Abstract
Bitcoin and other privately created digital currencies are beginning to challenge central banks’ monopolies on money creation. These decentralized cryptographic payment media could ultimately displace legacy banking, finance, and Payment services at a lower cost across the globe. These currencies are likely to continue experiencing a faster rate of improvement than traditional payment media and require less force for safekeeping. This chapter explores some of the forces that led to the rise of Bitcoin including the ball-in tax on deposits during the Cyprus banking crisis in 2013. We also examine the relative stability of Bitcoin as a store value. We also consider new internet-based P2P lending arrangements using Bitcoin rather than dollars as a payment media. Finally, we reassess Stanley Fischer’s criticism of Hayek’s competitive private currency proposal in light of Bitcoin and other open source digital currencies.
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Notes
- 1.
Cameraa et al. (2013), demonstrated this result in some carefully designed experiments in which participants voluntarily choose to use monetary tokens.
- 2.
Except in special locations such as Panama, such dollars are not generally legal tender outside the United States or its territories. Their use is widespread but informal.
- 3.
The Internet has created more efficient P2P matching mechanisms. Some of the new pairings represent the sharing economy, e.g. car rides (Uber https://www.uber.com) and rooms (Airbnb, https://www.airbnb.com), while others improved P2P pairings match investors and loan applicants. Two of the most prominent lenders are Prosper (https://www.prosper.com) and Lending Club (https://www.lendingclub.com).
- 4.
Champagne (2014) assembles a compendium of Nakamoto’s writings on Bitcoin from November 2008 to 2011 together with responses and enquiries from others involved in the project.
- 5.
Ripple operates with a more traditional corporate/employment structure than Bitcoin. It has different mechanisms to build consensus and distribute coins (XRPs). This MBC has also sought to establish direct banking relationships in part to facilitate global financial exchange. See ripple.com.
- 6.
There are no definitive estimates of the number of Bitcoin users. The number of outlets accepting Bitcoin was 100,000 (Curthbertson 2015). As of late October 2015, the number of Bitcoin wallets was about 4.6 million according to blockchain.info with the leading American Bitcoin banking outlet, Coinbase, having 2.7 million users. A lengthy discussion of the pitfalls in estimating the number of users puts the figure at 2.5 million in early 2014, https://bitscan.com/…/how-many-people-really-own-bitcoins-and-why-d.
- 7.
The code slowly changes to incorporate improvements, e.g., to scale up. But a real shift in the underlying protocol would require close to unanimous assent. Otherwise, a large fork in the Blockchain could disrupt the overall viability of the Bitcoin project. Most users would have an incentive to avoid such a possibility. Thus, while majority rule protects the integrity of the blockchain, a higher threshold of mutual agreement would be necessary to introduce significant changes in the protocol.
- 8.
“In its origin [money] it is a social, and not a state institution. Sanction by the authority of the state is a notion alien to it. On the other hand, however, by state recognition and state regulation, this social institution of money has been perfected and adjusted to the manifold and varying needs of an evolving commerce.” (Menger 1892).
- 9.
(Bob) Metcalf’s law asserts that the value of the network is proportional to n2, where n = the number of network nodes. If there are n nodes, then there are n * (n − 1) possible P2P pairwise network connections, distinguishing between ordered pairs. Finally, n * (n − 1) = O (n2) in Landau’s symbol.
- 10.
That is, Bitcoin and Ripple have a fixed supply of coins in the long run. The growth component for Bitcoin over the next 25 years is about 2 %, near the FOMC’s current inflation target. Some of these alternative currencies to Bitcoin have exogenous growth components. Also, some, such as Freicoin, have a demurrage (usage) fee, to encourage use; see Keynes (1961, 353–358). An economy based on Freicoin might be able to avoid the nonstandard monetary policies that the FED and other central banks have followed recently in the aftermath of the Great Recession.
- 11.
Satoshi (Champagne 2014, 281–282), explicitly compares Bitcoin with gold. He notes that while it possesses none of gold’s metallic features such as corrosion resistance, it does have “one special, magical property, [it] can be transported over a communications channel.”
- 12.
Strictly speaking, as implemented Bitcoins only have a limited degree of anonymity since the blockchain lists all transactions. More invisible MBCs are being created such as Dash.
- 13.
The transaction costs of holding gold are not small. Among other costs, commissions on buying or selling coins can be 5–6 % while insurance runs as much as 1 to 1-½ % per year.
- 14.
