The problem bitcoin solves. Response to Paul Krugman.

By Shane Hadden, CFA, CBP

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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. 

Tethering: 

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 shane@globalcurrencyreport.com.  

 

 

 

Framework for a bitcoin-based global monetary system

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The Global Currency Report is developing a comprehensive framework for building a new global monetary system based on bitcoin or other decentralized software currency. Provided here is a list of the core principles as well as our initial thoughts on the system design and transition. 

For background on the motivation of this new system, see our previous posts, especially:  Bitcoin banking - everything will change, no deposits neededThe market will create a decentralized currency and Bitcoin notes will deliver bitcoin to the world. 

Core Principles

Design of the new monetary system should be driven by the following core principles:  

Competition: Foster competition between currency issuers and between banks and alternative custodial methods. 

Stability:  Include mechanisms to stabilize the value of currencies and manage operational risks.       

Property Rights:  Promote every individual's ability to control his or her digital money directly.   

Growth:  Reduce transaction costs and promote global economic integration.  

Individual Protection: Protect individuals from economic harm caused by profligate governments and predatory financial institutions. 

Flexibility:  Facilitate the issuance of currencies that reflect the unique needs of issuer and users.   

Security: Include mechanisms to address local and systemic security threats.  

System Design

The new system is comprised of three components: a Base Currency, Note Issuers and Collaboration. 

Base Currency

The market selects a decentralized software currency to serve as the Base Currency for the new system. There are three critical features of this Base Currency:

1) Decentralized:  It must not be feasible for any small group or organization to control the Base Currency. Software changes should be adopted based on super-majority, voluntary consensus. 

2) Good user experience:  The Base Currency must have a user friendly interface such that individuals are able to easily control their money directly without any form of third party intermediation. It is not necessary that the Base Currency have all of the features of a centralized currency, but it must be a viable payment option. 

3) Global:  The Base Currency must be accepted by merchants throughout the world. 

Note Issuers

It is expected that most transactions will be conducted in Notes that are exchangeable into the Base Currency, rather than in the Base Currency itself. 

Any creditworthy entity, public or private, can issue a Note in this system. The features of the Notes are driven by market demand and the objectives of the issuers. 

Governmental bodies issue Notes to replace existing fiat currency. The primary objective of these Notes is to promote a healthy economy within the governmental region. These issuers will maintain a stable price for the currency by adjusting the supply of the Notes. Highly creditworthy countries will be able to hold less than 100% reserves of the Base Currency. These Notes could include features to serve other governmental purposes, such as identity, taxation or voting.   

Private entities issue Notes as a marketing, fundraising or arbitrage tool. These Notes could include any feature that is in demand by the market, such as an attractive user experience, merchant deals or financial returns.  

The market will drive the success of each Note issuance. The exchangeability into Base Currency will provide liquidity and support to new issues.  The Notes may be centralized or decentralized depending on market demand.   

Coordination

The success of this system depends on the ability to achieve the Core Principles.  A commitment to decentralization itself will drive many of these principles, including Competition, Property Rights, Individual Protection, Flexibility, and Growth. 

Coordination will be required to achieve other goals, including Stability and Security.  Risks such as attacks on the Base Currency, system failures due to infrastructure problems and use of the Base Currency for illegal activity will need to be managed through cooperative efforts while maintaining maximum decentralization.  

Governmental monitoring of transactions in the Base Currency for valid security reasons should occur directly, rather than through the banking system.  

Transition

Transition to the new system will require a large amount of transactional activity in two areas - deleveraging of the banking system and conversion of old currencies to new.  It is critical that all interested parties, public and private, start to plan for this transition now to ensure an orderly process that is stable, efficient and fair. See We are all short bitcoin. Cover needed.

The markets will continue to push towards this system regardless of coordinated design. If governments wait too long to participate in this design, they risk putting themselves at a competitive disadvantage in the future market for Notes. They also risk causing significant economic harm to their citizens by delaying currency conversion.

The first steps in this process are inquiry and debate to build consensus support for a coordinated plan and the creation of a level regulatory playing field for software currency.    

Inquiry:  The initial focus should be on research to assess the potential societal and economic benefits of a decentralized software currency based monetary system.  We should be measuring the potential benefits of competition, property rights and individual protection and critically questioning the continued use of the current system. 

Level playing field:  Governments should not restrict use of software currency by giving monopoly protection to banks or their own currency. For example, banks should be allowed to issue accounts denominated in software currency, and software currency should be treated as currency for tax purposes if the taxpayer in fact uses it as currency.    

Project

The Global Currency Report is developing this new framework for purposes of assisting in the transition to a better global monetary system. We would like to collaborate with and assist all interested parties in this process. 

Contributing:  If you are passionate about building a better monetary system with software currency, please ask us about contributing to the project. 

Collaboration:  If you are working on a similar project and would like to compare notes or partner, please let us know. 

Consulting:  If you are an organization trying to plan for the future of money, we'd love to help. 

