“I’d feel a little stupid buying these things,” a dear friend of your editor’s recently remarked. “But that’s probably not, in and of itself, a bad thing. After all, I felt pretty stupid buying gold back when it was still $250 per ounce.”
Our friend was referring to a peer-to-peer (P2P) cybercrypto currency called bitcoin. What is bitcoin? How is it used? What are the risks? Let’s begin where all good non-Tarantino stories begin…at the beginning.
The demand for a totally free market currency arose, naturally, out of the dismal state of the current monetary environment, in which governments around the world systematically debase the value of their printed monies in order to pay for the various welfare-warfare states they promised but can’t possibly afford. The resulting inflation is sometimes referred to as a “sneaky tax,” one that silently, insidiously infiltrates the marketplace, with each freshly-inked dollar compromising the value and integrity of each and every currency unit already in circulation.
This is by no means a new phenomenon, as we remarked in this space last Friday:
“The history of centrally controlled monies is a history of theft, inflation and, eventually and invariably, defaults. From coin clippings during the Roman Empire through to debasement of German marks under the Weimar Republic…to hyperinflationary corruption of, in no particular order, Hungarian pengős…Zimbabwean dollars…Greek drachmai…Brazilian cruzeiros…Polish zlotych…Chinese yuan…Nicaraguan córdobas…US continentals…Peruvian soles…Angolan kwanzas…Russian rubles…Argentine pesos…
“…and the list goes on (and on…and on…).”
It is hardly a surprise, therefore, that after having labored under the state’s unquestionable, unchallengeable monopoly on counterfeiting, and enduring the capricious, inflationary whims of the central banker class, the free market would demand – and will eventually provide – a superior alternative.
At various times throughout history, this has meant chaining the Feds to a gold and/or bimetal standard. Alas, as we know too well thanks to the likes of FDR and Nixon, the temptation to inflate is matched only by politicians’ reliable tendency to make promises they can’t keep. And so, gold standards are frequently tossed out the window at moments of manufactured convenience, proving further that entrusting the state to maintain the integrity of its currency is about as effective as locking them in a cell and giving them the key.
The free market requires something better, something beyond the grasp of the state and its many and varied manipulators and do-good meddlers. So, what’s the solution? Again, from this space last week:
“Advocates of a small but fast-growing digital currency network called bitcoin think they’ve found the answer (or, at the very least, an answer). If it is successful, claim its adherents, this totally-decentralized, peer-to-peer (P2P) currency could supplant the world’s central bank-issued money, potentially providing savvy speculators with an opportunity to cash in on the greatest politically motivated market distortion of our time.”
Which brings us back to our original questions. First, what is bitcoin? An article that appeared on Yahoo! News this morning provides as good a definition as any (and a hint that the mainstream is catching on). Bitcoin is “a peer-to-peer system of electronic money that allows payments to be sent directly between two parties without the need for a financial institution.”
The currency also makes redundant the concept of a central bank, Federal Reserve or any other such easily corruptible nonsense institutions. For starters, bitcoins are not generated, but rather awarded to miners – individual computers participating in the network – as a reward for processing transactions and securing the bitcoin currency network, thus providing an entirely decentralized, highly competitive marketplace, much like the Internet itself. What’s more, the amount of bitcoins is strictly (mathematically) limited to 21 million coins. There are currently about 6.5 million coins in circulation and anywhere up to half a million dollars worth (at today’s exchange rate) changes hands daily. As more and more coins are mined, the difficulty (amount of CPU required to mine each coin) increases exponentially, ensuring a steady (though ultimately finite) supply.
As more and more vendors begin accepting bitcoins as form of payment for goods and services, the universe expands against the number of available coins in circulation, thereby driving the value of the currency ever higher. (When we mentioned bitcoin last Friday, it was trading for about B$1 = US$8. Today it hit B$1 = US$14.25.)
As you might expect, bitcoin has its fair share of skeptics; maybe even more than its fair share. Bitcoin has appreciated at an incredible rate since it “took hold” in the online community, especially over the past few months. One of the first ever transactions using bitcoin, according to the forums, involved a consumer who paid B$10,000 for a pizza online one year ago. Those same bitcoins are today worth about US$140,000. Not a bad tip for the delivery guy. Still, such phenomenal currency appreciation has led many to assert that bitcoins are in a “bubble.” And maybe they are…but not for the simple reason that they have appreciated against other currencies.
Value, as Ludwig von Mises described it, is not determined by the nature of objects themselves, but through our interactions with and appreciation for them. “Value is not intrinsic, it is not in things,” he wrote in Human Action. “It is within us; it is the way in which man reacts to the conditions of his environment.”
