Much has been made in the last few months about Bitcoin lacking “Intrinsic Value”. Furthermore, with the whole Mt. Gox debacle, many wonder about the “Honesty” inherent in Bitcoin.
I would like to address both issues, and illustrate a future that is coming. A set of changes that are coming down on the financial systems of the world that are going to radically change how finance is done. Change is coming to government. To business.
The change is Honesty.
Why are Central Banks Dishonest? Why can’t Gold Fix the System?
I first started thinking and talking about the fundamental link between cryptocurrencies and honesty while at the Freedom Summit a few weeks ago. But I have been railing about the dishonesty of “backed” currencies for years. Many call for an Audit of the Federal Reserve. But the truth is, none of the hundreds of thousands of companies that hold parts of the current money processing, financial asset management, and banking systems are open for audit by the public. They are all closed systems. They are exclusionary.
Some keep pushing the idea of going back to a Gold Standard. This requires some combination of:
1. Minting bold coins
2. Issuing certificates from some trusted third party (the Federal Reserve?) to back those certificates with gold.
3. Transactions between individuals requires the use of many third parties. These third parties must be trusted to maintain the balance of obligations (in gold), despite the fact the individuals transacting rarely know exactly who the third parties are, and certainly the individual has no right to audit those third parties.
And number 3 in that list is critical in a modern world where Internet based transactions (both domestic and international) are critical. And number 3 is based on number 2, the management of certificates of Gold held in vaults.
Gold is supposed to be honest. You have a fungible, mostly indestructible, valuable, and portable thing, gold, that you can use as a measure of value. Instead of pricing goods in a range of commodities, everyone can price their goods in gold. In other words, if you exchange an ounce of Gold for a HD TV, you have a pure and honest exchange of value for value.
The problem to day is that, even if gold would be great at a physical store, it isn’t good as a direct component of most transactions.
Transactions that trust third parties that cannot be audited and verified at the time of the transactions allow for dishonest.
A system that allows dishonesty, and even encourages dishonesty, is dishonest.
Under a gold standard, we suddenly and immediately find that the implementation is dishonest. Gold may be honest, but transactions in gold that necessarily require representations of gold by Transactions are not provably honest. A system that allows for dishonesty is itself dishonest.
To be clear: When a certificate (like a gold backed dollar) is exchanged for a product, you are not trading value for value. Because no certificate has no intrinsic value. No promise has intrinsic value. They only have value to the extent that the backing organization is trustworthy. Only the gold behind a promise for gold has value, and the user has no way of auditing in real time if that promise is good.
And History shows that these promises for value are always abused when the system of promises comes under strain. As it does in a war, or a severe economic stress.
Note that the same problem occurs with dollars, yen, euros, pounds, yuan, and all the other legacy currencies that underlie the legacy central banks. These institutions collect gold, silver, and other currencies and store them in vaults to use to protect the value of the notes (dollars, yen, euros, pounds, yuan, etc.) that they issue. And when the people ask for an audit of these institutions, the central banks refuse.
Anyone would be a fool to trust a system that will not be audited,
What is Honesty? How can an Honest System be Created?
So what is honesty in money really?
Honesty in money occurs when every exchange of value for value in an economic system is a true exchange of value. When the money exchanged between parties truly represents a noted economic value, not a promise to provide an economic value.
The exchange of value for value in an honest economic system cannot depend on third parties.
With Bitcoin, the model is different than any monetary system prior. It is truly something new.
The Bitcoin blockchain represents a public ledger of transactions that record all the transactions over time. Miners look for very difficult solutions to a math problem that involve all the new transactions to be entered into the blockchain, (as well as all previous transactions). Using all the computers world wide looking for a solution, the problem is so difficult that a solution is only found every 10 minutes. That becomes the next block in the chain. Then more transactions are validated, a new block is created chained to the previous block, and another solution is sought.
Think of the blockchain as Matryoshka (nesting) dolls.
"Photo: Lachlan Fearnley"
A set of transactions are locked down with a hard to compute, but easy to check solution. Then placed in with the transactions of the next block, and another lock is added. Then another, and another.