For more information contact Shane Hadden at shane@globalcurrencyreport.com.  

 

Photo Credit: Alex Wong on Unsplash

We are all short bitcoin. Cover needed.

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A few brave skeptics are intentionally short bitcoin.  For the rest of us, we are also short bitcoin by the nature of the financial world changing around us.  

A short position exists if there is a commitment to do something in the future and you haven't yet performed the action that is required to meet this obligation. This means that you are at risk to the cost of performing that action rising. To eliminate this risk, you cover by performing the action. It is often the case that the longer you wait to cover the position, the higher the expected cost of covering.   

Many short positions are beyond your control. You become committed to do something because of external factors. For example, you are a builder and your client gives you a deadline to complete a project for a fixed price. In such case, you are short the project. You must to do it by the deadline and the longer you wait to cover, the more costly it may become to produce what is required.  

This is the case with bitcoin. The invention of bitcoin created two economic realities that cannot be ignored - banks must change and decentralized currencies are inevitable. We have a lot of work to do to refashion our financial system to these new economic realities. The longer we wait, the higher the cost will be. Especially to those who wait the longest.  

Economic reality #1:  Banking must change. It is now possible for people to safely custody digital money themselves, without a bank.  The centralized web of interlocking credit risk that is the global banking system is no longer necessary.   

This is a very good thing. Consider the benefits - No requirement to lend money to others. No required fees for holding the money. No taxes for bank insurance. No cascading defaults. No too big to fail. No distorted interest rates due to forced lending. No closing hours. No fake accounts. No discrimination. Fill in your own problem with banks . . . 

If bitcoin is an attractive option to banks, then the global economy is short a major banking redesign. Bank balance sheets will shrink, with the primary role of banks shifting from principal to custodian or escrow agent. An enormous de-leveraging must occur as the banking credit web is unraveled. Banks will need to meet market based standards for efficiency and value added, rather than relying on government subsidies. The cost of this transition will be high, but the cost of not transitioning to accommodate the promise of bitcoin is even higher. 

As bitcoin matures, there will be more and more money taken out of the banking system by consumers making a free choice of the better product.  If central banks wait too long to adapt, bank runs are inevitable.  

The IMF recently acknowledged this risk:

"To be sure, there are choices and policy trade-offs that would require careful consideration when it comes to designing central bank digital currency, including how to avoid any additional risk of bank runs brought about by the convenience of digital cash. " Empshasis added. Quoted from "Monetary policy in the digital age. Crypto assets may one day reduce demand for central bank money." June 2018, by Dong He, deputy director of the IMF's Monetary and Capital Markets Department . 

The Bank of International Settlements does not seem to share the IMF's concern.  They recently released a report describing bitcoin with words such as hype, disaster and bubble.  This PR strategy may be an effective tactic to reduce bank runs in the near term, but in the long run it only distracts the policymakers from debating the more serious questions about what banks need to do to adapt to the new reality of bitcoin.  

Economic reality #2:  Decentralized currency is inevitable.  The creation of centralized currencies like the dollar was the result of there being no viable decentralized option. Before bitcoin, there was no commodity that served as a good currency. With the bitcoin technology available, currencies will now be rebuilt with this sound, decentralized base.  Creditworthy central banks will be able to manage the money supply with synthetic decentralized currency and open market operations. Non-creditworthy governments will be forced to be fiscally responsible. This is a better system that is only now possible with the invention of bitcoin.

Everyone in the world is short any currency that will become needed in the future.  This is always the case with a new currency - for example, everyone in the eurozone was short the euro prior to its issuance. However, as in the case of the euro, the risk of this position is usually managed by the government through an orderly conversion process. So long as you convert your money by a certain date, you are OK and everyone will get the same price.  The problem with bitcoin is that the governments are not yet on board with this transition.  

This problem is especially concerning for the majority of the people in the world who do not have the luxury of being able to speculate on bitcoin's price appreciation.  As it exists today, as bitcoin grows to maturity with a value in the trillions, this value is going to accrue to the wealthy. Others will need to buy in at a higher price in the future to obtain their everyday currency. We urgently need a more organized, coordinated system for the adoption of bitcoin or other decentralized currency.  

Cover needed

We are all short bitcoin because of our inexorable desire for economic and social improvement. With modern market economies and democracies, an invention that greatly improves society cannot be held back for long. Just like the builder who takes on a commitment to construct a building, our drive to improve our society commits us to build our economy around decentralized currencies. It is inevitable, the only question is the cost of construction. The eventual cost will be determined by how quickly we cover.  

We should all be concerned when we hear policymakers use diversion as a delay tactic.  The factors that the policy makers point to to divert attention from the real issues are all knobs that can be turned with the widespread adoption of bitcoin.  Criminal usage, power usage, transaction costs, transaction speeds, etc. - these are not necessary attributes of bitcoin, they are variables to be optimized over time on a concerted basis.  

