Dear Mr. Krugman and Mr. Greenspan,
You recently expressed your respective observations that "Bitcoin is evil," and lacks "intrinsic value." Paul Krugman stated that he is "unconvinced" that Bitcoin could be a "medium of exchange and a reasonably stable store of value." Alan Greenspan asserted that Bitcoin is a "bubble."
Krugman and Greenspan's pieces and statements do not address whether digital currencies could work, but whether they should work. It is not surprising that the previous Federal Reserve Chairman likes the central monetary model of control, but many Americans do not. Mr. Krugman's opposition is a bit more surprising as one of his first ventures into economics was writing The Theory of Interstellar Trade. One may have thought, given Mr. Krugman's forward-leaning work, that he may have a more open mind on monetary instruments.
Krugman turns to Charlie Stross in explaining that these digital currencies "look. . .designed as a weapon intended to damage central banking and money issuing banks." Perhaps - but maybe that's a feature and not a bug. Stross on the other hand, "want[s] Bitcoin to die in a fire."
Both Krugman and Greenspan reflect the language of fear that innovation, competition, and user adoption in the marketplace of a new but competing standard may outflank the old.
But Digital Currencies are Deflationary!
One of the principle reasons why we would expect a previous Federal Reserve Chairman to be against digital currencies is that these new currencies are deflationary (and Krugman references Stross's piece, which includes this argument).
Fiat currencies, such as those printed by the Fed, are inherently inflationary. The government can always print more money either to try stimulating the economy, or as a solution to pay off our nation's enormous and growing national debt.
Friedrich August von Hayek observes that "history is largely a history of inflation, usually inflation engineered by governments for the gain of governments." But with math-based currencies, there's a new (decentralized) sheriff in town that precludes such top down meddling. The finite supply of Bitcoins, and newer digital currencies like Ripples and Dogecoin, are inherently deflationary.
Krugman and Greenspan are right to question the validity of bitcoins and ripples as assets that stores actual value, but they are wrong to not also question US fiat currency as well. While American dollars were once based on the gold standard, they are no longer based upon any gold evaluation (or any other backing). As a result, both American dollars (for that matter most international currencies) and digital currencies have value on the market solely because the marketplace assessing them believes them to have value. In fact, because cryptography makes it essentially impossible for anyone to create more of any one digital currency than the predetermined amount set by its coder, digital currencies exemplify an important innovation: material commodities are no longer necessary to prevent inflation.
Bitcoin is only the first major digital currency, it will not be the last. Although it is not perfect, newer currencies like Ripple are attempting to improve upon its protocol. While it is possible that they could fail, the improvement they offer over standard fiat currency makes it likely that they will avoid debasement and function as designed. Since they are open source, as flaws are discovered the protocol can adapt rather than collapse. These open-source systems are how the internet functions (see TCP/IP and SMTP). There is hope that open source protocols for value transfer may work as well as those for sending other kinds of data, such as email, around the world without the guiding (or meddling) hand of central governments and/or big banks.
But Digital Currencies Aren't REAL!
Krugman and Greenspan may argue: Aren't digital currency systems just a big Ponzi scheme - a high tech version of the Dutch tulip mania from 1637 where a single bulb peaked at a price that exceeded 10 years of wages for a skilled craftsman?
Krugman and Greenspan's skepticism of this new currency seems to forget Milton Friedman's observations about the monetary practice on the Island of Yap (aka The Island of Stone Money):
Their medium of exchange they call fei, and it consists of large, solid, thick, stone wheels ranging in diameter from a foot to twelve feet.... [A] noteworthy feature of this stone currency ... is that it is not necessary for its owner to reduce it to possession. After concluding a bargain which involves the price of a fei too large to be conveniently moved, its new owner is quite content to accept the bare acknowledgment of ownership and without so much as a mark to indicate the exchange, the coin remains undisturbed.
What was the actual value of Fei? There was none, except in the minds of everyone that accepted it as currency. Mark Twain's Tom Sawyer aptly captures the dynamic of a money system based on scarcity - even when scarcity is measured in the opportunity (rather than the obligation) to paint a picket fence: "[I]n order to make a man or boy covet a thing, it is only necessary to make the thing difficult to attain."
Satoshi, creator of bitcoin, showed us a means to create scarcity not of a a physical asset such as gold (which is a natural propensity) but of a digital asset. Satoshi, through cryptography, has inverted this precept to enable scarcity where none would otherwise exist.
But Digital Currencies Prices Fluctuate!
All currencies and assets fluctuate in price (just look at gold and the foreign exchange markets). We've never seen a decentralized digital currency before, one would expect a discovery period to determine its value. If it becomes more widely adopted, with more people owning bitcoins and a more developed infrastructure, it will ensure that the volatility is significantly reduced.
