Cryptocurrencies have been in the news capturing the imagination of speculators and investors alike. The reason for the interest and enthusiasm has everything to do with dreams of riches and nothing to do with the economic importance of the technology itself. Those who identified Bitcoin and figured out a way to get their hands on some have made out like bandits. Indeed, few if anyone caught up in the emotions of the price gyrations understand the technology. Yes, they toss around words like “blockchain” but few understand what it really is, either its promise or its challenges.
Furthermore, cryptocurrencies exist at the pleasure of governments. To protect their domestic fiat currency monopolies, they could make them illegal, declaring them as dangerous as the latest designer drug. Now it seems that the horse is out of the barn door. As cryptos build acceptance, making the holding of cryptocurrencies a criminal offense, harder and harder to do. Should the price of cryptos collapse as fast as they rose, may set the stage for a government takeover.
The new tax law in the US is hostile to Cryptos. It is our understanding that one could trade among Cryptos and not have to worry about any tax implications. Such transactions were considered like-kind exchanges, which is a common treatment for trading one piece of real estate for another. One would be subject to tax when the Crypto was monetized and ultimately converted to US Dollars. We understand that an obscure like in the bill eliminates like-kind exchanges for all assets with the exception of real estate.
The government, as are many theoreticians and speculators, are a Bit confused in defining the nature of a Cryptocurrency. The inventors of the Bitcoin were clear and defined by its “asset class.” It is a currency. But it is treated as an asset by governments. If you buy something with your Crypto, you are supposed to determine the gain or loss on the currency at the time of the transaction and pay the appropriate capital gains tax on the Crypto spent. No so convenient.
If Cryptos are indeed currencies, then we can only hope the governments allow them to flourish. But once the excitement is over, will Cryptos pass the “Market Test?” That is to say, will Cryptos capture broad market appeal such that people and corporations will use to facilitate trade, which is the true use of currency. The following is an article written by Frank Shostak, a Ph.D. from Rands Afrikaanse University, who thinks about the implications of Cryptos from a theoretical point of view. While we believe Cryptos are here to say, there are still issues for the technology to confront, not the least of which is how they fit into the economic picture. Technical issues are likely to determine which Crypto(s) will ultimately be the winner. Without further ado, here is what Dr. Shostak gas to say.
Many economists and financial commentators hold that in the unregulated market of the internet economy, Bitcoin is likely to emerge as a new form of money that is going to bypass the central-bank supervision. Bitcoin, the invention of a person, or group of people, using the name Satoshi Nakamoto, was launched on January 3, 2009. The basic idea behind Bitcoin is to create, by means of a mathematical algorithm, a substance that is scarce and fungible.
Nakamoto devised a software system that enables people to obtain Bitcoins as a reward for solving complex mathematical puzzles. The resulting coins are then used for online trading. Nakamoto also arranged that the number of Bitcoins can never exceed 21 million.
Some experts maintain that Bitcoin will displace the existing fiat money and will usher in a new era of free banking, which will finally put to rest the menace of inflation.
To establish whether Bitcoin is likely to become a new general medium of exchange (i.e. money), let us first see how money comes about. The distinguishing characteristic of money is that it is the general medium of exchange, evolved from the most marketable commodity. On this Mises wrote,
“There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money.”
Money is the thing for which all other goods and services are traded. Furthermore, money must emerge as a commodity. An object cannot be used as money unless it already possesses an objective exchange value based on some other use. The object must have a pre-existing price for it to be accepted as money.
Why? Demand for a good arises from its perceived benefit. For instance, people demand food because of the nourishment it offers. With regard to money, people demand it not for direct use in consumption, but in order to exchange it for other goods and services. Money is not useful in itself, but because it has an exchange value, it is exchangeable in terms of other goods and services.
The benefit money offers is its purchasing power, i.e. its price in terms of goods and services. Consequently, for something to be accepted as money, it must have a pre-existing purchasing power — a price.
Once a thing becomes accepted as the medium of exchange, it will continue to be accepted even if its non-monetary usefulness disappears. The reason for this acceptance is that people now possess previous information about their purchasing power. This, in turn, enables them to form the demand for money.
The key to acceptance is the knowledge of the previous purchasing power. It is this fact that made it possible for governments to abolish the convertibility of paper money into gold, thereby paving the way for the introduction of the paper standard. Again, the crux here is that an object must have an established purchasing power to be accepted as a general medium of exchange, i.e. money.