Hayek (1962) explores the history of thought of this concept.
- 15.
Guidotti and Rodriquez (1992) presents this long-run reversal of Gresham’s law in an optimizing framework.
- 16.
It was altered numerous times, e.g., to assuage U.S. silver mining interests. Of course, gold (or silver) discoveries would alter prices. Moreover, the prices of precious metals depend on demand and supply. But supply put onto the open market occasionally depends on the behavior of nation states. Together with the IMF, governments remain the largest holders of gold bullion. Accordingly, the incentives of these players may lineup with political and not necessarily economic objectives. Finally, one reason that gold often tends to accumulate in the hands of nations is the considerable amount of force needed to safeguard it, e.g. at Fort Knox. Monetary instruments went from being in hoards held by individuals (Peebles 2008, 235), to being held in financial institutions. There is no reason Bitcoins couldn’t revert to this earlier form of dispersed “storage” in individual hoards, at least provided adequate safekeeping facilities appear. Alternatively, Bitcoins, could become part of the short-term liquidity pools in repurchase agreements and the like.
- 17.
- 18.
“An Empirical Analysis of Economic Returns to Open Source Participation,” Il-Horn Hann, Jeff Roberts, Sandra Slaughter, and Roy Fielding. http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.89.6697&rep=rep1&type=pdf.
- 19.
Buttonwood transactions represent preannounced meetings where a buyer with cash buys Bitcoins from a seller that has the relevant information on a smart phone.
- 20.
Chinese interest was partly the result of deliberate governmental policy in which a state-sponsored TV show portrayed Bitcoin in a positive light.
- 21.
The ECB, IMF, and European Parliament all agreed to this plan. Finally, at the end of July the Cypriot central bank agreed to a 47½ % haircut with international creditors on deposits exceeding €100,000 in the Bank of Cyprus with the confiscated funds used to recapitalize the bank.
- 22.
About a year later, the Europeans decided to extend the Cypriot bail-in strategy for all ECB bank failures. The G20 reached a similar conclusion at their Melbourne meetings in the fall of 2014. A rational depositor might now worry that that deposit insurance might not afford as much protection and thus be more willing to assume the vagaries of holding Bitcoin to avoid the potential bail-in taxes on their bank deposits.
- 23.
A prize block is found about every ten minutes. It is a Poisson process with parameter λ with λ chosen so that 2016 blocks are found on average every two weeks. Since the expected number of events is proportional to the elapsed time between prizes, or ten minutes, i.e., it follows that 2016/(2 * 7 * 24) Bitcoins are found on average in an hour.
- 24.
A kitchen-sink regression could include downloads of the Satoshi client in various countries, which is a clearer indication of more active interest than an encyclopedia inquiry. Also, the behavior of existing Bitcoiners or miners would also affect the price.
- 25.
- 26.
Margeirsson (2014) discusses the strong interest in Bitcoin on Iceland.
- 27.
As of late July 2015, one Auroracoin is worth a little over 3¢.
- 28.
This possibility was anticipated by Margeirsson (2014).
- 29.
We believe Bitcoin’s strength lies in the absence of any central authority of any kind. Ironically, this decentralized structure has also arguably been its Achilles’ heel, as Moore and Christin have chronicled in their study of continuing problems plaguing a number of exchanges (Moore and Christin 2013). Well before Mt. Gox’s bankruptcy in 2014, they showed that nearly half of all Bitcoin exchanges had disappeared in the previous 3 years. We believe these are temporary problems reflecting the newness and complexity of the technology and the naiveté of the entrepreneurs who started exchanges. These failures are to some degree implicit in the volatility of market price quotes from Coinbase that we use in this study. But without further information, we are not able to break them out.
- 30.
There is growing interest in Argentina in Bitcoin, see http://www.nytimes.com/2015/05/03/magazine/how-bitcoin-is-disrupting-argentinas-economy.html?_r=0.
- 31.
- 32.
- 33.
- 34.
- 35.
- 36.
- 37.
The problem is that the price of Bitcoin fluctuates at a relatively high frequency, and the chart only gives the results on a monthly average basis.
- 38.
- 39.
- 40.
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Porter, R.D., Rousse, W. (2016). Reinventing Money and Lending for the Digital Age. In: Tasca, P., Aste, T., Pelizzon, L., Perony, N. (eds) Banking Beyond Banks and Money. New Economic Windows. Springer, Cham. https://doi.org/10.1007/978-3-319-42448-4_9
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