Is Google Inc., to take a real world example, in a bubble because it has more or less quintupled since IPOing in 2004? Or is it fairly priced at US$525 (or one third an ounce of gold…or B$37.5) because buyers and sellers of the stock agree, in this moment, that’s what it is worth?
Another cause for concern among bitcoin skeptics is that, as the economy of the free market currency expands it will inevitably begin posing a threat to the state’s own money-printing racket. It will, thereby, raise the ire of bankers and politicians who will have every incentive to make the currency illegal in order that they may protect their own monopoly and continue cheating their citizens of the value of their president-stamped notes and coins. Given the state’s nature when it comes to these matters (and here we refer readers to the recent and despicable case against Bernard von NotHaus) there is every reason to expect that it will indeed crack down…and hard.
Here we expect all the usual arguments from all the usual suspects: Bitcoin transactions are anonymous and therefore provide cover for peddlers of child pornography and drug traffickers, they will contend.
But the astute reader knows in his gut there is something very wrong with this line of thinking right from the beginning. Cash is anonymous too. People by things deemed illegal by the state with state-issued currency all the time. So what? Does this mean US dollars should be banned? Some people drive their cars recklessly, with little or no regard for their own safety or for others’. Should we ban cars?
The question, however, is not whether the Feds should do something (moral considerations have rarely, if ever, stopped them before), but whether they could do something, even if they wanted to…
Whether or not you agree with the organization itself, the WikiLeaks scandal did nothing if not expose the limited power of government when it comes to policing the cyber world. Presented with every motivation to “take down” the WikiLeaks site, the Feds went after them in typically cumbersome fashion. Within a few days of the attack on their site, 10,000 WikiLeaks mirror pages had sprung up around the world. Six months after the largest leak of sensitive, highly-classified and obviously embarrassing state documents found its way into the light of virtual day, the organization now has more followers and supporters than ever before. Go figure.
Your editor has no idea whether bitcoin is a great idea or simply a great scam. Maybe it’s both. And maybe it is in a bubble of epic proportions due to implode promptly at high noon tomorrow. And maybe the Feds can and will crush its rapidly expanding base of freely associating participants. Who knows?
In any case, the fact that the market has demonstrated the motivation and, arguably, the means to challenge state-sponsored currency manipulation is good news for freedom lovers everywhere. Bravo!
Joel Bowmanfor The Daily Reckoning
Joel Bowman is managing editor of The Daily Reckoning. After completing his degree in media communications and journalism in his home country of Australia, Joel moved to Baltimore to join the Agora Financial team. His keen interest in travel and macroeconomics first took him to New York where he regularly reported from Wall Street, and he now writes from and lives all over the world.
How is a free market currency created(where does it come from and who sets the quantity in teh system)?
What keeps you from creating more of it? Isnt it simply another for of a fiat currency?
J, your questions and more can be answered here:
Short answer, there is a limited supply. No, you can’t ‘copy’ coins. Unlike other fiat currencies, you can’t just print more to solve anything. The absolute number is capped at 21 million. Also, bitcoin is decentralized, which prevents misguided policies derailing the entire economy.
Hope that helped.
if elected accountable governments can’t help but inflate their currency, just how will anonymous bitcoin handlers avoid such temptation? “oh darn, I pushed the wrong button and suddenly there are twice as many bitcoins as before.”
and if we can’t control money we hold in our hand just how are we supposed to control bitcoins? “oh darn, the server is down again.”
and if counterfeiters can fake gold bars just how trustworthy are bitcoins? “what do you mean you didn’t send me 100 bitcoins?”
and if hackers hack dod, twitter, and facebook just for fun, how long will it take them to hack bitcoins?
@J @gman: These comments are stemming from a fundamental lack of understanding of how Bitcoin works. The supply can’t arbitrarily be increased because the software running on *each and every user’s* machine would refuse to accept a rogue attempt to create Bitcoins out of thin air (in excess of the prescribed rate of awarding new Bitcoins to miners who expend considerable physical resources (hardware, electricity) to secure the Bitcoin transaction history). It’s like if a bunch of kids in a clubhouse were collectively keeping track of how much soda pop each kid has bought for the group and one kid proclaimed he’d contributed twice as much as he really had, all the other kids would be like, “um, no you haven’t.” Bitcoin is democracy applied to currency. The only way to forge an entry in the global “ledger” would be to control more than half of all the computing power in the Bitcoin network, and at this point, that would be financially infeasible for all but the wealthiest entities (e.g., Google could do it, as could the NSA, and that’s a real concern, but eventually, as more and more people join the network, even those entities will be powerless to become a majority).