We all need to respond to the bitcoin invention with calm objective reason, not knee jerk reactions based solely on what we have known before. Good bankers aren't going to lose their jobs.  Good governments aren't going to lose their ability to manage monetary policy.  

We need to move our critical eye from bitcoin to the banking system.  We need to ask the hard questions:

Why is it required that people hold their digital money in banks? Is it to reduce credit risk? No, credit risk is caused by the banking system, not reduced by it. Is it for surveillance? No, we don't need banks to monitor people's transactions if that's what we want to do. Is it to provide credit efficiently? No, the market can handle this very well with government subsidies here and there.

Why do we need a centralized currency? Is it to manage the money supply? No, credit worthy countries like the U.S. can easily manage the supply of synthetic bitcoin just like they do synthetic dollars.  

The reality is that bank policymakers are not being self-reflective.  They are hoping that bitcoin just goes away.

We should all be very concerned by this.  The best way to manage our collective short position in bitcoin is to cover by working cooperatively on a global basis to redesign banking and convert to decentralized currencies.  Putting our head in the sand only increases the eventual cost of covering. 

 

 

Stablecoins: Should we privatize money supply?

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Bitcoin privatized currency, or at least made it possible to do so.  Currency can now be used without the government entanglements of bank credit risk and printing by profligate regimes.  The question now is, do we also want to privatize the management of the amount of money in the system. 

Bitcoin left this question open. Bitcoin is beautifully simple. It is just a fixed amount of digital value to be managed for the public good as we see fit.  Credit worthy governments can easily create synthetic bitcoin with fractional reserves to increase the supply of bitcoin or buy synthetic or real bitcoin to reduce the supply. See The supply of bitcoin is not capped - but that's a good thing.  So the management of the supply of money is still in the hands of governments if they want it.  (Yes, there is a bigger difference between real bitcoin and synthetic bitcoin than there is between real dollars and synthetic dollars, but this will not matter to a large part of the population who are OK with a centralized component of their money.  See Bitcoin banking - a better monetary system).  

The problem for bitcoin is that governments have not jumped in to help manage its supply and orderly distribution. Governments are not yet ready for the decentralized privatization of their currency, so they are not supporting it. As a result, bitcoin is highly volatile and is being distributed solely to investors rather than to the public at large.  

So do we also need to privatize the management of the government's role as a stabilizer of currency value?  This can be done in two ways:  A new currency can be created with automated adjustments of supply (Algorithmic Money Supply) or private parties can play the role of a central bank with respect to an existing currency such as bitcoin (Private Sponsors).  Each approach is briefly discussed below.   

Algorithmic Money Supply:  There are several new currency project that include automated money supply adjustments designed to maintain a price pegged to a reference rate.  Examples include Basis and Carbon. In these projects investors play the role of the government. If the price of the coin rises, new coins are issued to investors, thereby increasing supply.  If the price of the coin falls, investors use the coins to buy rights to future coin issuances, thereby reducing supply. The terms are preset and execution is through one or more separate tokens.

These approaches are clean in that they attempt to create a new stable currency, but there are several major concerns with using investors as the mechanism for adjusting supply:  

First - Market forces are working against the goal of the program.  Investors only make money when the price is not stable.   

Second - Investors earn all of the network benefits. People who are loyal to the currency should naturally expect to earn a return as it is their loyalty that creates the network effect that drives up the price. In the algorithmic money supply protocols, these benefits are shifted to investors. It is questionable whether such a transfer of value will be acceptable to currency users at scale.

Private Sponsors:   Private entities can manage the price of bitcoin just as a government would. These sponsors would create notes backed by a variable amount of bitcoin and commit to stabilize the value of the note through its own buying and selling. This approach is similar to the issuance of Bitcoin Notes described here. These notes may be called Stable Bitcoin Notes (SBNs).  

A sponsor, such as a retailer or finance company, would create a branded SBN.  The note would have value added features provided by the sponsor, such as fast low-cost transactions, deals, rewards, etc. The sponsor would be expected to maintain a price floor through purchases and would be allowed to issue additional SBNs at its discretion as the price rises.  These new SBNs could be held in reserve or given to customers or the general public.   

Such programs could be very profitable if managed properly.  The value of the upside in this synthetic bitcoin position is likely much more valuable than the cost of hedging the downside. The sponsor also benefits from the marketing benefits of the coin and any premium paid for the value added features.     

As bitcoin matures, these SBN programs would become easier to administer.  At some point governments may create their own SBNs having learned from the private programs.

Third Alternative - Do nothing

The other alternative is to simply ride the wild price swings of bitcoin as a speculative investment and wait for governmental adoption. This might be possible with a currency that has broad distribution, but with bitcoin the wealth concentration is only going to continue, making it harder and harder for governments to adopt.   

So what does this mean for bitcoin?  We can assume that governments are not going to assist any time soon.  Bitcoin could reduce the wealth concentration problem by changing the protocol to distribute bitcoin to a global user base, but considering how hard it is to make small changes, this major change does not seem feasible in the near term.  This leaves private sponsor programs as the only option. It will be interesting to see how these develop over the next several years.  

