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Virtual Currency


The kind of money an economy uses tends to reflect the ideals and desires of the people who run that economy. In his book Debt: The First 5000 Years, David Graeber argues convincingly that empires such as Rome gravitated to gold and silver coins because it allowed for paying soldiers who might not trust their paymasters, and might not be trusted by them. Graeber contrasts this with economies that used various systems of obligation–formal or informal records of who owed what to whom–which by their nature required on-going interpersonal relationships.

He cites cases where participants in an economy go to great lengths to avoid reaching a final resolution of accounts, because that would end the relationship. One classic example of this is the gift economies of the Trobriand Islanders, which Marcel Mausse wrote about. We might even compare the relation of a currency to an economy with the famous statement by Mausse’s uncle Emile Durkheim that “god is society, writ large” – that a society chooses a god that reflects its judgments; a currency is an economy, writ small.

We could say that the currency reflects the values of a community, but that risks confusing the economic definition of value with the general definition. Gaeber might argue that the two terms are not as distinct as they seem, but that is an issue to be discussed separately. But as Graeber noticed, hard currency provides for a greater depersonalization of transactions–if you have someone in your debt, you have to deal with them; if you can be paid in specie, you don’t.

New technologies–the internet, faster processing speeds–are allowing for the creation of a new kind of money, a fiat currency not issued by a large financial or political institution. The most prominent of these post-industrial virtual currencies is Bitcoins, although it’s not the only one.

Virtual or digital currencies offer two great advantages–the potential for an extreme level of anonymity and depersonalization, and freedom from the influence of large political and economic institutions. And in fact these two advantages are closely related, because one of the reasons to seek anonymity is to be free from controls imposed from above. But we should not think that virtual currencies could ever be free of ideals, ethics and assumptions–the cultural weight a currency carries is too deeply imbedded to avoid. In fact in this case, the advantages are the cultural values of the currency.

Separate, but related to the preference for decentralization and anonymity in the virtual currencies is the way they express the most basic difference of the post-industrial from its industrial predecessor–a de-emphasis on material, industrial products in favor of products that exist in cyberspace or as experiences. But that is a much larger point.

Do virtual currency believers want a money free of cultural baggage? Some clearly do. In fact, the slogan on the Bitcoins themselves is now the wonderfully ambiguous Latin phrase “Vires in Numeris,” meaning “Strength in Numbers.” And major Bitcoin investor Tyler Winklevoss much more clearly said has said he was backing Bitcoins in part because he wanted to put his “money and faith in a mathematical framework that is free of politics and human error.”

Free of the errors of a central bank, certainly. And that’s what many virtual currency supporters say they want most of all–to be liberated from the power behind traditional fiat currencies, the centralized institutions that do the fiating. It’s hard not to feel some sympathy, given how much trust we are asked to maintain in organizations like the Federal Open Market Committee, which largely determines interest rates (the price to borrow money) and the dollar money supply itself.

This is possibly the most important cultural assumption underlying virtual currencies, as well as the most obvious–that we don’t need centralized institutions. This appeals to the decentralizing ethos of the post-industrial age, but as often before it seems that the most important cultural biases are the organic ones that grow unnoticed. The people who develop and support virtual currencies are almost assuredly the kind of financially sophisticated and computer literate people who would naturally regard large economic institutions (public and private) as more of a hindrance than a help.

As others have noticed, the kind of cell phone apps being developed seem naturally designed to address the needs of the kind of people who develop cell phone apps–more help in finding a good Thai restaurant than a pharmacy that sells generic medicines.

Supporters of virtual currency argue that they can be used to make international money transfers cheaper and easier, and this is true. But we might expect the currencies to be more likely to facilitate the transfer of money from a Dutch spammer to a Russian hacker than from a California domestic to her grandmother in Bolivia, at least for the immediate future.

From a more theoretical standpoint, it could be argued that decentralizing control of the money supply could be a way to let it more closely mimic the network nature of the economy. But when expressing a distrust of central bankers, a virtual currency places its trust in another group of sophisticated technocrats.

We can see this best in the way the Bitcoins system makes a crucial decision–how it determines the money supply (a question of huge and constant debate when central bankers attempt to guide the fate of conventional fiat currencies). Other virtual currencies are less careful about the amount of currency they put in circulation, but builders of the Bitcoin system have clearly thought through the issue, so we can take theirs as the most sophisticated example.

In short, the number of Bitcoins in circulation is preset by formula. The human network that is the economy would trade a dictatorship of a centralized human institution for a dictatorship of decisions previously made by a group of software engineers and mathematicians who, for all intents and purposes, could be dead.

The process by which Bitcoins are created is called “mining.” Note that it’s not called printing or minting. We might suspect that the term mining was chosen in the hope that some of the sense of stability and reliability questionably assigned to specie might transfer to the Bitcoin system–the founders perhaps wanted to metaphorically sprinkle the new virtual money with gold dust.

