By Shane Hadden, CFA, CBP
In a July 31st New York Times editorial, Paul Krugman asked for an answer to the question “What problem does cryptocurrency solve?” As of August 31st there were no satisfactory answers among the 365 comments posted on the NYT website. I would like to answer this question and also respectfully comment on several of the points made in this editorial.
The problem is that people are not able to hold their own money - they are required to put their money in a bank. In other words, banks have a monopoly on the custody/control of money. This is a relatively new problem. When money was in physical form and transactions were mostly local, people could easily avoid giving their money to a bank. But now that money is primarily digital, most commerce is impossible without using banks. This point is likely not in dispute.
The real question is, “Is it a problem that people are required to put their money in a bank?” If yes, then bitcoin clearly solves a problem, because bitcoin is digital money that can be held outside of a bank.
Here are four reasons why monopoly banking is a problem:
Credit risk: Banks create credit risk. If you hold your money yourself, there is no credit risk. When you give it to a bank, you become at risk to the bank defaulting. To reduce this risk, you pay tax to the government to guarantee the bank’s credit. The bank then lends your money to other banks, creating a complicated web of credit risk that can lead to cascading defaults. People should have the option to avoid this risk.
Competition: Monopolies stymie innovation. Competition from decentralized software currencies would make banks better. Monopolies should only be protected by the government in extreme circumstances. What critical service do banks provide that needs monopoly protection - surveillance, credit provision, monetary policy? The government could accomplish each of these services without the protection of banks as a monopoly.
Property Rights: Government has far greater control over our money than any other form of property. Is this an overreach that will be corrected? Hopefully. What if we had to give control of other property to government agents like we do with money? For example, what if our guns and medicine had remote on/off switches held by the government? This is easy to do with technology and arguably would serve critical functions that can’t be accomplished otherwise. Is this where we are headed?
Consumer Protection: The best way to protect consumers from banks is to not require that consumers put their money in banks in the first place. If the government requires a person to develop a business relationship with banks, the government is exposing that person to well documented predatory behavior, such as fake accounts, usury and manipulated fees. Shouldn’t consumers have a choice?
Financial prudence, competition, property rights, consumer protection – these are all values that Americans hold dear. Why are we seemingly not aware that these values are all being violated in a massive way with monopoly banking? Why do people not think that this is a problem?
I’ll use one of Paul Krugram’s statements to answer this question: Dr. Krugman says: “Using a bank account means trusting a bank, but by and large banks justify that trust, far more so than the firms that hold cryptocurrency tokens.”
Use doesn’t mean trust – The first part of this statement illuminates a large part of the problem. Using a bank account does not mean trusting a bank. We use banks because we are required to, not because we trust them. Maybe this is a version of Stockholm syndrome - we are captive to banks, so we think we trust them. Granted that we may trust banks because of the governmental guarantee that we pay for, but even if we didn’t trust them, we would still have to use them.
“By and large” – This is a big qualifier. If any person does not trust a bank, should the government nevertheless require that person to place their savings with a bank? Without making any inference about Dr. Krugman’s view, this is a common conceit of wealthy people. Most people in the U.S. (not the developing world) live paycheck to paycheck. They should not be forced to place their precious cash with anyone they do not trust.
Misdirection – Dr. Krugman compares banks to “the firms that hold cryptocurrency tokens.” I’m sure this is not intentional, but this comparison is not appropriate. It is not necessary for any entity to hold a person’s bitcoin. That is the whole point of bitcoin. It is why bitcoin was invented. This statement alludes to exchanges that have been hacked. It serves to prevent people from questioning banks. The constant association of bitcoin with criminal activity also scares people away. This is particularly sad because the people with limited funds who need a banking alternative the most are likely to be the ones who have no capacity to risk being associated with anything that society views as suspect. Hopefully this type of misdirection stops soon so that a healthy debate can begin.
Lack of evidence/wrong question - Lastly, one can observe why we don’t question banks by how Dr. Krugman frames the question and the evidence he uses. He basically says banks are OK because most people trust them. That is not the question we should be asking. The relevant questions are about choice on the one hand and monopoly justification on the other.
Regarding choice, we need to ask people questions like: Would you like to be able to choose whether you lend your money to other people? Would you like to be able to choose whether to custody your money yourself or pay someone else to do it? Would you like to be able to choose whether to control your money yourself of put someone else in control, in which case you may not have access to your money when you need it?