By Shane Hadden, CBP, CFA; shane@globalcurrencyreport.com

About the Global Currency Group:  The Global Currency Group promotes the adoption of a decentralized global currency through investments, advisory services, new currency creation and advocacy.  

The Currency Report.  A regular newsletter of news and insights related to Global Currencies and the tokenization of finance.  Subscribe. 

The Global Currency Fund.  An actively managed private fund focused exclusively on the Global Currency segment of the cryptocurrency market.  Accredited Investors only.  Inquire. 

 

  

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

   

Currency creation requires thoughtful distribution. The $20 trillion question.

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The creation of a global currency will require a balancing of the power of the market and equitable distribution of resources.  Can decentralized markets make it happen?  

Let's say in 20 years there is a decentralized currency worth $20 trillion or roughly 20% of the global currency market.  Maybe it's bitcoin, maybe it's a new currency.  Where will this $20 trillion in wealth come from?  Who will be $20 trillion richer? Will some people be poorer? Who? Will global assets be more evenly distributed or will inequality increase?  

These are very important questions. Below are a few thoughts.

Where the value comes from:  The $20 trillion is comprised of new value creation and wealth transfers from other currencies. New value is created due to cost efficiencies, increased trade and reduced conflict.  The wealth transfer happens as other currencies are used less and fall in value relative to the new currency.  The value creation process is driven by network effects with currency users (buyers) and currency accepters (sellers) increasing the value through usage.  

Who gets this value:  Two groups of people: those who initially issue the currency (seigniorage) and those who purchase the currency and hold it as the price rises.  

Wealth transfer problem:  From a social perspective, many people support bitcoin and other global currency projects because of their potential to reduce inequality. If the creation of these currencies results in a massive transfer of wealth leaving one group poorer, the net benefits would be in question.  Also, from a practical perspective, the creation of a decentralized currency is a voluntary, market-based exercise.  If people have full knowledge of an unfair distribution, they will likely not adopt the currency.  For these reasons, for a currency to reach $20 trillion in value, it must have a distribution scheme that minimizes wealth transfer.

Traditional approach:  When a government is involved, the creation of a new currency is relatively easy.  The government sets an exchange rate, old currency is exchanged for the new currency and the old currency destroyed.  New currency holders benefit from the subsequent increase in value of the new currency in proportion to the amount of old currency held.  There is no wealth transfer with the initial exchange.  If the currency increases in value the government may choose to issue additional currency supply to reduce the price.  What the government does with this seigniorage determines whether this value is then distributed equitably.          

Volatility problem:  When there is no government to orchestrate an orderly currency exchange, there may be a long period of uncertainty about the ultimate viability of the currency, which leads to price volatility.  See Bitcoin is a publicly traded future currency - new territory for finance.  This exacerbates the wealth transfer problem because only people who have money to lose can purchase the currency and thereby benefit from the increase value.  The people who don't have this wealth will eventually need to purchase the currency at a price much higher than the others.  

Seigniorage as a solution:  Seigniorage can be used to solve the wealth transfer problem.  The creator of the currency can distribute the currency broadly for free at inception or as the price rises.

Seigniorage as a problem:  Seigniorage can also exacerbate the wealth transfer problem.  For example, the currency creator could retain the seigniorage for itself or distribute the currency to a select group of people.  

Bitcoin's status quo:  Bitcoin's current value of $150 billion is mostly new value - the wealth transfer has not yet begun in earnest as usage of other currencies has not yet fallen significantly. Bitcoin has a potential wealth transfer problem because bitcoin does not have any form of seigniorage and the price is extremely volatile.  Without a change in the distribution scheme of bitcoin, it is not clear how it will reach maturity without a massive wealth transfer.  

"Stable Value" distribution:  Some coin projects seek to control price increases by distributing new currency. This reduces the price by increasing the supply. The big question is who gets the new currency.  If the new supply is distributed broadly to people who don't already hold the currency, this could be a good method for achieving equitable distribution.  If the new supply is distributed to a small group of investors who have purchased the right to this additional supply, this could make the problem even worse than it is with bitcoin. 

Bitcoin notes: New bitcoin backed notes issued by governments, finance companies and marketers can help with equitable distribution, especially where there is no seigniorage of the currency itself.  See Bitcoin notes will deliver bitcoin to the world.  These notes serve as synthetic bitcoin (or other currency) and can be used to effectively increase the supply of the currency.  This synthetic issuance can be used to achieve distribution in a manner similar to that of seigniorage.   

Government involvement:  Ideally governments will be involved in the creation of a global decentralized currency.  This is the easiest way to ensure an equitable distribution of the new currency. Governments can issue bitcoin backed notes and exchange these for their local currency in an orderly, equitable process.  Governments that do this will protect their citizens from a loss of wealth in the event a global currency is created outside of their region and then later displaces the local currency.   

