There's been a digital cash rush over the past few months, with Bitcoin rising in value from $13.50 to over $1000 in 2013. Economist Paul Krugman calls Bitcoin "evil," while economics-obsessed scifi author Charles Stross says he wishes it would die in fire. Why do they think Bitcoin will usher in the econopocalypse?
Bitcoin is a cryptographic currency — a form of digital money that is designed to be anonymous as it passes from hand to hand, just like cash. It requires no central banks, and is inherently limited because of the computationally-intensive way it is "mined." As Stross puts it, Bitcoin is the ultimate econo-porn for Libertarians:
Libertarians love it because it pushes the same buttons as their gold fetish and it doesn't look like a "Fiat currency". You can visualize it as some kind of scarce precious data resource, sort of a digital equivalent of gold. Nation-states don't control the supply of it, so it promises to bypass central banks.
So what's the problem with this? As Krugman points out, there are really two questions to answer here. First, what is the philosophy behind Bitcoin? And second, can it work in the real world? As for the first question — if you enjoy having a relatively stable society where you can depend on your next paycheck having value, the rise of Bitcoin might be a Really Bad Thing. Stross continues:
It's also inherently damaging to the fabric of civil society. You think our wonderful investment bankers aren't paying their fair share of taxes? Bitcoin is pretty much designed for tax evasion. Moreover, The Gini coefficient of the Bitcoin economy is ghastly, and getting worse, to an extent that makes a sub-Saharan African kleptocracy look like a socialist utopia, and the "if this goes on" linear extrapolations imply that BtC will badly damage stable governance, not to mention redistributive taxation systems and social security/pension nets if its value continues to soar (as it seems designed to do due to its deflationary properties).
To editorialize briefly, BitCoin looks like it was designed as a weapon intended to damage central banking and money issuing banks, with a Libertarian political agenda in mind—to damage states ability to collect tax and monitor their citizens financial transactions. Which is fine if you're a Libertarian, but I tend to take the stance that Libertarianism is like Leninism: a fascinating, internally consistent political theory with some good underlying points that, regrettably, makes prescriptions about how to run human society that can only work if we replace real messy human beings with frictionless spherical humanoids of uniform density (because it relies on simplifying assumptions about human behaviour which are unfortunately wrong).
Again, this isn't a judgement about whether Bitcoin can work. It might be able to work, but kind of badly.
Bitcoin is designed to be forked into other currencies — anyone can use the code make their own kind of digital money. Tomorrow, I could create Klingoncoin and start paying you with it to assassinate my enemies. The problem is that my cash is really only as secure as the online trading system where I store and exchange it. There are flash crashes, of course. But more worryingly, as the Dogecoin adherents discovered, it's easy to find your virtual pockets emptied by enterprising (or not-so-enterprising) thieves. In the case of Dogecoin, hackers modified the Dogewallet system to send everybody's money to one wallet.
UC Berkeley economics professor Brad DeLong talks about the Dogecoin debacle and notes that Bitcoin lacks some "too big to fail entity" promising to back it, or becoming a currency sink for it:
So how do actual fiat moneys maintain their value? Well, they don't always do so–coughZimbabwe, cough Weimar Germany. When they do so, it is because a government (a) accepts its money in payment of taxes, thus giving people a reason to hold it, (b) doesn't want the financial chaos that hyperinflation would generate, and so (c) sets its central bank the mission of being a currency sink–of maintaining the value of the currency by buying it back and burning it up if necessary. Thus I tend to be a "chartalist": commodity moneys can maintain their value via their cost of production, but fiat moneys maintain their value when some very large too-big-to-fail entity backs them.
In my view, BitCoin's chances would be a lot better if there were some large and durable entity that promised to be a BitCoin sink if necessary. If, say, Google Cayman Islands were to start GoogleCoin, and announce that it would always stand ready to buy back GoogleCoins at a fixed real value, it could make a (small) fortune and, I think, eliminate BitCoin's business in a month…
So the current Bitcoin rush is likely to end in disaster — either for the Bitcoin millionaires, or for the "fabric of civil society," as Stross puts it. Just yesterday, casual gaming company Zynga, makers of Farmville and boneheadedly-titled Cityville, announced that they'd be taking Bitcoin. That sent the price up to $1000 per Bitcoin. Not exactly an auspicious sign when your currency jumps based on the announcements of what amounts to an online gambling company.