It was through a prolonged process of selection that people had settled on gold as the most marketable commodity. Gold, therefore, had become the frame of reference for various forms of payments. Gold formed the basis for the value of today’s fiat money.
In today’s monetary system, the core of the money supply is no longer gold, but coins and notes issued by governments and central banks. Consequently, coins and notes constitute the standard money we know as cash that is employed in transactions. Notwithstanding this, it is the historical link to gold that made paper money acceptable for exchange.
Observe that Bitcoin is not a thing as such; it is a unit of a non-material virtual currency — it has no material shape. Thus, it is likely that Bitcoin can function only as long as individuals know that they can convert it into fiat money, i.e. cash on demand (see, e.g., Lawrence H. White “The Technology Revolution And Monetary Evolution,” Cato Institute’s 14th annual monetary conference, May 23, 1996).
Given that Bitcoin could be transferred rapidly across various locations makes it very useful in this regard, however, this does not make it a new form of money but rather a new way of employing existent money in transactions. It is like issuing checks — which still must be cashed up.
Some supporters of Bitcoin hold that it is on its way to becoming the general medium of exchange since it has already established purchasing power. So on this score, it is not important whether Bitcoin had originated from a commodity.1
We can trace back its purchasing power until the point at which Bitcoin was invented. Certain people really did sell pizzas and other goods against Bitcoins in the first transactions. Why did they do so? The reason is unimportant. The point is, they did do so. That gave everybody an objective frame of reference for the market value of Bitcoins, which then snowballed to the present day.
One could argue that the fact that Bitcoin has an established purchasing power with various goods and services could be an important step towards it becoming the general medium of the exchange. But on this logic, various other goods and services are good candidates to become money given that goods and services that are traded by implication must have purchasing power.
Note that historically various goods have served as a medium of exchange such as wine, tobacco, gold and various precious stones. All these were participating in the prolonged process of selection until only gold became selected as the general medium of exchange i.e. money.
So from this perspective, it is not enough to have an established purchasing power. A particular thing must also pass the market selection process. So far, we do not have much evidence that bitcoin has received general market approval.
Given that the present monetary system displays ongoing signs of instability because of the central bank’s abuses, we suggest that at some point in time it is more likely that gold could replace the present paper standard. (Note again that given the prolonged historical selection process gold is likely to renew its role as the general medium of exchange i.e. money). The trigger for this could be a severe economic crisis because of a severe depletion in the pool of real savings — the heart of economic growth.
As far as bitcoin is concerned, it is likely to feature among various electronic forms of money i.e. as a particular way of using the accepted medium of exchange.
Nor can the present monetary system cannot be saved by central banks. On the contrary, thanks to the central banks’ prolonged abuse of the monetary system, any further policies of tampering are going to destabilize the monetary system further and will speed up the emergence of the natural i.e. the market selected money. If history is any indication, the private-sector money is likely to just be gold.
We would note that the author focuses on Bitcoin, presumably because it has first-mover advantage, more participants, and better market awareness This makes it the leader in the Crypto world. But there are many problems with Bitcoin, not the least of which is that it is becoming more and more expensive to transact in the currency. This is putting the idea of “micropayments” out of reach. Furthermore, as the “work” involved to mine the currency hets harder and harder, the time for a trade to settle is growing rapidly. Depending on how much one is willing to pay, it might take 4 or 5 hours for a trade to sell, or a number of days.
There is a question in the Bitcoin world that goes unanswered. What happens when the last Bitcoin is created/mined? The Bitcoin created in the mining process is used to pay the folks who facilitate the transaction. How this plays out is unclear to us, but we think other Cryptos will emerge to address the design flaws of Bitcoin. What that winning Crypto will be is the million dollar question. This, of course, presumes government and central banks do not ruin all the fun.
I own a fraction of a Bitcoin and other Cryptos (Bitcoin Cash, Litecoin, Dashcoin, Dogecoin, Etherium, Ripple) accumulated through very simplistic and terrible inefficient mining exercise as a means of learning how this young technology works (or doesn’t). There are now hundreds of coins and token out there, most of which will probably become worthless (like so many dotcoms). Nonetheless, we will be looking for ways to mine some of these more obscure Cryptos as times and technology allow.
