This article was written when reached nearly 20,000 USD. Although it has dropped significantly, the theories discussed in this article are noteworthy for future political and economic decisions.
With the price of gaining huge strides the last couple of weeks, it has gained a lot of media attention. This has caused many prominent economists to decry as a ponzi scheme and a bubble that has far exceeded its intrinsic value. Many have also accused of being created out of thin air and having no intrinsic value. I seek to address some of these issues and argue that regardless of the so called “inflated hype” surrounding – technology, decentralization, and a mistrust of centralized authority is here to stay.
Introduction
Every couple of centuries a new technology revolutionizes the political, social, and economic arena, completely turning upside down the known world paradigm and creating a new one in its place to stand for centuries. The agricultural revolution radically changed the way in which humans interacted with one another and influenced their lifestyle. A band of nomads could settle down and provide exponentially more than they were able to before, resulting in a huge population boom. Prior to the fifteenth century, the power of knowledge was focused in the hands of the oligarchies and aristocrats. The common folk relied heavily on religious leaders and those of the ruling class for knowledge on things ranging from science to religion. The printing press was invented around 1440 A.D. and endowed the common folk with the chance to be literate and knowledgeable (Dittmar 1). A monotonous shift in power took place, resulting in radical change in government, philosophy, science, and religion. Then came the era of the industrial revolution, making the work of man much more efficient and contributing to another population boom due to the increased effectiveness and production (Ecology Global Network). As the 1900’s ended, the installment of the internet was such a vast leap in progress that the possibilities were endless. The communication gap was bridged, and people thousands of miles apart could now interact. But it doesn’t end there, within the last decade or so, the development of technology and the subsequent innovations such as , has led to foundational paradigm shift in the way the trust gap between central banking, government regulations, market contracts, and third party mediators has been filled. Although many have criticized as being a financial bubble and an outlet for criminal activity, this paper seeks to explore the viability of these claims and establish the innovative possibilities that come with and the underlying technology of . Namely the paper will outline ’s ability to resolve the double spend problem, its deflationary nature, and its capacity to avoid state monetary control. These factors and more have revolutionized the way in which society views economics, , and gives a glimpse into the limitless possibilities that accompany and the other cryptocurrencies.
What Is ?
On October 31st, 2008 a man under the pseudonym Satoshi Nakamoto released his white paper to a cryptographic list entitled, “, a Peer-to-Peer Electronic Cash System.” In this paper, he explained how a digital system would be designed to circumnavigate the “third party problem” and allow for a confirmation process that avoided any sort of double spending problem. In the words of Nakamoto, he points out a pressing demand: “What is need is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party” (Nakamoto 1). Essentially, Nakamoto established a system in which economic transactions could be completed without the aid of mediation, extended transaction times, and solved the perpetual problem of double spending (Nakamoto 2). is a digital currency that can be traded, liquidated, or saved depending on the need of the individual. has recently gained widespread traction, is accepted by many retailers, and functions just as any other currency. While fiat currency is issued by a central bank, and the money supply and monetary policy is tweaked via legislation and governmental needs, is unique because its of transactions is decentralized across all the nodes that connect to the network and requires no centralized authority that checks for double spending. can be spread across all nodes of the network because of the technology known as . is a recording of all transactions that have occurred. With each new group of transactions, a new block is added to the network creating a chain of transactions. It is spread out across every computer that connects to the network and to hack such a system, every past transaction also must be changed. To do so is nearly impossible and requires that the hacker possesses control of over half the network power. Such an event is so unlikely it is negligible (Nakamoto 8). Essentially the “crowd” acts as the mitigating source to ensure the integrity of the network (Nakamoto 3). It is important to recognize that technology and are intertwined and the key ideas behind would not exist without .
How Is Made?
