Understanding Bitcoin

By Torrence Footsock

Much has been made of Bitcoin’s meteoric recent price rise to over $10,000. Its huge climb in value is compelling more “respectable” investors to join the mania and Bitcoin is graduating from being a hobbyist ponzi scheme to an establishment one (despite some financier naysayers).

So how does Bitcoin stack up as an alternative to state-backed (e.g. the dollar, pound or euro) money? Its true that many online vendors do accept Bitcoin as a currency (and not just amoral traders attracted to crypto currency’s unique ability to perform electronic payment transactions anonymously). It also meets other key properties of money (fungibility, durability, portability, substitutability, divisibility, etc).

However, its exponential price rise and general volatility mean that unlike state-backed money it is not (roughly) consistent in value over time verses everything else. This is because if money’s value is expected to rise (deflation) too fast then people hoard it, and if its value is expected to drop (inflation) too fast then everyone wants to get rid of it (to exchange it for things that might hold their value or are at least useful). Where most people earn and spend their money in stable state-backed money Bitcoin holders hoarding it or spending it all at once doesn’t make much difference to the wider world, but if Bitcoin were the only money out there then social activity based on monetary exchange (which is rather a lot) would come to a shuddering standstill. Luckily for us in the vast scale of human money, Bitcoin is a bit-player.

If Bitcoin is not a great form of money then, why does it appear so successful as an investment asset? And what in substance are investors buying beyond they all the hype (if anything)?

One of the reasons for Bitcoin’s early success – born in 2009 amongst an online community of largely right-libertarian folk – was an inbuilt planned scarcity which attracted conspiracy-theory, fed-hating, gold money advocates. The total maximum number of Bitcoins in circulation is intended never to be more than 21 million. Until that limit is reached new Bitcoins can be “mined” by spending exponentially increasing amounts of computing power to solve otherwise pointless maths problems. The issue is that this scarcity is an illusion because that decision can be reversed by computer engineers – although the technology makes it hard (but not impossible) to do so.

A more important question is what innate value does Bitcoin have anyway, with nothing real to back it? In contrast to other investment or money assets Bitcoin yields no income (like shares and bonds), is not backed by a state and accepted in payment of tax (like state money), and it will not continue to be valued should civilisation collapse (like gold). So, why has Bitcoin not floundered long ago?

To answer this we need to go back to the beginning, when the earliest valuations of Bitcoin were based on the cost of the electricity required to mine it. Bitcoin was valued at mere fractions of cents – being the cost of electricity used to solve the simple maths required to mine to those early coins. This tiny price albeit represented an innate value because electricity costs a lot of real-world work and actual social value (securing access to an energy fuel, installing the equipment, converting fuel or renewable energy, generating it, distributing it, etc.).

As the maths got harder, so the amount of electricity required to compute the answers (and so mine new Bitcoins) got larger. So what we’re seeing here is a very clever ruse, a psychological trick: the ever escalating input of energy required to mine more Bitcoins complements its ever escalating price and the feeling that the price too is one directional. Bitcoin’s price long ago went far beyond the social value that the cumulative electricity involved represents, but the fact is that more social value-laden electricity must be used to make more of it (with all the environmental ignorance and destruction that entails) and this gives it a perceived legitimacy as commodity money – as a “universal equivalent” commodity by which all other commodities can be valued. As gold or the US dollar has real underlying value so too does Bitcoin represent real human energies so its proponents claim.

So what happens when the mirage of value has evaporated away? It may be wiped out, or it may revert back to the price of the electricity used to mine it but we can be sure that early investors who bought low (when mining it was cheap) and exchange out for other assets in time will be extremely wealthy. Unfortunately this will reinforce their right-libertarian beliefs about the virtues of markets and the sins of states (who will likely cop the blame on the old Bitcoin forums).

But for those Bitcoin participants that have come late, expect desolation. Like tulips in the 1630s or any number of baseless company share bubbles (e.g. in the late 1920s or 1990s) Bitcoin mania is a classic case of irrational exuberance. The outcome will bring even more inequality and the winners will take all, literally all – they will walk away with the value of all that state-backed money savings which countless foolish people will have converted into overpriced Bitcoins.

Maybe after all the hype though, Bitcoin, or something like it could function as money. If The Clarion will have me back, next time I’ll delve into the technology behind it and consider some of the uses that socialists might put it too. Or, does its basis in the technologies of secrecy and mistrust mean it is of only limited use to those of us who want to build a future based on transparency and solidarity?

Let us know what you think? Write a reply? theclarionmag@gmail.com

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