Timing matters: The $20 trillion outcome presented above is a real possibility considering the potential benefits of a decentralized currency.  What happens over the next several years will determine whether we are able to achieve this outcome and who benefits. New currencies like bitcoin and others risk failure if they wait too long to distribute their currency broadly. Governments risk harming their constituents if they wait too long before conducting an orderly exchange.  

By Shane Hadden, CBP, CFA; shane@globalcurrencyreport.com

About the Global Currency Group:  The Global Currency Group promotes the adoption of a decentralized global currency through investments, advisory services, new currency creation and advocacy.  

The Currency Report.  A regular newsletter of news and insights related to Global Currencies and the tokenization of finance.  Subscribe. 

The Global Currency Fund.  An actively managed private fund focused exclusively on the Global Currency segment of the cryptocurrency market.  Accredited Investors only.  Inquire. 

 

Bitcoin banking - everything will change, no deposits needed

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We no longer need a deposit-based banking system.  Government guaranteed deposits provide no benefit in a bitcoin world where currency can be more safely held outside of a bank than inside. See Bitcoin basics - no credit risk. 

This is not to say that we don't need the other common functions of banking.  In fact, banking services will be greatly improved without deposits as we can eliminate the high costs of interlocking credit risk and safety and soundness based regulation. 

Below are predictions of what banking will look like in a post deposit, bitcoin-based world.

"Bank" - The term bank will either fall away or be colloquially used for any institution that performs the traditional roles of a bank.  

Custody - Custodial services for private keys will be the backbone of the banking system. Governments may offer free custody insurance similar to FDIC protection of deposits.  

Note Issuance - Banks will issue notes that can be exchanged for bitcoin on a one-to-one basis.  Each issuer will add local features to the notes based on marketing, financial or governmental needs.  See Bitcoin notes will deliver bitcoin to the world

Payments - Bitcoin of course is its own payments system. The Bitcoin blockchain will be used as the primary settlement system for banks and as an optional payments platform for end users. Credit worthy entities will provide value added services on top of bitcoin with synthetic forms of bitcoin such as bitcoin notes. Banks currently have a practical monopoly on this space because of how the credit card networks were developed based exclusively on depository institutions. These legacy banks will continue to have an advantage if they adapt, but there will be much more competition without the need for regulatory oversight of deposits.  

Lending - Lending will finally be divorced from deposit taking. Lenders will able to focus on lending rather than the regulatory protection of depositors. There will be no subsidy of the borrowing cost of bad lenders.  It will be purely marked based, to the ultimate benefit of borrowers.     

Money Supply - Governments will control the money supply by directly issuing government sponsored bitcoin notes.  The reserve requirement (amount of bitcoin collateral) will depend on the creditworthiness of the government. Highly credit worthy countries such as the U.S. will be able to manipulate the local bitcoin note money supply much more effectively than they are currently able to do with their fiat currency using the deposit based banking system.  

Regulation - Supervision of bank safety and soundness will not be necessary as there will be no depositors to protect.  Each function of a bank will be regulated according to its appropriate policy considerations.  Notes will be regulated with a focus on investor protection, lending with a focus on borrower protection, custodial activities with a focus on security, etc.  We will no longer have a system where safety and soundness trumps other considerations.      

Surveillance - This is the elephant in the room with many bitcoin discussions.  Banks currently facilitate governmental surveillance of payments. Regardless of the degree of surveillance that we as a society decide that we want, there is no reason that this needs to be done through a global interlocking web of deposit-based credit risk as it is today. Surveillance will move to the other functions of banking, particularly payments and custody.  

By Shane Hadden, CBP, CFA; shane@globalcurrencyreport.com

About the Global Currency Group:  The Global Currency Group promotes the adoption of a decentralized global currency through investments, advisory services, new currency creation and advocacy.  

The Currency Report.  A regular newsletter of news and insights related to Global Currencies and the tokenization of finance.  Subscribe. 

The Global Currency Fund.  An actively managed private fund focused exclusively on the Global Currency segment of the cryptocurrency market.  Accredited Investors only.  Inquire. 

  

Bitcoin is a publicly traded future currency - new territory for finance

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Before bitcoin, was there ever an asset that could be described as a future currency that was also publicly traded in the market? Not that I know of.    

The problem with future currencies is that they are not good currencies today.  This is because the future is uncertain and nobody wants an uncertain currency. This creates a feedback loop in which people question the future viability of an asset as a currency because it does not have current viability.  This is happening today with bitcoin.

Bitcoin has a very promising future as a global currency, but the timing and potential scale of bitcoin adoption is highly uncertain.  This results in price volatility as well as an expectation of significant appreciation in value until bitcoin reaches a mature scale. Bitcoin is particularly prone to this problem with a capped supply. Because of these pricing dynamics, few people want to use bitcoin as a currency today.   

A related problem is that bitcoin can only be purchased today by people who are able to lose money on bitcoin as an investment. This means that when bitcoin matures, many of the people who need to get bitcoin to use as currency will pay a much higher price than others who were fortunate enough to buy bitcoin as an investment. This isn't good.    