A finite number of is created by people that participate in a process known as mining. This is an important part of because as a result, transactions are completed relatively fast and it makes it nearly impossible to hack. This process of mining is incentivized by earning to decrease payment transaction times. Essentially the miners will solve a complex math problem (hash algorithm) that confirms transactions occurring around the world into a block. These hash algorithms can be described as very difficult to solve but relatively easy to verify. The miners that complete the block first is verified by the rest of the network, checking the correctness of the math problem, and the successful miner is awarded X amount of (Nakamoto 4). Initially a successful miner would earn fifty bitcoins for each block compilation, but approximately every four years that amount is reduced by 50%, this is known as halving day. , just like other currencies is heavily dependent on the prevalence of circulation and use i.e. the faith of those that invest in cryptocurrencies. Essentially, this mining process is how comes into circulation and widespread use. This functions like any other stock or currency. The perception of the public towards a commodity is a determining factor of the viability of a certain currency. Many have criticized for not meeting the requirements of a conventional currency which are: 1. Scarcity 2. Fungibility 3. Divisibility 4. Durability 5. Transferability 6. Acceptability (Functions of Money). Many people are seemingly confused by the value of because of an inherent misunderstanding of medium of exchanges. is analogous to other monetary currencies such as the USD, Yuen, Peso, etc. The total amount of is 22 million, it is divisible up to the eighth decimal place, homogenous in the way it is programmed, does not erode over time, and is easily transferable between wallets; thus, fulfilling the economic standards for currency.
Negative Financial Bubbles
Those optimistic about will say it is a long-term bull market, but skeptics accuse of being a bubble. A bubble can be defined as having a market price that exceeds its intrinsic value. Economists Peter Schiff, an outspoken critic of the housing market prior to the 2008 crash said: There’s certainly a lot of bullishness about and cryptocurrency, and that’s the case with bubbles in general. The of bubbles fuels it. You just become more convinced that it’s going to work. And the higher the price goes, the more convinced you become that you’re right. But it’s not going up because it’s going to work. It’s going up because of speculation” ( Bear Peter Schiff). As Schiff correctly identifies, bull markets typically attract investors that know little to nothing about the market. Because of this, it causes a false impression for outside speculators resulting in a quick increase in purchases. This inflates the “ bubble” and according to some theorists, the bubble will come crashing down upon reaching a price where many people will try and cash out. The volatile nature of the market has many people skeptical and worried of huge losses. The main concern with ’s stability is that one who does not liquidate their investments could find themselves with little to nothing in a matter of weeks or months if the so called “bubble” collapses. John Fry draws upon statistical and physics principles to model potential negative bubbles in the cryptocurrency markets: “recently developed econophysics models for negative bubbles also provide a useful description of cryptocurrency markets. Evidence for a negative bubble is found from 2014 onwards in the two largest cryptocurrency markets and Ripple” (Fry et al 351). Fry’s statistical modeling seems to find a strong correlation of negative bubble characteristics. His modeling is based on past crashes in market sectors that are compared with the current cryptocurrency markets. Fry continues with his comments on the lack of sustainability: “Further, evidence suggests that there is a spillover from Ripple (XRP) to that exacerbates recent price fall in . This finding does reflect both concerns raised about the long-term sustainability of ” (Fry et al 351). With the inception of , it controlled a huge majority of the market share. Fry is implicating from this study that potential competition between other alternative currencies could aid in harming the integrity of pricing. The evidence he uses suggests that the spillover that occurs between cryptocurrencies are symptoms of a negative bubble. Financial bubbles are of concern because many that chose to go into the market could be hurt dramatically. Additional concerns about the “ bubble” is the potential for both endogenous and exogenous shocks. Competition between cryptocurrencies is expected, but any crashes to the network, potential hackers, and government legislation can drastically affect the market and cause a crash. Although this is potentially true for all stocks, Schiff and Fry are concerned that the current “ bubble” identified fluctuates much more and could lead to dramatic financial harm. Additional comments on how the government regulatory bodies effect markets will be discussed below.
