FT Alphaville Izabella Kaminska

4/18/13 Bricks of gold, bits of code: the worship of things shiny and useless from FT Alphaville

by Izabella Kaminska
If the meteoric rise and fall of the cyber crypto currency Bitcoin this month teaches us anything, it’s to what degree a market can be influenced by speculative flows pumped up by internet hysteria and viral marketing. There is no intrinsic value to a Bitcoin. The asset class, in many ways, behaves just like gold. Bitcoins can never be consumed. They can never be destroyed. They can only ever be hoarded or transacted. If there is value to a Bitcoin (or gold) it is tied to its cost of production, that being the energy it costs to produce it, its restricted supply — a function of a computer protocol — and the cult-like beliefs of its dedicated followers. In many ways the movement is akin to a religion, one spawned from the foundation myth of the pseudonymous Satoshi Nakamoto, the mysterious architect of the high-level programming that backs the system. Its followers are attracted by the promise of a new age of decentralised currency markets, in which Bitcoin reigns supreme under no authority but its own, free of government interference. This anarchic philosophy is propagated on a daily basis through the counterculture internet community, often by vested interests, vying for the hearts and minds of a disillusioned and vulnerable post-financial crisis generation. But just like with any product being pitched by snake oil salesmen there is a twist. The marketing reads “fairer system for all” but the content is actually intended quite strategically to concentrate wealth amongst the view and increase inequality more generally. Proponents of Bitcoin (and gold), of course, cry out for its currency status. But while the nature of money has been long debated, there is a general consensus that its core attributes consist of it being a stable store of value, a universal unit of account and a liquid form of exchange. Some have even argued it is primitive version of technological memory.
If last week has shown anything, it is that the Bitcoin system is fundamentally flawed in that capacity. It is at worst a useless commodity and at best a speculative asset class resembling an investment in a high-risk technology stock. Or even worse than that a money laundering scheme for criminal economy. If it was a currency, it would be a deflationary one by design — hardly the makings of a viable monetary system that spreads wealth. The problem lies in the rigidity of the source code, and its inherent inflexibility and volatility. In a normal commodity market when prices go up, the mining industry responds by producing more to capture as much of the price rise as possible. This inevitably brings more supply to the market, leading prices to adjust to the downside. At that point miners rein in their supply and a new price equilibrium is set. The only exception to that model is if speculators believe, for some reason — perhaps due to marketing — that miners will never be able to satisfy demand in the future even with increased production today. In that case speculators end up paying too high a price for the commodity’s delivery in the future, which incentivises miners to keep producing regardless. These supplies, instead of being consumed, go into financialised hoards — kept safe for the eventual day that consumption demand returns. Like the biblical Joseph encouraging pharaoh to hoard during the seven years of plenty. With Bitcoin (and gold), however, there is never any potential for consumption. These coins can never be consumed, leaving them fit only for hoarding. Miners can also never produce more to respond to a demand shock, making them in some ways worse than the now-notoriously indisciplined Opec cartel. For Bitcoin, when prices go up, production discipline is maintained by the need to solve a statistical cryptogramme, whose difficulty increases as more players enter the game. If you happen to crack the code you get to benefit from the high price. If you don’t, you have to invest in more computer power so that the code can be cracked more quickly. Consequently, the perception of a shortage in the future is always maintained and prices continue to go up until the rush of speculative “retail” interest realises that there is more logic in learning how to mine than in competing for existing supply. When that happens, demand is diverted from speculative inflow to production — or perhaps even into forging a competitive system (like Litecoin, or Ripple) that compromises the monopoly. Either way, the inflection point creates a powerful incentive for more-established miners to cash out. It is greed and fear in its purest form. At that point, the dam holding back hoarded supply inevitably breaks, and the price has no choice but to correct lower. At least until a new Bitcoin cartel can be revived. Exactly the same mechanics apply to gold.
All that said, the phenomenon has had its uses. People are debating the nature of money and the economic system on an entirely new level. It has also taught us that the current e-money infrastructure must be lacking in some capacity. A better universal payments system on a digital level, though hopefully one underpinned by central bank digital currency and not new manifestations of gold in digital form, is what we should be striving for instead.
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Izabella Kaminska: Uberisation of the Economy: Gosplan 2.0.

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