So how do we solve these problems. Below are some options.  

Immediate widespread government adoption:  Governments worldwide convert their currencies to bitcoin backed notes. This would solve both problems because it would eliminate uncertainty and offer everyone a way into bitcoin at a fair price. This is not likely to happen anytime soon. 

Nix it: We give up on this experiment in currency building. This is clearly the wrong answer if we believe bitcoin is a better currency than fiat.

Switch to a more stable decentralized currency:  We could adopt a new currency that is designed to track the dollar or a basket of goods, or to otherwise maintain a stable price.  The problem with this is that it is artificial. If we are designing a global currency, it should be its own unique commodity with supply based on market dynamics and/or democratic governance.  Bitcoin works well because its M0 supply can't be changed except through a decentralized voting process, and, at maturity, M1 and M2 can be manipulated by creditworthy governments to create regional price stability. Also, some degree of increase in the value of the currency during its growth phase is important as this is what creates the network effect.    

Promote bitcoin and get it into everyone's hands as quickly as possible:  This is the right answer. Bitcoin is going to be a volatile/bad currency until it becomes mature. During this ride only investors are going to benefit. It is not responsible for people who don't have money to lose to buy bitcoin until it is stable within their economic sphere. For this reason, we need to (1) find ways to spread bitcoin ownership without investment, for example, grants or bitcoins air drops adopted as a change in the protocol, and (2) push quickly for individual governmental adoption to create relatively stable bitcoin regions. 

Bitcoin is the world's first publicly traded future currency.  Hopefully one day it will be the world's first decentralized global currency.  For this to happen, we need to be creative and aware that it can't happen without a reasonably fair distribution of the value of the currency creation around the world. I'm optimistic that we will figure this out.   

By Shane Hadden, CBP, CFA; shane@globalcurrencyreport.com

About the Global Currency Group:  The Global Currency Group promotes the adoption of a decentralized global currency through investments, advisory services, new currency creation and advocacy.  

The Currency Report.  This is a regular newsletter of news and insights related to Global Currencies and the tokenization of finance.  Subscribe. 

The Global Currency Fund.  This is an actively managed private fund focused exclusively on the Global Currency segment of the cryptocurrency market.  Accredited Investors only.  Inquire. 

Bitcoin basics - no credit risk

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The biggest financial impact of bitcoin is that money can now be held without taking credit risk. Our financial system is built on a base layer of mandatory credit risk. Everything sits on an interwoven fabric of instability. Bitcoin solves this problem with the option to self custody funds. 

Prior to bitcoin, savers had no practical choice but to deposit their money into a bank. The act of placing the money at the bank reduces the risk of theft, but it creates credit risk. This risk is either borne by the depositor or taxpayers through a governmental guarantee.

With bitcoin, individuals and institutional savers can keep custody of their funds directly on the bitcoin blockchain. They can even set up escrow arrangements to facilitate collateral agreements. They don't have to subject their money to credit risk unless they are presented with an attractive opportunity to do so.            

Below are a few benefits of such a system.  

Cleaner risk - Banks muddy the water when it comes to risk. It's hard to do a trade that isolates a particular risk if money must be held at a bank as part of the deal. This risk may be ignored in good times, but it is real, as the financial crisis proved.   

Cleaner services - Today, value added services, such as mobile banking, are tied to credit risk - if you want a bank's value added services, you have to take their credit risk. This will be fixed as these value added services become de-linked from deposit taking.     

Better terms - If self custody is an option, credit will be repriced on market-based terms.  

Less entanglement - Banks lend to each other, creating a potential domino effect in a crisis.  This problem will be reduced with self-custody as more money will be held outside of this interdependent system.  

Easier oversight - Self custody means fewer bad banks. Banks will need to compete to add value without monopoly protection. 

Consumer protection - Bank scams to create fake accounts, inflate overdraft fees and the like will be reduced because people will not be as dependent on banks.

With bitcoin, we can now rebuild the financial system on a firmer base.      

By Shane Hadden, CBP, CFA; shane@globalcurrencyreport.com

About the Global Currency Group:  The Global Currency Group promotes the adoption of a decentralized global currency through investments, advisory services, new currency creation and advocacy.  

The Currency Report.  This is a regular newsletter of news and insights related to Global Currencies and the tokenization of finance.  Subscribe. 

The Global Currency Fund.  This is an actively managed private fund focused exclusively on the Global Currency segment of the cryptocurrency market.  Accredited Investors only.  Inquire. 

Bitcoin notes will deliver bitcoin to the world.

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Bitcoin notes will transform bitcoin from a decentralized payment option into a viable global currency.  These notes will create multiple manifestations of bitcoin, each with its own local features, but all with the common value of bitcoin underneath.   

So what is a bitcoin note?  A bitcoin note is simply an IOU that requires payment in a fixed amount of bitcoin on demand. It is similar to a bank account in dollars. It is not technically bitcoin, but so long as the issuer of the IOU is highly credit worthy it will be accepted as bitcoin just like debit card payments in dollars are accepted as dollars. The notes can also have features unique to the note issuer, but these features do not change the fundamental value of the note as bitcoin.  