It’s a computer program,,, like all others it can be hacked. It’s open source so that may make it easier. Government will either make it illegal to use or hack the system to death.
Eliminate the Fed,,, get the rogues out of the rogue governments, it may have a chance.
Wouldn’t count on it though…
@kenn: A hacker could rewrite portions of the Bitcoin code, but he could only run the hacked version of the software on computers that he himself controlled. And if he hacked the software in a way intended to give him more bitcoins or to let him spend them more than once, the rest of the (unhacked) copies of the software running on the network would reject his transactions.
To put it simply, in order for a Bitcoin transaction to be “confirmed,” a majority of the computers in the Bitcoin peer-to-peer network have to agree that the transaction is legitimate (not fraudulent). If the transaction doesn’t satisfy all of the rules that the software enforces (like maybe it’s an attempted double-spend or it conjures money out of nowhere), all the unhacked machines (which are checking all the rules) will ignore it, and it will never be confirmed. The few hacked machines (which are ignoring some or all of the rules) will not have a majority say in whether the transactions are valid.
Real money is gold or silver. Fake money is everything else.
Keep on keepin’ on. Well done and well said.
BTW – I haven’t personally de-constructed the BitCoin algorithm. Anyone planning to invest in it should probably be very familiar with the Poisson distribution before doing so.
P2P money is between us; we’d better get used to it. Even if governments somehow manage to kill Bitcoin, they can’t kill the idea of P2P money. So far they haven’t been able to stop P2P sharing of music and movies (In fact, each attack reveals governments’ fundamental weaknesses, and seems to stimulate the growth and safety of such networks.)
oh. bitcoin is guarded and secured by software. I guess it’s safe then.
good luck with that.
Bennet Cecil said: “Real money is gold or silver. Fake money is everything else.”
Why? After all, money is a tool – a very important one, granted, but just a tool: Gold is a better tool than fiat currency backed by violence; and bitcoin (or any of its descendants) might be a better tool than gold. Why not? After all, the use of gold has also been, in the distant past, a novel idea.
Gman said: “oh. bitcoin is guarded and secured by software. I guess it’s safe then. good luck with that”
Well, good luck with money guarded and secured by governments, or any third party susceptible to government intervention. And good luck carrying your gold coins through the border.
as far as the algorythm security goes, its pretty much pure genius. it relies on very strong hash and public key functions that are considered pretty much unbreakable today. from what i can see bitcoin is more secure than banks. firstly the code is open and free and during last two years thousands have reviewed it and so far nobody has found a successful attack vector(banks get infiltrated all the time). secondly unlike a bank, there is no physical attack vector. you cant just dress up as a repairsman and walk into serverroom where all is controlled from and you cant hold a gun onto someones head and tell them to hand over others peoples money. i have no idea if bitcoin will be an economic and social success but it already is a technical sucess.
at the moment combined value of all bitcoins in circulation is ~107 963 520 USD, thats worth something, right?
(6.4MBTC at 16.8USD/BTC)
Nobody seems to realize that EVEN gold/silver BACKED Currency ALWAYS Fails too!!
Only gold/silver are real money – not even “backed” notes/bills.
It looks as though if bit coins can be created many other forms of “bit coins” can and will be created and soon cyber “money” will be so confusing to everyone they will be forced to throw their hands up in surrender. Then of course there will be ads on TV touting their form of “money” and how really smart people invest in their “money”. Sound familiar?
You can keep your cyber money. I would rather own a gold or silver coin.
what’s really funny is that .9 of all dollars existing now are already cyber-money. the quantity is tightly regulated, tracked, audited, and controlled, and never increases.
unless tptb want it to.
“They stumble over such concepts as bitcoin.”
and those with the geek/hacker frame of mind tend to stumble over such concepts as “people”. really.
bitcoins sounds like a cool toy for the in crowd. it might even be a useful tool for certain circumstances, such as company scrip for use in the company store or as military money for use in the px. but as general purpose go-everywhere money? not a chance. as soon as anyone tries to move it into that role it will be co-opted, because there will be enormous motive for people to do so. bitcoins is not a solution to the problem of money because the problem isn’t with the money. it is with us. we ourselves are the problem. and the only solution to that problem is christ.
DaveGillie said: “Only gold/silver are real money – not even “backed” notes/bills.”
There is no such thing as real money. There is good money and bad money in a given context. Cigarettes can be the best money available.
Nothing more than a highly secure, highly verifiable box with nothing in it … no commodity backing it.
What makes a good currency? Aristotle said durable, portable, divisible and have intrinsic value.
