Banking v Bitcoin explained… and how to fix Bitcoin

All arguments in support of Bitcoin refer to its use as a medium of exchange. There are no problems with that aspect of it — in principle. In practice, Bitcoin is less than perfect due to its wild valuation swings. These derive in part from the fact that it has no fixed face value.

More of that in a moment. 

The main point of contention is the idea that so-called “miners” are doing work to create the coins, and should be rewarded in Bitcoins. This also sounds a perfectly reasonable assertion.

But it is not.

To understand why, we need to separate the two aspects of money:

  1. Its creation, and
  2. Its use.

In terms of use, Bitcoin’s “messaging” approach has a lot going for it. It allows for secure transactions between parties who are unknown to each other. The trouble is that, once made, the transactions cannot be reversed. I’m also concerned about the huge amount of computing resources and electricity required to operate the system. Nevertheless, its technical design may offer a possible solution for creating a true digital currency.

What I mean by a true digital currency is one that has all the desired attributes of money.

Use of money

A key attribute is that it should have a fixed and stable unit of account — a face value. Bitcoin is neither fixed nor stable.

The sole purpose of money is to record the value of a transaction, so that the person receiving the money can use it in turn as a valid claim on other resources of exactly (not more or less) equal value. It is the reason why central banks are charged with keeping inflation within a few percentage points per annum.

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When you are paid in dollars (with a fixed face value), you understand clearly what you are getting. You can readily account your profit and loss. Given its huge swings in valuation, with Bitcoin this is impossible.

But that is the least worry.

Creation of money

Banks create new money through lending. However, the new money they create has no impact on their net worth. Their Liabilities (Deposits) go up at the same time as their Assets (Loans). It is as simple as making two simultaneous entries in the books of the bank: Debit Loan to Borrower $100 (Asset) while you Credit Deposit account in the name of the same Borrower $100 (Liability). The Loan records the Borrower’s debt, while the Deposit provides the avenue to draw down the Loan — to get cash out. See thisBank of England paper for details.

Nor does the net worth of the Borrower change when the money is loaned. When the borrower spends the proceeds of the loan, they hand it over to the seller in recognition of the value given. Again, the net worths of the buyer and seller are unchanged by the exchange.

This is the essence of money. It does not of itself change your wealth — money only records value that you have previously created through work and/or investment and not yet consumed. This record is in the form or a token (coin, dollar note, notched sticks), or an electronic record (your deposit record in a bank’s computer). The record itself is essentially worthless and ideally costs nothing to produce.

The basic social contract is that you put in before you take out — unless it is a loan, in which case you still have to put in by working to pay it off.

If you’ve spent all your money, it means (in economic terms only) that you have taken out all that you have put in.

When a Bitcoin miner creates a Bitcoin, their net worth immediately increases by the market value of the coins mined — and it could go on increasing by many orders of magnitude for many years.

In the case of the original miners, this could grow into the trillions of dollars — just for running a bit of code that someone else has written (unless the miner happens to have been the developer), while using huge amounts of our electricity.

This is the major reason why Bitcoin is a really bad idea. (See my previous article on LinkedIn for more detail.)

Fixing the problem

We can get over this problem relatively easily … sort of.

First, by outlawing the creation and passing of digital currencies that give the creator access to the newly created money for their own purposes (just as we outlaw the counterfeiting of paper money).

Second, by establishing regulated miners that produce Bitcoins (or their ilk) with a set value of, say, one cent per unit — and issuing them at face value to whoever wants them in exchange for legal tender. Just like buying any currency.

These regulated miners could still use the resources of the net (just as miners now pool their resources), but instead of owning the coins, they would be transferred to a central bank for a fee. It would be even better if we could find a way to get the same functionality without requiring the consumption of so much electricity. There would also need to be a way to distinguish legal from illegal coins.

As the legal alternative would offer the same functionality as the illegitimate currencies, without any of the risks, it would likely put a stop to all but criminal use of the illegitimate currencies.

Any legal tender paid for the coins would go to the central bank and be held in a vault until required (saving on printing new dollar notes). Electronic payments would similarly go to the central bank for recording and holding — they would not be handed to the miners. The miners would get fees for mining to cover their costs and make a reasonable profit. The network would also get fees for confirming transactions in competition with other settlement modes.

This ensures that the mere creation and issue of the Bitcoins does not in any way change the net worth of the person to whom they are issued.

Of course, this strips away the huge unearned windfall the Bitcoin miners are hoping for. You might imagine they would be none too happy to have this happen — though they all say they are only interested in it as a new form of currency.

About the Author

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Michael Haines is CEO and founder of VANZI (Virtual Australia and New Zealand Initiative), a stakeholder driven Initiative to develop the Digital Built Environment: “An authorised enduring federated fully-integrated secure 3D+ computer model of the Natural and Built Environment (inside and out, above and below ground) on all scales required for decision making, together with all Legal Entitlements, for every property over time” – for use throughout the Property Cycle, from planning to decommission. It is supported by buildingSMART Australasia and The Spatial Industries Business Association. He is also author of the blog:

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