The purpose of a bitcoin note program is to improve upon bitcoin as a payments method while maintaining the underlying integrity of bitcoin as a decentralized store of value. 

Bitcoin note programs can be centralized or decentralized.  Centralized programs have the benefit of being able to create a payments system in bitcoin similar to what we have today in dollars.  Decentralized programs may also be created to add or change features of bitcoin while maintaining decentralization.   

Below is a description of three broad categories of note programs.  

Government issued bitcoin notes

This is the fastest route to the adoption of bitcoin as a global currency.  A government replaces its fiat currency with government-issued, bitcoin notes. Banks and card networks adopt the new currency, resulting in a payment experience identical to that of dollars.  The government starts the process by buying bitcoin reserves in the market with the new currency.  The government would not be able to "print" their currency in this program, but they could manage the supply of notes by adjusting the reserve requirements of banks. 

When governments convert their currencies to bitcoin notes they may choose to update to a blockchain-based record keeping system. They may also choose to add features to the notes such as identity or voting functionality. The decision as to which features to add would be made on a country by country basis and would not greatly affect the nature of the notes as bitcoin. This would preserve national flavors while eventually creating a single common global currency in bitcoin.    

Note that this is similar to the gold standard, but with bitcoin instead of gold. The difference will be that a bitcoin-based note system will have much less leverage. Unlike gold, people can actually use bitcoin as a currency directly, so the demand for the notes relative to the demand for the underlying will be much less than with a gold standard - resulting in higher reserve rates.  This lower leverage will make bank runs less problematic.

It is not likely that the largest governments will convert to bitcoin notes anytime soon for political and economic reasons. Politically, voters do not yet understand bitcoin well enough to accept such a transition.  Economically, the amount of leverage built into the banking system of most countries would not be suitable for bitcoin, based on current levels of bitcoin price volatility. The first note programs will need to be created with reserve ratios that are much higher than that of most banks.  As bitcoin matures and the price volatility subsides, it will be more easy for governments to convert.   

Although it is not likely that a government will start such a program in the near future, there is a big economic incentive to do so.  The first governments to convert to bitcoin notes could create enormous value for their citizens as the price of bitcoin increases due to the additional network effects derived from the citizens of the country becoming bitcoin users.  

Privately issued bitcoin notes

Bitcoin notes can be issued without government backing.  This can be done by banks or highly credit worthy non-bank organizations.  It is also possible that a group of organizations could partner to issue the notes.  

A centralized, private bitcoin note program could offer the same user experience as a government-backed program - either through the existing credit card networks or new networks.

As with the government programs, the sponsors of private note programs will likely add features to the notes specific to their own organization.  For merchants, the notes could be used to administer a loyalty program.  Banks and non-bank finance companies may use the notes to arb liquidity and borrowing rates between bitcoin and the bitcoin notes. Non-profit organizations may use the notes to create a more equitable or environmental friendly form of bitcoin.   

The issuer of a centralized, private bitcoin note program would not necessarily be required to hold 100% reserves in bitcoin.  The reserve rate and the structure of the notes as secured or unsecured would be a function of the credit-worthiness of the issuer.  For example, Walmart and Goldman Sachs may be able to issue unsecured bitcoin notes, whereas the market may require other companies to hold 100% bitcoin collateral.   

Decentralized bitcoin notes

Bitcoin notes can also be issued on a decentralized platform.  As with other types of bitcoin notes, the holder can exchange the note for a fixed amount of bitcoin, but there is no central authority to monitor the program or guarantee conversion - the conversion would happen programmatically. 

This type of note program could be used to add or change features of bitcoin to meet the needs of a particular market.  For example, the decentralized note platform could use a different consensus algorithm or have different governance features. Trades in the bitcoin notes would be executed with the new protocols, but the underlying bitcoin blockchain would serve to support the value.

Conclusion

Each of these forms of bitcoin notes will serve to expand the reach of bitcoin and strengthen the bitcoin network.  The bitcoin protocol will continue to be improved and used as a direct means of payment, but most people will likely choose to operate through centralized bitcoin note networks for everyday transactions.

Many note programs will be created to meet the diverse appetite of the market or to promote issuer objectives. The value of bitcoin will grow as the note programs grow.  The note programs will create leverage/additional bitcoin supply, but this leverage will not be as great as that of fiat programs.

The bitcoin network should work to assist third parties in developing these note programs. If a template for these note programs is developed and several large programs are successful, bitcoin has a very good chance of becoming the world's common currency and most popular store of value.  It is also possible that other currencies like DASH or Litecoin could use the bitcoin note model to pass bitcoin.  It is still very early in this process.  #bitcoin2030.     

By Shane Hadden, CBP, CFA; shane@globalcurrencyreport.com

About the Global Currency Group:  The Global Currency Group promotes the adoption of a decentralized global currency through investments, advisory services, new currency creation and advocacy.  

