How Will the Bitcoin Mania End?

I’ve tried to remain pretty balanced in my view on Bitcoin and cryptocurrencies in general. Back in 2013 I said Bitcoin was definitely money and that the ideological hatred of it was irrational. This monetary view is consistent with the general view I have on cryptos as a part of someone’s portfolio – as I said yesterday, no one really knows how this will play out so you need to be extremely cautious and avoid taking recklessly ideological positions in either direction. As a monetary nerd I am much more interested in the application of cryptocurrencies than I am with the unpredictable value of the corresponding coins. I think of it as trying to decipher the utility of the internet circa 1995 as opposed to trying to figure out if Netscape is overpriced or not.

That’s a good segue into this post. So I’ll get this out of the way upfront – I have no idea how any of this is actually going to play out, but I have an opinion and I think that opinion might help some people better understand what’s going on and what could go on. So let me elaborate on all of this.

bitcoin mania

First, I think it’s helpful to hash some of this out by defining some of the terms we’re using:

Bitcoin is a peer to peer electronic cash system.

Blockchain is a type of distributed ledger created to trace the use of a decentralized application.

Mining is the process of creating new coins in exchange for validating the ledgers and verifying their accuracy.

Cryptocurrency refers to any of the coins being created to incentivize the mining for various blockchains and their corresponding applications.

There are two elements at work here. First, there is the actual utility via an application; and second, the coin that validates the ledger that traces that utility. So, for instance, in the case of Bitcoin and the Bitcoin blockchain the coin itself is a payment processing tool. The Bitcoin blockchain itself is validated by the miners who are incentivized to mine for Bitcoin. You might use Bitcoin to process a payment with a local business and that transaction will be verified via the mining process. So it’s a decentralized payment system that is self validating and secure. At present, Bitcoin is kind of the “central coin” in a crypto world with a whole bunch of coins. It’s kind of like the reserve currency of cryptos.

The real goal of a cryptocurrency is to create a decentralized system of peer-to-peer applications. For instance, if you had a crypto wallet that traced the title of your house in your name then you could theoretically give that title to a new home buyer in exchange for some amount of crypto. You cut out all the middlemen in the process and the title is secured on the blockchain as a valid transaction. Super secure, safe and inexpensive. You could take this general framework and apply it to millions of other applications.

There’s a couple of problems with this system and I’ve touched on them in the past:

The coins have no par price settlement. This is a colossal problem with any form of money. The reason we centralize money is mainly because we can create stability in its value relative to everything else. No, not the real value, the nominal value. Yes, governments sometimes do a piss poor job of this and create hyperinflation, but in general fiat currencies are extremely stable in nominal terms. You can almost always settle a payment at par even if you’re losing some marginal purchasing power over time. Cryptos currently have no par settling mechanism which makes them a pretty bad currency. I’ve described the current iterations as non-financial collective equity because they are more like commodities than currencies. Centralized money is very good at settling at par in nominal terms because the entities that achieve this do so through massive economies of scale and, in the case of the government, no need for profit. Many Bitcoin advocates claim that Bitcoin’s decentralized nature is its strongest point, but you could also argue that the lack of a centralized market maker settling at par, is also its greatest weakness since the utility of the coin collapses when its value collapses. This is not a small flaw in Bitcoin. It is arguably a fatal flaw. The historical graveyard of monetary units is comprised of instruments that could not maintain stability in either nominal or real terms.

Some crypto activities aren’t consistent with public purpose. Again, this is arguably the greatest strength and weakness of cryptocurrencies. The decentralized peer-to-peer applications are going to be extremely useful and world changing because they cut out the middleman in many transactions and transfers. But they can also be used to evade taxes which creates a big problem for society as a whole. We have taxes for specific reasons. We need firefighters, public roads, police officers, military, etc. And we need revenue to pay those people so we need to be able to tax. One of the main reasons we centralize forms of money is so we can regulate it primarily so we can tax it and create a system whereby everyone chips-in to public purpose. Yeah, I hate taxes as much as the next guy and I think we all pay too much in taxes and that governments suck at spending our tax dollars, but I also realize there’s a logical need for some level of taxes. Therefore, a currency has to be consistent with implementing public purpose. It has to be taxable.

Now, when I think of the current state of cryptocurrencies I think we’re still way in the early stages. Just like Friendster gave way to MySpace which gave way to Facebook we will likely see many iterations of these coins over time as they evolve and become more consistent with solving practical real-world needs.

That brings me to my grand conclusion and how I think this might all play out over time. Bear in mind I am just spit balling, but I think this view kind of resolves the above issues and creates a parallel crypto world where these decentralized applications blossom.

– Read the rest of the interesting article here