Bitcoin Primer: 5 Things Conservatives Should Know Following the Discovery of Its Creator
“Satoshi is dead.”
With those words, the mystery behind who created Bitcoin came to an end. Or maybe it didn’t.
Today Craig Steven Wright, a computer scientist with a doctorate in theology from Queensland, Australia, claimed to be the inventor of Bitcoin, Satoshi Nakamoto. Almost nothing is known about Satoshi, the man (or woman) who devised both the concept and the original Bitcoin program, and though Wright has offered some complicated evidence as proof, many people remain skeptical.
Here are five things small government conservatives should know about Bitcoin:
Bitcoin Was Created for Ideological Reasons
In 2009, a programmer using the pseudonym Satoshi Nakamoto (Satoshi means “reason” in Japanese) self-published a nine-page paper explaining how a digital currency could be created that would eliminate the need for centralized third-party financial institutions.
In most forms of ecommerce, a third-party acts as a mediator between the buyer and the seller for the purpose of electronic funds transfer. This mediation not only increases the transaction costs, but the ability to reverse the payments allows the financial institution to have the last word on any transaction. Although this function is necessary for the current trust-based system of online commerce, it conflicts with a core value of the super-secretive Satoshi: absolute privacy.
What was needed, claimed Satoshi, is an electronic payment system without a third-party mediator, where the buyer and seller could remain completely anonymous, exchanging goods and services without having to disclose any private information about each other. So he created Bitcoin.
The intent and motivations of the founder are usually of no concern when evaluating new technologies. However, in the case of peer-based systems such as Bitcoin, they can be a useful starting point for understanding how the project will evolve and its likelihood of success. Crowd-sourced technology projects are often driven as much by political and social concerns as they are with economics. Bitcoin is a prime example. The system is cumbersome, limited in use and has many economic disadvantages that far outweigh — at least for the common user — any advantages. The primary motivation for advancing the system is to advance concerns common to cyberlibertarians: online privacy and a disdain for fiat money.
Bitcoin Is a Form of Commodity Money
Most global currencies are fiat money — money that has value only because of government regulation or law. Fiat money is not convertible by law into anything other than itself, such as gold or silver, and has no fixed value in terms of an objective standard — its value can fluctuate based on numerous economic factors.
In contrast, commodity money is a medium of exchange that may be transformed into a commodity, useful in production or consumption. Commodity money can be based on minerals (e.g., gold or silver), found objects (e.g., shells or stones) or consumer goods (e.g., cigarettes in prison or POW camps). Although it was the dominant medium for exchange for over two thousand years, commodity money has fallen out of favor because of it limits the scope for monetary policy and other actions that alter the value of money.
Technically, Bitcoins have no intrinsic value since they are nothing more than electronic bits created by a laborious process on a decentralized network of computers. But because the supply is limited (they are rare commodity not easily produced) and their use is recognized as a medium of exchange, they are assigned a value by their users. Their worth is solely determined by what people believe they are worth.
Bitcoins Are Not Fungible
“For federal tax purposes, virtual currency is treated as property.”
With those ten words, the IRS made it more difficult — if not impossible — for bitcoin and other virtual currencies to gain widespread, mainstream acceptance as a currency for commercial transactions. Because they are now treated as property, virtual currencies are considered, like stocks, bonds and other investment property, as capital assets and will be subject to capital gains tax.
But why does this hinder bitcoins use a currency? The answer is fungibility: Bitcoins are no longer completely fungible.
Fungibility is the property of a good or a commodity whose individual units are capable of mutual substitution. For example, since one ounce of gold is equivalent to any other ounce of gold, gold is fungible. Similarly, a $10 bill is not only interchangeable with another $10 bill, it’s also interchangeable with two $5s, ten $1s, and other combination that adds to 10. Fiat currency is completely fungible.
And from the seller’s side of an exchange, so are bitcoins. If you owe me 1 bitcoin for lunch, I don’t care if you give me a bitcoin you acquired last year or one you acquired yesterday. To me, they are completely equal and thus completely fungible. But they would not be completely equal to you.
Say you bought bitcoin A for $10 in 2011 and bitcoin B for $550 in 2013. Today, however, a bitcoin is worth about $444. If you trade bitcoin A, you’d have a capital gain of $434. But if you use bitcoin B, you’d have a capital loss of $106. Since you’d have to pay the capital gains tax if you use bitcoin A, you’d be better off using bitcoin B.
While such considerations may not be a hassle for those who have few bitcoins, rarely spend them or refuse to pay taxes, they become onerous for those who have many bitcoins, use them frequently in exchanges and fear IRS audits.
Bitcoin Is Prone to Deflation and Speculative Bubbles
Deflation, a decline in the general price level, occurs when the price of goods and services decline relative to a specific measure. The value of the goods and services themselves do not have to decline for deflation to occur; all that is required is for the value of the currency itself to increase. This is exactly what has occurred for the entire existence of Bitcoin.
Imagine if you used Bitcoin to buy a cup of coffee for 99 cents in October 2011. Had you held onto those 16.5 Bitcoins, you could have used them to buy 19,800 cups of coffee in 2013 (today you’d only get 7,234 cups). Such ridiculous deflationary effects are the reason sensible Bitcoin holders (at least those that bought them when the exchange rate was low) are hoarding them, rather than spending them at their local tech-savvy coffee shop. Bitcoin is currently a speculative bubble, with people holding on to their e-wallets waiting for the “greater fools” to bid up the price of the currency. When there are no more fools left, they bubble will pop — and thousands of people will have lost real money.
To Become a Success, Bitcoin Has to Fail
Assuming it survives once the speculation bubble pops, the future of this digital currency can take one of two paths: Bitcoin will either fail to become a legitimate currency — and thus fail to live up to the vision of its users — or it will succeed in becoming a legitimate currency — and thus fail to live up to the vision of its users. Both failure and success would change the nature of the online social experiment in ways that would disappoint its most ardent supporters.
To fail, Bitcoin merely has to prove its critics right — to show that it is, at best, an unworkable monetary system or, at worst, a complete sham set up to sucker late adopters. If it succeeds, though, it will have to become a currency that can be trusted by more mainstream consumers. That will require adding such features as regulatory oversight and a centralized monetary authority — the very features of other currencies that Bitcoin was created to avoid.
Now that “Satoshi is dead,” can his creation survive as an unregulated, anonymity friendly, alternative currency for the masses?