The Currency Report.  This is a regular newsletter of news and insights related to Global Currencies and the tokenization of finance.  Subscribe. 

The Global Currency Fund.  This is an actively managed private fund focused exclusively on the Global Currency segment of the cryptocurrency market.  Accredited Investors only.  Inquire. 

  

 

 

Bitcoin's three financial disruptions; the pull of decentralization

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No financial invention has triggered as much potential disruption as Bitcoin. The implications of this technology affect every corner of the industry. In fact, the transformations that are resulting from Bitcoin are so broad that they are sometimes hard to keep track of in an organized way. This post offers a simple approach to thinking about these changes and a prediction that, in the long run, decentralization will be the most fundamental change.   

There are three major disruptions of finance resulting from Bitcoin:  decentralization, tokenization and blockchain.   

Decentralization:  Value is transferred without intermediaries. This prevents the formation of transactional monopolies.      

Tokenization: Value is represented by digital tokens. This increases liquidity for all forms of ownership.  

Blockchain: Value is tracked on an immutable ledger. This increases trust in the transactional record.  

  Centralization versus Decentralization

Note that the only one of these disruptions that is a direct result of Bitcoin is decentralization.  Tokens and blockchain existed before Bitcoin. As a practical matter, however, Bitcoin launched tokenization and blockchain as disruptions because decentralization brought a new level of interest to these areas.

Of these three major disruptions, blockchain gets the most positive attention from the financial press, tokenization has the most revenue impact for investment banks, and decentralization has the most potential for positive impact for society. 

The adoption of blockchain technology in finance will greatly improve the transparency of who owns what when. This has tremendous benefits in the form of cost savings, risk reduction and the promotion of property rights.  

Tokenization will be a bonanza for investment banks who get in early.  Traditionally illiquid assets will be traded in token form and a new asset class, the utility token, will grow as a funding option to rival debt and equity.

Note that decentralization is not required for the blockchain and tokenization disruptions.  This may explain why they are achieving mainstream adoption first. These innovations can occur in a centralized manner with big benefits. Private blockchains can deliver cost savings and risk reduction and exchange traded utility tokens can be powerful marketing tools and result in lower funding costs. 

However, decentralization is the full promise of Bitcoin. Decentralization results in the continual improvement of the financial system through the power of consumer choice.  

The Pull of Decentralization

The ultimate power of Bitcoin's innovation may be that it is self preserving - it creates an environment that favors decentralization. 

As mentioned above, Bitcoin unleashed blockchain and tokenization onto the markets. Blockchain seems to have already gained mainstream adoption. Tokenization should also gain mainstream adoption as soon as the regulatory environment catches up with the innovation.   

Decentralization is not catching on as quickly among mainstream financial markets, likely because the institutions in these markets feel threatened by the competition. (Institutions that are relying on monopoly protection should feel threatened, whereas high quality institutions should see this as an opportunity to take market share).   

It is usually unwise to say something is inevitable, but the power of democracy and the markets is so strong that it may be reasonable to say that decentralization is inevitable once blockchain and tokenization become mainstream.  This is because over time these innovations will prove that society does not need centralized monopolies for a healthy financial system.  

In order for centralized financial institutions to resist market demand for decentralization, they will need to convince voters that central monopolies are necessary. This will become harder and harder to do as tokenization increases liquidity in global markets and blockchain reduces the potential for secrecy. 

As money and information flow more easily, people will demand a competitive decentralized financial system based on credit worthiness and value rather than a centralized system based on monopoly protection. 

This will not just be a populous movement. As markets improve there will be centralized institutions in certain countries that come to the conclusion that they could do better competing in a decentralized global financial marketplace than maintaining their smaller centralized position.  

Additionally, over time strong central banks will realize that they can manage their economies as well or better in a decentralized system, because in such as system, credit worthiness is king. Strong central banks will be better able to manage the supply of money in their regions. Weaker countries will need to become more fiscally responsible.  .  

This pull of decentralization is strong and will only get stronger. Central bankers today seem to not appreciate this. They talk about a world with blockchain, but without Bitcoin, as if this is possible or even likely. This dismissive approach to decentralization is not healthy for the growth of a stronger global economy. 

In sum, Bitcoin has triggered three major financial disruptions - decentralization, tokenization and blockchain. Tokenization and blockchain will dramatically transform finance, but their largest contribution to the world will be to promote the adoption of decentralization.    

By Shane Hadden, CBP, CFA; shane@globalcurrencyreport.com

About the Global Currency Group:  The Global Currency Group promotes the adoption of a decentralized global currency through investments, advisory services, new currency creation and advocacy.  

The Currency Report.  This is a regular newsletter of news and insights related to Global Currencies and the tokenization of finance.  Subscribe. 

The Global Currency Fund.  This is an actively managed private fund focused exclusively on the Global Currency segment of the cryptocurrency market.  Accredited Investors only.  Inquire.