Legality, Regulation, and Government
As mentioned, has often been accused of being part of a criminal network. This is the case because of its capacity to avoid state monetary control (Gruber 141). Because of these reasons, some governments have sought to regulate or ban it. In 2014, Russian legislation called a “money surrogate” and passed into law fines and punishments to dissuade the use of cryptocurrencies. The difficulty that comes with regulating a decentralized currency has caused many governments to pass no laws. In the case where regulation is attempted, it is typically fines or prison sentences (Hendrickson et al 189). In Hendrickson’s recent study, they comment on the ability of government to dismantle the capacity of to be a functioning currency: “Our results call into question the view that only a large government can stymie an alternative to its preferred money. A government can prevent an alternative from circulating if it is willing and able to mete out sufficiently severe punishments” (Hendrickson et al 194). People are often under the assumption that government must be sufficiently established in the realms of most of financial institutions through a regulatory body for it to ban the use of cryptocurrencies. But this study shows that governments that enact severe punishment for use of cryptocurrencies, such as Bangladesh’s 12-year imprisonment law, may be sufficient to curtail use of it on legal markets. Economic speculators predict that these types of exogenous effects can and would impact the pricing dramatically. In the summer of 2017, banned initial coin offerings (like initial public offerings, but for companies based on cryptocurrencies) and threatened to ban all transactions containing . This had a massive exogenous effect on , resulting in a thousand dollar drop. It is important to note that a couple of weeks later it rose back up and exceeded its previous high (Boivard). Essentially what we can see from government action against cryptocurrencies is that it could potentially cause a huge drop in value and investors looking to cut losses may cash out of the market and cause a potential crash. Government legislation if enacted could have a huge effect on the market, thus speculators may be skeptical of entering because of the potential of big price drops following regulatory laws. Another notable example of an exogenous shock to the market was the United State’s FBI agency’s banning of the Silk Road Market (Fry et al 351). The Silk Road Market is a network of sites that use Tor browsing to avoid monitoring and detection on the deep web. It has been notoriously known for hosting criminal activity. was a currency that was commonly used on the Silk Road because of its ability to avoid detection. The banning of the Silk Road caused major drops in , but it has since risen to exceed prior high values.
The Double Spend Problem
A perpetual economic problem is transactions being fraudulent and users transferring funds they do not have. Nakamoto’s paper identifies this as a double spending problem. The issue that Nakamoto identified was that all financial transactions, especially on the internet, required mediation and the risk of fraud was typically expected. Additionally, to ensure that owners do not double spend, a centralized third party is introduced to mediate such transactions. The problem with this, as Nakamoto pointed out, is that the trust is completely placed with the third party.
The Double Spend Problem Resolved
Negative factors aside, /’s ability to resolve the problem known as double spending is a fundamental leap in economic history. technology can resolve this problem using time stamp servers, and proof of work algorithms. Nakamoto said: “The timestamp proves that the data must have existed at the time, obviously, to get into the hash. Each timestamp includes the previous timestamp in its hash, forming a chain, with each additional timestamp reinforcing the ones before it” (Nakamoto 2). As explained earlier with technology, the set of items inserted into the block contains individual transactions that occurred over a short period of time. Each transaction is associated with a certain time in which it was completed and is given a unique public address. Any subsequent transactions from that address is inextricably linked and is not able to be spent twice, i.e. the amount contained cannot be exceeded. As more blocks are added on to the chain the previous transactions solidify the entire network. Essentially the addition of each block makes the network more secure and increasingly difficult to hack. The record of transactions is on every node of the network and the crowd acts as the validation source. A central bank is no longer required, and the problem of double spending is resolved. This revolutionary application of time stamps in technology has resulted in a huge network of users across the world. The implications that have followed are increased security in transactions across the world and an obviation of the need of a third party. Essentially, political, and economic perspectives on central banking and the federal reserve have been met with skepticism from advocates of cryptocurrencies opening discussion and debates on the necessity of these institutions (Atzori 12–15).
