Today Fred Wilson of AVC.com wrote about one of my favorite new topics in economics and money: Bitcoin.
As someone involved in the future of money and banking, I am asked almost every day what I think of Bitcoin and whether it could become mainstream.
There are three parts to the Bitcoin story in my opinion: modern money, ongoing global wealth and income growth and the potential collapse of modern money in favor of multiple competing digital currencies.
Inflationary currencies (fiat currencies) and their monetary systems like the US Dollar, Euro, etc, that we use today are basically a “carefully” managed house of cards. We build the house higher by printing more money. The house doesn’t collapse because there usually isn’t excess currency supply or excess investment leverage creating unnecessary risk – or needlessly weighing down the house. Modern fiat currencies maintain their strength of position by implicit legal contracts with our government to pay tax and other debt obligations. In other words, you can’t pay your taxes with your Google stock or sheep or even tulips. You have to sell these items for cash first and then use the cash to pay your taxes. Remove these legal restrictions and modern currencies have a real problem.
Ultimately the house of cards is kept alive via innovation and entrepreneurs who create value out of the new currency being printed and distributed through loans – not the other way around. Such innovations include farmers expanding using new plowing technologies, industrial innovation building a manufacturing base, the military industrial complex, innovation via Internet, information and communications technologies, and on and on. Sometimes this value is an illusion like in a housing or asset bubble. That’s when the public starts to feel that there is a manipulated game going on out there but they really can’t fully explain what’s going on. I also believe this is why a few of the people participating in Occupy Wall St sit-ins can’t really explain why they are so pissed off but still have a valid beef.
I believe that a carefully managed house of cards is the single best chance we have today for peace, democracy and happiness at a global scale as it incentivizes people to do their part to create new wealth and it (usually) incentivizes us to police people who try to game the system. This is part of why I’ve become so interested in behavioral economics the past few years. We need to continue to find new and better ways to incentivize each other to participate positively in this ongoing 225-year experiment in peace and democracy through capitalism.
As we saw in 2008 the house of cards is put at risk when excess leverage is introduced such that a small percentage loss that is followed by a margin call can cause the house of cards to buckle at the girders when the proverbial music stops playing.
Beyond the dangers of operating within a managed house of cards what are the real world problems with Fiat currencies that could create the need for a different model? The most cited problems have to do with government interference and individual liberty. Most notably those ideas espoused by Friedrich Hayek and Ludwig von Mises who helped to create a modern “Austrian School” of economic thought. If you watch Fox News or pay attention to Ron Paul you’ll get a good dose of the pop culture version of the Austrian School – my apologies for to those who really get the Austrian School for associating you with Fox News in this manner.
While the Austrian School’s philosophy is very appealing to me personally, we don’t live in that world today and I believe most people don’t want to live in that world.
My bigger concern is what is likely to happen to our current house of cards over the next 25, 50 and 100 years. First I believe that we’re witnessing a new form of wealth redistribution that is going to have very interesting effects on a global scale. With the exception of the top 0.1% of the global population who will have an exaggerated benefit of compounded interest via rich parents’ inheritance, the rest of the world is moving towards a state of economic equilibrium at an amazing rate. If you’ve ever watched one of Hans Rosling’s moving charts you know what I’m talking about. Think about Chinese migrants building iPods, Mexicans building homes and picking fruit, and Indians working oil fields on the Arabian Peninsula. (Note: “economic equilibrium is my term, not referring to any formal term taught in economics.”)
What happens to the house of cards when we reach something close to economic equilibrium on a global scale? I believe the system collapses sometime before we reach that point of equilibrium. Probably in about 75 years. By that point, Africa, China, India, South America and other Asian economies will be moving towards per person GDP parity with the US and Europe at an unsustainable rate and then the rate will start to slow. At that point managing a house of cards becomes difficult if not impossible, as our global interests in creating new growth will no longer be aligned. Individuals will be more interested in personal advancement and enlightenment as well as technological advancement and less interested in growing the global wealth and income pie. Of course this does create significant issues for wealth preservation which I’m not qualified to address here. Ultimately this could be the point at which our collectively disparate agendas will no longer allow us to effectively manage the house of cards.
This is where Bitcoin comes in.
At the point where momentum towards equilibrium is unstoppable, we probably have a viable global education system, a global trading system and machine-based innovation happening at an amazing rate. Thousands of self-organized meritocracies are likely to ensue based upon needs, wants and desires of individuals. Traditional organized religion will start to take a back seat to the needs and wants of these meritocracies. It is at this point I believe individual liberty needs to take preference over the needs of any state for the good of the human race and to ensure that we are appropriately incentivizing technologic progress. This is also the point at which fiat currencies and fractional reserve banking probably no longer make sense. This is the point at which anyone can create their own currency (re: asset) and these new assets can be easily represented digitally and traded electronically in real-time. There is no difference between stock exchanges, currency exchanges, Amazon.com or the IRS. Everything is just an asset and everything is fungible.
It’s easy to imagine lots of different groups issuing lots of different asset backed currencies similar to Bitcoin but with an underlying asset of value – such as intellectual property rights, physical property, art or other forms of content, gold, food, etc.
Today we don’t necessarily have well formed meritocracies throughout society but we do have some well-formed business and social circles.
One such business circle exists today operating mostly in isolation from the rest of the modern business world. Of course, that is the global drug trade. The drug trade is probably the number one individual contributor to Mexican GDP and is run by very smart, albeit ruthless, criminals. Another social and business circle is the millions of people who visit a Starbucks coffee shop every day, although I suppose that could be considered an extension of the drug trade – just kidding Starbucks. In both cases these business circles could benefit greatly from having their own underlying currency representing the assets they are selling – or trading.
In the case of Starbucks they have it already in the form of a Starbucks Card. People buy Starbucks Dollars on a 1-1 basis for real US Dollars but Starbucks Dollars are only fungible for Starbucks’ products. Great for Starbucks! The consumer benefit is mostly in the form of less stress around feeling like you’re spending $6 for a cup of coffee. There’s that pesky behavioral economics again.
In the case of the drug trade Bitcoin is clearly catching on, albeit slowly, as a form of alternate currency. If you know what Bitcoin is I don’t need to explain why consumers and traders of illicit drugs love Bitcoin. The more important point than our personal feelings on the global drug trading market is that this is the model that all social groups and meritocracies will utilize to conduct trade in the future. Many of my entrepreneur friends get this, which probably explains why they are such big fans of Hayek, von Mises, and their ilk.
Once we have lots of fungible digital currencies floating about a new problem is created. How do we normalize trade and transact across different digital asset types? Several computer programmers and mathematicians have actually solved this problem in the lab already. The e-Rights system could easily be used to trade Bitcoins for Goats and Goats for Starbucks Dollars. E-Rights are a form of Smart contracts originally proposed by the genius Nick Zsabo. Of course, the Bitcoin block chain could probably be used to simulate a lot of this as described here.