In the end, nobody can change the ledger without breaking every lock that was added after the transaction was included. If anyone does change the ledger, they break that block’s solution and every soloution following. And since these locks currently require over 30 Peta hashes (in M a second to compute a lock every 10 minutes, there is no way to change a transaction in the past and reconstruct all the following broken locks without involving an utterly massive amount of computing power.
A lot of words to say that transactions posted to the blockchain cannot be altered. Cannot be hidden. Cannot be removed. Cannot be added.
The past history of the ledger is thus fixed and secured. Every node in the network can validate the blockchain. As long as one copy of the blockchain exists. Because it is frankly just too hard to build a fake.
Honest Money doesn’t Track Intrinsic Value. Honest Money Tracks Economic Events
Bitcoin can only be acquired one of these ways:
*Receive Bitcoin as a Gift
*Buy some Bitcoin
*Receive Bitcoin as payment for goods/services/labor
*Earn a block reward through mining
All of these are economic events. The practice of giving gifts goes back to the far reaches of history. Buying Bitcoin is nothing more than a currency exchange. Again, quite historical economic activity. Receiving payment for goods, services, and labor is nothing new.
The award for mining is nothing more than validating transactions, and successfully logging them in a ledger. This is also legitimate economic activity. The maintenance of ledgers of accounts goes back to the earliest writings. Today, billions and billions of dollars each year are paid to banks, payment processors, and transaction processors to do this task in the existing payment systems.
But this is where Bitcoin and the current existing financial systems part ways. In the Bitcoin ecosystem, each transaction involves Bitcoin in exchange in one of these four activities. Because Bitcoin is easier to transact and faster than the legacy systems, individuals using Bitcoin in the economy are really using Bitcoin. Not a representation or promise of Bitcoin.
If we consider the economy to be a game (businesses compete, they win markets, they lose market share, they make plays for customers, the study and execute strategies based on game theory, etc.), then the question is how do they keep score? Who is “ahead?” Who is “behind?” The answer is money, and those things that can be priced in money. If a company is winning, they are putting up big scores in their bank accounts, and valuable things into their control If a company is losing, their bank account and portfolio of assets shows their losing score.
Scores in Actual Games
Teams in sports across the globe spend billions and billions to secure scores in their games.
Scores have intrinsic value. They directly represent the quality of a team playing by a fixed set of rules.
A score does not need to be backed by gold, or sliver, or have the government’s support, or a central bank. Scores have value because:
*Each score represents an achievement on the field of play
*Scores are auditable in real time by everyone paying attention
*Bad calls that result in scores not reflected by achievement on the field are bitterly protested.
*Scores are defined by a set of rules, available to the players and and to the fans
We do not insist on scores being backed by “intrinsic value” because there is a one to one relationship between events on the field of play and the score. Its value comes from the events the score represents.
Bitcoin does this. It keeps score on the economic playing field. Your Bitcoin balance is the bitcoin you control on the blockchain. Any Bitcoin you own comes from some economic activity. Even Bitcoin thefts are economic events, since for all recorded history we know that theft is (sadly) a common economic reality, just like bad calls in sporting events are a sporting reality.
Bitcoin cannot be counterfeited. It cannot be printed off arbitrarily and provided at discounted rates to banks and financial institutions. Transactions are natively in Bitcoin, so fractional reserve banking is much harder (not impossible, but harder) to do.
This is honesty in transactions.
What about Mt. Gox? Mt. Gox is an illustration of what is wrong with our current financial system. They accepted dollars and Bitcoin from their customers, then managed a ledger of accounts that could not be audited. They did not document their Bitcoin resources on the blockchain.
Frankly Mt. Gox represents the current banking system. Technologies are advancing to provide openness in transaction servers, security of assets managed (but not controlled) by institutions providing banking, investment, exchange services, etc.
But these companies and technologies are developing, not deployed. Until they are deployed, we risk failures like Mt. Gox. But do not be fooled by the press over Mt. Gox! The US has seen 495 bank failures since 2008. (http://en.wikipedia.org/wiki/List_of_bank_failures_in_the_United_States_(2008%E2%80%93present)) And the failure of a bank represents a cost that is distributed across all of us.
Bitcoin represents an entirely new way to manage money. It is faster, and it can be made more secure. You could say that Bitcoin is distributed, autonomous, cryptographically secured, programmable money.
Or you could just say Bitcoin is Honest.