So, I came across this article this morning: Bitcoin is going to teach you a lesson. A costly one. First, there is something of a rant that should be stated here: a tech writer does not make a good person to comment on Bitcoin. It is true that Bitcoin is a technology based innovation. Yes, it is true that Bitcoin is based on software, and that software runs on computers, and that these systems are connective via the internet. But, those factors alone do not make Bitcoin something that should be analyzed by someone in technology. If the person that is doing the analysis has some real background in understanding the global financial systems and market based economics, then it might be more appropriate. But someone who has a passing interested in monetary items, and works in technology is just not the correct person to write about this. Especially when it should have been obvious to the editors of ZDnet that Ken Hess has a major mis-understanding of economics that even I can see because he states it very bluntly, he even gives examples of his mis-understanding. And I am not an expert in economics or financials systems. End of mini-rant.
I was astonished by the ignorance on display in this article. The core of the ignorance in the article appears to come from the author’s own misguided attempt at establishing a currency. Let me quote the central mis-understanding of a currency from his own failing:
Here’s the problem with fake currencies. Aside from having no actual value, they have no tangible exchange rate. The theory behind barter dollars was that you have to set a standard value on labor, which at the time, it was suggested that we use $40/hour.
And that is the core of his mis-understanding. He seems to feel that a currency has to incorporate the exchange rate for the currency. He, in fact, states the need to have some external factor that provides some “value” to the currency:
You see, for a currency to work, it has to have some external value. Digital currency, no matter how cute it is, or how you spin it, it has no value. It’s a silly concept but someone always tries it.
This is where he is wrong. He is correct in pointing out that the U.S. used to have the gold standard, and that when we went off the gold standard the value of our currency dropped. It has, of course in the many decades that have followed, recovered a fair amount of that value.
If, in fact, there wasn’t any value in our currency because it isn’t backed by some external factor, then it never would have recovered its value. But it did recover, so why did it recover?
Simply this: consensus. There is a market based consensus that the U.S. currency has value. Guess what the value of Bitcoin is based on? Market based consensus of value.
The author goes on to try to make other points about using digital currencies. For example, he states: “The other reason why fake currencies fail is that you create a false sub economy with them.”
No one can claim that Bitcoin is creating a “sub economy”. If anything, the vendors that are dealing in Bitcoin are very clear on using it as intended: a store of value for exchange. Their pricing is typically based on the market value of Bitcoin relative to another currency. I wish this weren’t true, I wish that Bitcoin was stable enough to not be seen in relation to an external currency. But, as it stands now, the market is based on consensus value relative to other currencies. No “sub economy” is involved.
So, that’s two strikes… Do we have a third? Of course…
There’s this ridiculous statement: “The good and services exchanged don’t get taxed and while you might think that’s a good thing, let me tell you that it’s not.”
Nope. Not by a long shot. The Bitcoin FAQ is clear on this, as the author even points out: “Bitcoin is not a fiat currency with legal tender status in any jurisdiction, but often tax liability accrues regardless of the medium used. There is a wide variety of legislation in many different jurisdictions which could cause income, sales, payroll, capital gains, or some other form of tax liability to arise with Bitcoin.”
In other words: because Bitcoin is de-centralized, and has no central authority there is no way to enforce taxation legislation. This pushes the responsibility for handling taxation out to the ends of the transaction chain. That is, taxes must be handled by vendors, merchants and customers instead of through some form of central authority.
And, there is still another extremely stupid statement in Ken Hess’s article: “…the evil Bitcoin overlords are limiting the number of Bitcoins to 21 million. Weird.”
The things that are stupid about this statement are many. First, there are no “evil Bitcoin overlords”. Again: Bitcoin is a de-centralized currency with no single authority. It is based on software.
And, the “…limiting the number of Bitcoins to 21 million.” is not something that is “dumb” as he states. It is a fact, and it is a property. Software has properties that define it’s operation and it’s scope. The cryptographic algorithms that control Bitcoin have been set up to have this property. That’s it. End of story.
I think he doesn’t understand the fact that each Bitcoin is divisible up to 100,000,000 times. This means, effectively, there are (or will be) a total of 2.1 Quadrillion units of currency available. If he doesn’t like that restraint, Litecoin will have 8.4 Quadrillion units of currency.
For what it’s worth, this property can be seen (in a somewhat limited manner) as being analogous to having a backed currency. When we were on the gold standard, it was a known property, and built into it was a limitation: there is only X amount of gold in the world. By having a currency based on a limitation of a resource there is a fixture of value. Bitcoin being limited by the number of coins in circulation provides a similar fixed nature to the currency.
However, I have stated before that I see an issue or a flaw with this concept. It is possible to remove coins from circulation. When a coin is removed from circulation, it is impossible to remove it, and issue a new coin in its place. That could, potentially, lead to inflation through the reduction of circulation.
Some might even argue that the Silk Road bust is part of the current rise in the value of Bitcoin. (Not to mention several other factors, including China’s interest in the currency.) But speculation of that nature is hard to prove, or disprove.
Personally, I do see this as a flaw in the scheme of Bitcoin and Litecoin. I think that it would be more advantageous to have a mechanism to allow marking “dead” coins. IE, coins that are removed from circulation lose their value and can no longer be traded.
Once a coin was marked as dead, it would re-enter the mining pool to be re-issued as the miners produce more coins. This would ensure that there is always a fixed pool of 21 Million Coins, in the case of Bitcoin, and 84 Million Coins in the case of Litecoin. It will be much easier to have an economy based on a currency with a fixed number of units, than one in which the pool of currency units can arbitrarily be decreased with no accounting mechanism for detecting removed units. (I have to admit that I do not know how this is accounted for in any other currency system, I would love to hear more about this. I know that in the U.S. the Secret Service is responsible for dealing with currency crimes, but I don’t know if that means they have a link to the Fed, or if there are similar law enforcement / currency relations in other countries.)
Update: It was pointed out to me by Greg Cook on G+ that overall the purchasing power of the US dollar has been on decline over the past 100 years: The Decrease in Purchasing Power of the U.S. Dollar Since 1900. My thoughts on what I wrote were more on a global scale, rather than looking at the dollar within in the U.S. economy. However, I would easily concede that inflation, increase in currency available, shifting markets, and other factors have weakened the purchasing power of the dollar.
Update #2: Chad Kemp pointed out that I had the units wrong. It’s really 2.1 Quadrillion instead of 2.1 Trillion (and 8.4 Quadrillion instead of Trillion). Fixed in the main body of the text.
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Bitcoin Teaching Inept Tech Writer Costly Lesson by SndChaser, unless otherwise expressly stated, is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 Unported License.