Backgrounder: Bitcoin
The value of Bitcoin has soared over the past year. Yet, with the price of the digital currency fluctuating wildly, some fear that the bubble may be about to burst. Two historians weigh up the risks and rewards of cryptocurrencies
Bitcoin and other cryptocurrencies should be understood as part of a general shift over recent decades toward privately issued money PROFESSOR REBECCA L SPANG
Weoften imagine the history of money in terms of material and technological advances. First there was barter, then people used salt or wheat to measure value, then they went to gold and silver coins, then paper backed by gold, followed by ‘fiat currency’ (paper declared as money by a government). Now we have digital trade and mobile money.
In fact, things have never been that simple. The print revolution in Europe dates from the 1450s, but it wasn’t until the 1800s that Europeans started printing paper money in large quantities. So new technologies don’t necessarily produce new forms of currency.
It’s precisely because Bitcoin is a new technology that it has commanded so much media attention. It is a digital asset that runs on a shared (not ‘public’) ledger. It can be bought, sold or traded like a commodity; in some cases, it can be used as payment – as a currency – as well. But what’s important about cryptocurrencies like Bitcoin isn’t that they are digital or virtual, it’s that they are issued by a private (ie non-governmental) entity and allow not just private but secret transactions (‘crypto,’ from the Greek kruptos or ‘ hidden’).
Proliferation of private money today is due partly to technology but owes even more to financial-sector deregulation. This is not just a modern phenomenon. At the beginning of the French Revolution, there was a similar deregulation. Revolutionaries extended the idea of political liberty to monetary liberty. Results were chaotic at best because, while the political message was all about national unity, monetary reality was fragmented. Popular confidence in money – always crucial – was badly damaged.
The United States between the 1830s and 1850s offers another example. After President Andrew Jackson vetoed the Second Bank of the United States (the quasi-national bank) in 1832, each state chartered its own banks, issuing their own paper dollars. Historian Stephen Mihm estimates that more than 10,000 different kinds of paper circulated. But how was a merchant in Cincinnati to know if there really was a First Bank of Nantucket, or what its bills looked like? Publishers issued ‘counterfeit detector’ booklets, but those were also counterfeited!
Proponents of Bitcoin often position themselves against governments that ‘ just print money’, but the difference between the two isn’t technology. It’s that central banks are subject to public oversight, whereas cryptocurrencies aren’t.
Of course, most of today’s money supply isn’t created by governments but by commercial banks lending funds they don’t have. Bitcoin and other cryptocurrencies, then, should be understood as part of a general shift over recent decades toward privately issued money. We don’t see private-bankissued money as different from state-issued money because they’re denominated in the same units, but history demonstrates the dangers. When money is issued for private gain instead of for the public good, fraud becomes commonplace. Every transaction becomes a conversation about how much your money is worth compared with mine.
In the 19th and 20th centuries, governments took over controlling and insuring the money supply because leaving it in private hands fuelled social and economic crises. It may be time to remember that lesson.
Bitcoin was developed to operate without a central authority, such as a government or central bank. However, the system has not been subjected to any real stress. If something ever goes wrong with Bitcoin itself, there is no one to take responsibility for the whole system.
History is littered with financial crises. Some, like the South Sea Bubble in 18th-century Britain or Tulip Mania in the 17thcentury Dutch Republic, seem to have involved a brief over-valuation of shares or assets such as tulip bulbs. Others, such as the Wall Street Crash of 1929 and the Credit Crunch, led to lasting economic damage.
Public outcry, amplified by politicians and the media, can make it appear that each financial event is catastrophic. Yet the South Sea Bubble and Tulip Mania were limited in the amount of damage they caused, while the Wall Street Crash and the 2007/08 Credit Crunch were truly damaging in comparison.
There will always be some people given to speculative behaviour. However, ironically, many investors in early bubbles (and later ones) were actually trying to find a safe home for their money. Anything that catches the public’s imagination can bring in more money and more investors. This, in turn, creates an opportunity for would-be entrepreneurs. Not all of the schemes they come up with are going to work. The dot. com bubble grew so large because a basically sound idea (that websites were going to be important) was taken too far. Some of these websites really did make money, but some did not. There is a sorting of the wheat from the chaff.
Trust has always been an important issue in financial transactions. In the past, networks of individuals, linked by family or religion, were successful in creating financial networks. This was precisely because there were powers of censure involved. People within the same family or tightknit community trusted each other.
Today, Bitcoin is attempting to build trust by removing incentives to cheat (through using software to broadcast information about transactions publicly). Also, it appeals to those who do not trust institutions or governments. Bitcoin does not use a mechanism based on social controls, as older financial networks did, but on technological safeguards. But the underlying issue of how to create trust remains.
Bitcoin has been demonised in some quarters, but it is not the first financial innovation to attract criticism. Bank money (when banks lend out paper notes in excess of their reserves), banknotes (‘merely paper’), and financial transactions carried out in ledgers or on computer screens have all stood accused of being less ‘solid’ or ‘real’ than other ‘things’. People routinely use the intangible in their daily lives – indeed, the rule of law is intangible – but sometimes get concerned when something is not visible.
As it stands, many voters (and politicians) do not understand what Bitcoin is. When it starts having real-world effects, they surely will.
If something ever goes wrong with Bitcoin itself, there is no one to take responsibility for the whole system DR HELEN PAUL