silver was too heavy, so
the gold was used instead.
Make a thought experiment now: if there was a gold-like metal that allowed
moving both big and small amounts equally cheaply, it would be useful on both
“small” and “big” markets. Thus it would be more marketable (more
exchangeable) which by definition would make it a better money. Better than
gold and better than silver. People would then tend to keep their cash in
that magic metal because it would allow them access to bigger variety of
goods: from bread to houses. And they would not lose money on conversion rate
like when they sell some silver for gold or the other way around.
There was a competition in private coinage. Kings and private merchants were
making their own coins in gold and silver and selling them for premium. The
well-recognized coin was easier store and to verify if you trust the issuer.
Instead of measuring each coin, you could simply read the number on its face.
Names like “dollar”, “pound sterling” and others were all names for private
coins or bullion and meant particular weight of the metal. That is,
dollar was not some sort of separate money, it was simply a name for
a certain amount of silver, like “gram” or “ounce”. The money was still the
same — gold or silver, but there was a big variety of shapes of that money.
Of course, gold and silver were still quite limited. You could not drop a bag
of gold across the ocean. That’s why people invented banking. Bank
was simply a warehouse for your metal. You give them gold, they give you a
receipt. Then, if the bank had good reputation and connections with other
banks in the world, you could transfer those receipts of any face value quite
cheaply anywhere. The only real cost was trust in those banks. Because if the
bank is robbed or steals your metal, your receipt becomes worthless. If the
bank prints additional receipts for the same amount of metal, the value of
your receipt goes down proportionally (or you face a risk of bank run,
when more people try to redeem their receipts than is available in the
vault).
In old days, private currencies were simply those receipts for gold or
silver. Each currency could have different name and different reputation.
Bigger bank’s notes had more value on the market because they had less risk
associated with them and as a result, wider acceptance. But ultimately, they
all were receipts for the same metals that you could redeem at any time and
move to any bank or under a mattress. Because people valued receipts only for
their ability to represent readily accessible metal. Without the metal, those
pieces of paper would be worthless.
Today things are different. After several huge economic disasters created by
the governments of Russia, Europe and U.S. in the beginning of 20th century,
we now have state-issued money in almost every country with a nice twist that
now the money is not redeemable for metals. People use that money, though,
because various controls and regulations make it almost impossible to use
gold, silver or respective certificates in daily transactions. Every bank
needs expensive license and must not be very creative at what it can offer to
its clients.
Dollars can buy things in U.S., euros can buy things in E.U., but if you try
to use them in inappropriate places, you would have to pay very high
conversion fees. (Setting up your own clearing house or exchange with the
lowest fees is not possible due to regulation.) It should be clear now that
if, for instance, U.S. Dollar can buy more than Russian Ruble, Russians would
tend to use Dollars in daily life. The reason why it does not happen anymore
(it used to during liberal times in the 1990s) is stricter controls on
currency exchange that make it illegal to price goods in dollars and
expensive to exchange currencies frequently. For the same reason, gold and
silver are not used: they are too expensive or illegal in some contexts, or
there is a huge risk and cost on those who are going to store them. Several
years ago, Liberty Dollar, alternative silver-based currency was shut down
and all silver was confiscated by U.S. government. Founder was pronounced
guilty of “making, possessing, and selling his own currency”.
Here we do not discuss whether it is good or moral to make your own currency
or store other people’s money. The point is about demand for a single, most
universally accepted money. If gold, silver and foreign currencies need
violent intervention to not be used, it’s only a proof of existing
demand. Because if there was no natural demand, no government would care
setting up restrictions in the first place.
Now we enter crypto-currencies. It is a fancy name for Bitcoin and its many
clones based on the same source code. Bitcoin itself is very different to
ubiquitous government money, application-specific “credits” (like in
multiplayer games) or gold and silver. It is absolutely digital, does not
have a single controlling entity and is very cheap to store and transfer both
huge and tiny amounts of money. This property makes Bitcoin very useful on
certain markets: be it illegal market, or “sending money to family in another
country”, or a market where banking is unavailable or too expensive.
What about alternative Bitcoin-like currencies? They all provide the same
security risks and benefits. Nominally, they all have different divisibility
(so called “larger number of coins”), but at the scale of trillions of
smallest units in total money supply extra divisibility does not really
matter.
Economically, all Bitcoin clones (altcoins) have the same problem: they all
have much smaller market exposure than Bitcoin while not technically
superior. When people decide in which one to keep their money, they would
keep it in the money with the biggest market. There is not point in
“diversification” in the long term. If Bitcoin fails for some reason, all its
clones fail for the same reason automatically. If Bitcoin works well, any
amount in altcoins is simply inferior in its purchasing power. It does not
mean there won’t be any market. You can always keep some empty plastic bottles
for selling later, but the bottles can only buy cash, while cash can buy
anything.
Second problem of alt coins is mining. In the long term, any miner will throw
100% of computing resources into the most profitable currency. Even if
Bitcoin is only 1% more profitable than Litecoin, since there is no
fundamental difference between them, all the resources will be thrown into
Bitcoin. In the short term, there are plenty of enthusiasts who find
themselves equipped with a lot of outdated GPU hardware that was once used
for Bitcoin, but now cannot compete with specialized ASIC hardware. These
people now mine Litecoin in short-term expectation for any amount of reward.
It is sort of a private club of people trading in their own funny money. All
new miners devote all their energy to Bitcoin, while people who will sell or
retire their GPUs will make Litecoin network weaker and less technically
stable.
In the end, it is clear that we want the single money to be able to sell
anything and buy anything. We all want it to be cheap to store, move and
verify. And secure. With as little trust in middlemen as possible. Today we
find ourselves with a lot of artificial barricades in the sphere of money,
which causes artificial demand for various local currencies. Gold is being
seized or moved from the country. Foreign currency is prohibited for
merchants to price their goods at. Legal tender laws force you to accept
government-issued currency as a payment for debts.
Regulations and licensing limit variety of private currencies or money
substitutes. But all that trouble only proves almost universal desire to use
the single virtual entity for buying food and saving for the future. Bitcoin
gives us a mechanism to overcome all these regulations and trade as freely as
was ever possible. Maybe it will allow us to achieve that single, most
marketable entity that we all so desire.
Reprinted with permission.
|
|