Several articles have noted that the fluctuations in price make bitcoin a poor medium for exchange; however, they fail to note that many businesses are beginning to accept bitcoin as a currency despite the volatility. To hedge against the volatility, many websites that accept bitcoin do so on the front end then immediately convert it to dollars (reddit for example does this). In the case of newer digital currencies that clear nearly instantly, such as Ripple, the fluctuations in the currency can be mitigated and made nearly irrelevant. Digital currencies as a protocol for transactions work in such a way where fluctuations in the currency are not that relevant.
The Benefits of Digital Currency:
Rather than a mere technical feat, digital currency actually delivers seven transformative benefits over legacy financial infrastructure:
1. Nearly Instant:
Our 50 year old check, credit card, and ACH systems take time to clear. Digital currencies like bitcoin also take some time to clear, but new digital currency protocols, like Ripple, clear transactions nearly instantly - eliminating lag times and the resulting settlement risk of legacy systems.
Because digital currency runs as a decentralized protocol on the back of the public internet, the cost is essentially zero - a huge economic advantage over proprietary financial networks supported by governments and corporations. Current interchange fees for credit and debit cards constitute 1-3% of all transactions and can be especially onerous to small businesses both for the fee and also the risk and headaches of charge-backs (however, it should be noted that bitcoin mining to support the network does require computational power supplied by electricity and rewards successful miners with a fee paid in bitcoin). Charging small items, such as coffee, the interchange fees can take a large portion of the profit. Small transactions and small businesses are therefore uniquely benefited by such a digital currency protocol.
Further, digital currencies will likely disrupt the global remittance market which is around a $500 billion industry and growing at 8.5%. The industry average cost for transmitting money as a remittance, usually from from developed to developing countries, is around 8.93%. Thus currently over $44.65 billion is spent just on transmitting fees.
The digital currency protocol significantly reduces the resources needed to run financial networks and allow for third parties to build innovative new services on top of the protocol: QR code merchant terminals, P2P payments systems, FX exchanges are all brought into the realm of the possible with much less cost and complexity to execute.
2.0 digital currency protocol alternatives like Ripple are being designed to be currency agnostic, meaning that the aforementioned benefits can also apply to any and all currencies or things of value around the world rather than just Bitcoin. Free trade and unimpeded capital flows are all more easily supported on the back of a protocol that enables the unimpeded movement and conversion of value between any two parties.
As Satoshi, creator of bitcoin, explained in his original paper, "We have proposed a system for electronic transactions without relying on trust."
The ability for individuals and entities to diversify away from sole reliance on governments and banks for money, is a benefit to those who want an option to "trust in math" rather than politicians or bankers to manage currency and verify transactions.
Finally, extending access to electronic money far beyond the minority of people that have access to banking today is in itself empowering and potentially democratizing. For those who can't qualify for a credit or debit card, transacting online can be very difficult. Bitcoin and related protocols empower anyone with an Internet connection to participate in global banking and finance. As Marc Andreessen, co-founder of Andreeseen Horowitz, notes:
. . .hundreds of millions of low-income people go to work in hard jobs in foreign countries to make money to send back to their families in their home countries - over $400 billion in total annually, according to the World Bank. . .banks and payment companies extract mind-boggling fees, up to 10 percent and sometimes even higher. . .Switching to Bitcoin, which charges no or very low fees, for these remittance payments will therefore raise the quality of life of migrant workers and their families significantly.
New digital currencies are censorship resistant. Traditional payment processors are easy to regulate either through legislation or by political pressure. This could be seen by payment processors shutting off donations to Wikileaks, but digital currencies are still accepted.
As Krugman/Greenspan argue: Bitcoin's impact may be no greater than tulip bulbs, just as there was a belief that the internet might have no more impact on the economy than the fax machine. Who can forget Western Union's decision to stick with the telegraph rather than adopting the telephone because "This 'telephone' has too many shortcomings to be seriously considered as a means of communication. The device is inherently of no value to us."
Wanting these things to be so is not the same as reasoning them to be so. It seems that many of the fears of digital currency expressed by Krugman and Greenspan are linked to its potential success rather than its shortcomings. There have recently been many pieces on the current shortcomings of bitcoin technology, these pieces accurately reflect many of the problems with an early generation technology and not the actual potential of future digital currencies to overcome these shortcomings.
The U.S. government prints the US motto, "In God We Trust," on its coins and currency, perhaps to dissuade fears about our fiat currency. I propose that the digital currency crowd aptly counter with: "In Math We Trust."Derek Khanna was listed in the Forbes 30 Under 30 for Law and Policy for 2014. He is a Yale Law Fellow, columnist and policy expert. He wrote the House Republican Study Committee Memo on reforming copyright law and spearheaded the campaign on cellphone unlocking. Follow him on Twitter.