Regarding monopoly justification, we need to ask experts questions like: Is a bank monopoly required to perform transaction surveillance? Is a bank monopoly required to manage the provision of credit? Is a bank monopoly required to achieve monetary policy goals?
History – Possibly the main reason that many people don’t frame the question in different ways is that it simply does not occur to them. The banking system’s monopoly on money control did not come about by debate. When money evolved from physical to digital form banks were the only means of holding money as a technological matter. It started as a technological monopoly, so questioning it was a waste of time unless you could solve the technological problem. Now, however, that problem has been solved by bitcoin. Now the monopoly is not technological, it is government supported. Because of this we need to have the debate. The banks now have the benefit of 40 years or so of social programming, but we need to break through this.
In sum, to answer Dr. Krugman’s question – the problem bitcoin solves is it makes it possible for people to hold on to their hard-earned money without giving it to a bank. The burden should now be on the banks and the government to explain why they think the banking monopoly should be preserved.
Comments on Dr. Krugman’s other points
Dr. Krugman refers to high transaction costs and a lack of tethering in relation to bitcoin. As with other statements in the editorial, it is a matter of perspective.
High transaction costs: Dr. Krugman says: “[C]ryptocurrency enthusiasts are effectively celebrating the use of cutting-edge technology to set the monetary system back 300 years.” His point is that fiat currencies and their synthetic variations dramatically improved money relative to gold, because gold could not actually be used for transactions as a practical matter. This is true. What is not true is that bitcoin’s innovation is setting the world back to reliance on something similar to gold.
The flaw in Dr. Klugman’s logic is comparing bitcoin to gold. Gold is not a viable currency in the modern day economy. In contrast, bitcoin can be a very good currency in its mature form (when volatility falls). Bitcoin is the first decentralized currency that can be transacted long distances quickly and cheaply.
An alternative view of the evolution of money is as follows: Gold was improved upon by fiat and its synthetic variations. The cost of this transition was the cost of centralization and bank monolopies (see above). Bitcoin is now improving money another step by going back to a decentralized currency (like gold) but in usable form.
As far as the cost of this current transition from pure fiat to a bitcoin-based monetary system, this is to be determined. Bitcoin transactions are expensive to validate, but what are the savings of transitioning away from bank monopolies? Until we look at both sides of this equation, it is not appropriate to say that bitcoin is too expensive.
In comparing the costs of a government-only based monetary system to a bitcoin-based system with government overlays, many of the current misconceptions about bitcoin usage must be corrected. For example, transaction speeds will not be slower in a bitcoin-based system because every payment system that exists today can also exist in a new system, either off-chain or in note form. Also, volatility will be reduced by a bitcoin-based system because only creditworthy entities will have the power to manipulate supply. Bitcoin’s current price volatility is not relevant when designing a bitcoin-based system that will have the benefit at maturity of broad adoption and governmental support.
Dr. Krugman says that bitcoin is not “tethered” to anything. He says that currencies like the dollar have dependable value because they are backed by the government’s ability to tax. He states: “If you like, fiat currencies have underlying value because men with guns say they do.”
The point is that currency has value if people need to acquire it, they’ll need to acquire it if merchants accept it, and the government is both a large merchant (taxes, Treasurys, etc.) and they can require other merchants to accept their currency – ultimately with guns. This is a pragmatic and accurate explanation of why most fiat currencies have dependable value. However, this is a nationalistic view and there is at least a reasonable globalist view that would also create “tethering.”
Unlike this nationalistic view, a globalist view would consider that at a maximum of only 18.4% of the people in the world live in any one country (China). Each of these minority groups have their own country’s guns to depend on for the value of their national currency, but 100% of the people in the world are on the other side of some other country’s guns. Everyone in the world is driven by competition, opportunity and threat. Everyone is at least potentially more loyal to their local or global family than any one country. So, if bitcoin is viewed by the market to represent these global bonds, either as aspiration or refuge, then I would say that it is certainly “tethered” to something very real and possibly more powerful than any country’s guns. This may sound sentimental, but it’s ultimately up to the markets to decide, and a lot of people think this way.
I hope that Dr. Krugman and people with similar views will consider the important purpose of bitcoin explained here. I also hope that they will consider the impact that their words have on the actions of people who are vulnerable. We should not be scaring people away from bitcoin - we should be empowering people to be skeptical of our existing institutions and working to improve the monetary system for everyone.
For a summary of our project to create a bitcoin-backed global monetary system, please see here.
For inquiries, please contact Shane Hadden at email@example.com.