Deflation and Decentralization
The philosophy of Keynesian economics has typically associated deflationary currency with money hoarding and economic depressions. A main tenet of Keynesian thought is that the stimulation of government spending is what constitutes a economy. Many experienced mainstream economists would conclude that deflation is not good and further is not a viable commodity. This analysis of deflation is correct, but this conclusion about is misguided in what is meant by being a deflationary currency. Nobel prize winner and economists Friedrich Hayek said: “It is agreed that hoarding money, whether in cash or in idle balances, is deflationary in its effects. No one thinks that deflation is in itself desirable” (Hayek’s 1932 Letter). Hayek reflects the notion that deflation should not be considered an attractive characteristic of a currency because deflation of currency value does not mean that the economy is improving. Following Black Tuesday, the day that the stock market crashed in 1929, the Federal Reserve began to implement deflationary policies in the hopes that it would improve economic conditions. There is good evidence that bad monetary policy by the Federal Reserve had contributed to the . (F. A. Hayek, interviewed by Diego Pizano). When proponents of speak of the deflationary nature of the currency it is referring to its ability to avoid state monetary control. Therefore, is referred to as decentralized. Decentralization is the absence of a centralized server, control, or authority. In effect, the power is spread out across all users of the network and does not allow for any one node to make decisions that would drastically affect the network. Free market economic theory suggests that manipulation by exogenous forces such as government is what essentially creates bubbles, causes mal-investment, and results in detrimental results. This economic policy background is important for realizing that possesses intrinsic value by avoiding state manipulation, being finite, and filling in a trust gap between individuals that would normally depend on centralized systems. is deflationary in the sense that there is a finite money supply. This means that if factors such as circulation, widespread use, and acceptance by vendors is increasing, the value of will continue to rise. Compared to fiat currency, this offers security in the sense that no central authority can manipulate the money supply and decrease the purchasing power of consumers. Essentially the revolutionary value that offers is derived from the intersection of decentralization and deflation that regular fiat currencies do not possess. Argentina is an excellent example of a country where the use of cryptocurrencies has begun to rise. This is largely attributed to bad government monetary policy; thus, people are turning to other means to maintain their wealth.
Use of Crypytocurrency in Argentina
Bad monetary policy in Argentina have lead some economists to estimate that Argentina has an inflation rate of around 24%. People’s use of cryptocurrency is largely attributed to instability of Argentina’s currency. Moreno’s analysis on Argentina provides good insight: “For some Argentines, is a legitimate alternative to state-backed currency. ‘People using do not know technology, they are not financially savvy. They are every day people using , not because they think it is cool or glamorous but because it solves a problem’” (Moreno 8). In the United States the use of has been associated with political movements such as the Libertarians, but Argentina is an example of cryptocurrency use not because of an inherent mistrust in the state, but rather a medium to preserve wealth and improve the lives of individuals living in conditions that provide little financial stability. As mentioned previously, it is the very “deflationary nature” and decentralization of that possesses a capacity to be a viable currency. This protects the interests of consumers because their purchasing power cannot be diminished through government legislation. Although is still in its early stages of worldwide use, this phenomenon of cryptocurrencies is unprecedented in economic history, and many governments have begun to fear the impending loss of control and undermining of central banking.
Conclusion
For many, the potential future legislation and negative bubbles presents a challenge in viewing as a viable currency, but this is severely overlooking the intrinsic value that possesses. The primary purpose of is not a get rich scheme nor a currency for criminals, but rather an alternative to the current status quo of centralized banking and fiat currency. The analysis of government regulations for , the negative bubbles, and the ramifications that stem from these issues does not present convincing evidence that is not a revolution in the political and economic sector. Although evidence is found in favor of a negative bubble, it is not the current value of , but rather technology’s decentralized immutable ’s ability to resolve the double spend problem, and its capacity to avoid manipulation by government driven policies that has resulted in a revolutionary view on and economics. Whether ’s supposed bubble will burst, and crash does not negate the fact that the underlying technology and the potential innovations of presents limitless possibilities in how the future of financial transactions, government policy, and political views will be shaped in the up and coming generation.
Works Cited
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Published at Sun, 10 Feb 2019 04:02:57 +0000