Bitcoins are certainly divisible, but they are only durable and portable so long as we have electricity and computers and networks etc. Any of this can be disrupted (viruses, natural disaster, cyber attacks). Gold coins don’t need any of this.
This brings us to intrinsic value. They have none. If bitcoins were backed by something tangible, we’d have something.
It’s a good thing understanding of economics has advanced since Aristotle.
David X said: “Bitcoins are certainly divisible, but they are only durable and portable so long as we have electricity and computers and networks etc. Any of this can be disrupted (viruses, natural disaster, cyber attacks). Gold coins don’t need any of this.”
You should add: a natural disaster that shuts down every internet connection and destroys every computer connected to the Internet. In that case, you will not be around to enjoy your gold coins.
With regard cyber attacks, I quote R2K-in-the-vortex:
“As far as the algorythm security goes, its pretty much pure genius. it relies on very strong hash and public key functions that are considered pretty much unbreakable today. from what i can see bitcoin is more secure than banks. firstly the code is open and free and during last two years thousands have reviewed it and so far nobody has found a successful attack vector(banks get infiltrated all the time). secondly unlike a bank, there is no physical attack vector. you cant just dress up as a repairsman and walk into serverroom where all is controlled from and you cant hold a gun onto someones head and tell them to hand over others peoples money. i have no idea if bitcoin will be an economic and social success but it already is a technical sucess.”
In addition to this, the more successful the system, the safer it becomes (bitcoin mining is not the same as gold mining).
Soooooo….Does a 2Bit Ho still get her 2Bits??? Just sayin’
I have read ZH for years, never posted till now. I have and will ALWAYS own gold and silver coins as “real” money. I have read Von Mises, Rothbard et al. I am an austrian, but make these words and mark them well, Bitcoins are going to be HUGE and I mean kick yourself for not buying a measly $500 worth Huge, that is all.
PS thanks to all the ZH posters over the years from the bottom of my heart, Thanks.
Sorry I mean DR, although i do read ZH too! lol
Hackers will overcome any security even if it is a distributed architecture. It is foolish to claim that something computer-based is safe from such attacks.
Of all the companies that have claimed their software is safe from hacking EVERY ONE has been hacked. There have been no exceptions.
Please do not claim BitCoin is somehow different from all the rest and that it will be the one exception. The system itself may work but it WILL be compromised at some point.
DrNybble said: “Hackers will overcome any security even if it is a distributed architecture. It is foolish to claim that something computer-based is safe from such attacks.”
Your electronic wallet may not be safe, if you don’t take care of it. But don’t worry about the network: Today, five hundred of the most powerful supercomputers, all working together, would not be enough to somehow fool the system (we’re not talking about destroying the system, but perhaps to make a dishonest transaction.) Within a year, even that will be mathematically impossible.
I still don’t understand how bitcoin works or even know what it is. I read articles saying it’s just like gold but my understanding is it’s not a tangible asset like gold. In other words it’s made out of electric current going through a wire and you need a capacitor to store it and hopefully the capacitor doesn’t slowly loss power because a capacitor is a battery.
Marcelo y Mariana said:
“You should add: a natural disaster that shuts down every internet connection and destroys every computer connected to the Internet. In that case, you will not be around to enjoy your gold coins.”
I don’t know what you mean by this…are you implying that if electricity goes out it’s the end of the world? I wonder how the people live before electricity.
After a mass extinction, a sharp rock will be more valuable than a gold bar.
“I don’t know what you mean by this…are you implying that if electricity goes out it’s the end of the world? I wonder how the people live before electricity.”
If all electricity worldwide went out, for an indefinite period.
Yeah, I would say that most people alive would not live long at all.
The third world would fair far better then the rest of us.
me and my friends are setting up a Groupon-like market place for the Bitcoin community.
If you’re interested please visit:
It’s true that government is a terrible institution, but in the United States, the problem of irresponsible politicians wrecking our finances has been solved! That’s because the Secretary of the Treasury, the president’s economic advisers and all key financial officials are controlled by Goldman Sachs, which is a private company and therefore offers the best guarantee of a prosperous fyootch!~ Our troubles are over. Thank you, Goldman!
can see bitcoin is more secure than banks. firstly the code is open and free and during last two years thousands have reviewed it and so far nobody has found a successful attack vector(banks get infiltrated all the time). secondly unlike a bank, there is no physical attack vector. you cant just dress up as a repairsman and walk into serverroom where all is controlled from and you cant hold a gun onto someones head and tell them to hand over others peoples money.
Read more: An Emerging Free Market Currency http://dailyreckoning.com/an-emerging-free-market-currency/#ixzz1SHWMNUvO
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