Bitcoins are mined by solving an increasingly difficult series of mathematical puzzles, a process that requires sophisticated computer processing and which produces diminishing returns. In fact the math is designed to make it impossible to mine more Bitcoins after a certain limit has been reached. The point being to keep the mining process from being too easy, and to limit the number of Bitcoins in circulation.

Here framers of the Bitcoin were clearly concerned that the Bitcoin system not debauched by excessive amounts of the currency coming into existence. A fairly realistic concern for any newly invented currency not backed by a big government.

So the diminishing returns to the mining process mean that there is a functional cap to the number of Bitcoins that can be created. This means the Bitcoin could never become the dominant currency in an economy, because the supply of that kind of currency would have to grow to match the growth of the economy. Although critics of how market economies externalize issues such as their environmental limitations would disagree, classical capitalist economics would argue that an economy should be able to grow endlessly. And its currency should be able to match that.

The limit on the number of Bitcoins will also have what is probably a separate and unanticipated impact on its viability as a currency. The small number of Bitcoins will mean it will always be a small player compared to other currencies, with a very thin market. This means it will be vulnerable to speculation, and with it, wild swings in prices and exchange rates. That might not bother people in the Bitcoin world, but it should. It may make Bitcoins more valuable as a commodity, but it will limit its appeal as a currency, by making it too unreliable for merchants and consumers to use as an everyday medium of exchange.

The mathematical destiny that determines the Bitcoin supply is a direct descendant of Milton Freidman’s position that the money supply should simply increase by a steady percentage, with the power to print money taken away from a central bank and given to an impersonal formula.

This assumes a level of market rationality that many would argue does not exist, and ignores the need for an institution that can react to the animal spirits of the times. It assumes that the economy is inherently stable and self-correcting, which critics would argue it clearly is not. But we’re not about to settle that old argument here.

What kind of cultural impact would likely be expressed by a currency of this kind? Here we take up the other part of that equation–the anonymity. To see how this might play out it’s worth comparing virtual currencies to an older ancestor in the quest for utopian value neutral systems of accounting.

English Philosopher Jeremy Bentham argued that to pick the best action of a set of choices, one simply needed to add up the amount of happiness created by the various options and chose the one that meant the most happiness (or the least pain) for the largest number. To this end he theorized a unit of measurement – a util – which represented a quantity of happiness created. Chose the option that creates the largest number of utils, he said, and you can never go wrong.

Many have pointed to problems they see in that system, but it does have the advantage of an implied anonymity–it doesn’t matter who enjoys the utils, so long as someone enjoys them.

One important criticism that philosophers have leveled at Bentham and his utils is inextricably tied to this depersonalization. They argue that in theory Bentham’s kind of Utilitarianism would allow for horrific abuses of people, if the abuse created enough happiness for a large enough number to more than offset the pain imposed. Obviously this is not what Bentham had in mind. He was in fact, strikingly progressive for his times on issues of human equality. But something about the criticism sticks.

They argue that if enough people enjoyed the benefits, even the misery of slavery would be allowed under Bentham’s system. He might argue that the math doesn’t work, that any slave’s bound condition would out weight the pleasure or utility created. Perhaps. But as was common with the moral arguments for and against American slavery before the Civil War, slave masters can always find a way to cook the books–to weigh the damage they do as less than the greater good the bondage serves. And who is the final judge, after all? Who’s running the big abacus that totals the utils?

With virtual currencies, many of these questions of ultimate moral accounting are left to the machinery. Given the argument that there is no absolute privacy on-line, it’s worth pointing out that it is far from clear exactly how much anonymity Bitcoin's users could actually expect. How this will work in the real world has yet to be fully tested in court, or in the markets. And in many ways the atmosphere of anonymity surrounding Bitcoin and the other virtual currencies is only different in degree from the strong trend towards amorality in capitalism, a tendency in line with the expressed values of libertarianism.

But that tendency (especially it's high tech manifestation) is deeply congruent with the support for virtual currencies, and much of it has to do with the appeal of the currencies' offer of anonymity. And the framers of virtual currencies other than Bitcoin do quite consciously attempt to offer absolute anonymity and attempt to be much less subject to the limitations imposed by the law and moral judgment imposed by a polity. And in fact the most important criticism of them is that they could facilitate money laundering and illegal activity. No accident then that, after drug trafficking, human trafficking and modern slavery are enterprises some fear would flourish under a virtual currency system.

The broadest point? Perhaps that economies, and the currencies that express them are inescapably human systems, and that we as economic humans attempt to operate entirely beyond human judgment at our peril. And in fact this matches the notion that the system that determines prices is a collective subjective one, and that the economic value we pursue is a subjective one.

Which implies a good deal about the what will happen to the economy as it moves more into the realm of non-manufactured, non-material goods.


analysis/economics/virtual_currency.txt · Last modified: 2016/09/13 23:20 by drh