5/9/2012 Portland, Oregon – Pop in your mints…

We would be remiss here at The Mint if we did not enquire and make an honest attempt to understand the phenomenon of bitcoins.  Bitcoins, according to wikipedia, are units of a peer-to-peer digital currency.  They are a purely digital attempt to solve the eternal problem of what to use as money.  Are they to be trusted?  Lets take a look.

First, we must look at them from a purely conceptual standpoint.  Are they money?  Yes, bitcoins, as we understand their operation, meet our pure definition of money in the sense that they are not debt.

However, they have a rather severe limitation in that universal or even regional recognition as money in exchange and convertibility to other forms of money could prove elusive.  This is a psychological barrier that theoretically could be overcome, however, it is difficult to assume that a majority of persons would, in time, learn what a bitcoin is and then take the time to sign up for and monitor a bitcoin account.

The market penetration for bitcoins could be as large as the number of internet and mobile phone users in the world but would more likely be similar to that of banking customers who use online and mobile banking services.  In other words, those who are comfortable storing a portion of their wealth in a digital media.

Given the barriers to recognition and acceptance, at this point, bitcoins are probably best thought of as a share of stock in an amorphous payment clearing mechanism whose business model consists of the free exchange of its own shares of stock between account holders and the constant validation of transactions and subsequent logging of ownership of said shares.

These shares, then, would need to be converted into a local currency to be of use outside of the realm of bitcoin account holders.

The validation of the exchange and the logging of ownership of the bitcoins must be done by someone for the bitcoins to maintain their integrity and therefore any value which others may attach to them apart from a fickle monetary premium which is, at present, compromised by the barriers of recognition and convertibility refered to above. 

This validation is currently undertaken voluntarily by the bitcoin account owners themselves and is accomplished by the users offering their resources, in the form of computer processing power and the use of computer hardware and electricity which makes the processing possible, to the greater bitcoin network for this purpose.

In return for the computer processing power and use of hardware and electricity which they dedicate to these processes, the bitcoin account owner receives a quantity of newly created bitcoins in exchange for the completion of a set quantity of computing (read bookkeeping and auditing functions) completed.  These newly issued bitcoins serve to dilute the overall stock of the existing bitcoins. 

The process of bitcoin creation realized through computer processing is refered to as “mining,” a name which is a fairly accurate description of the way in which bitcoins come into creation, even though the process more resembles accounting than strip mining.

As of this writing, we understand that mining bitcoins on a small scale is not profitable, which in layman’s terms means that the cost of the electricity needed to perform the computer processing involved in mining is greater than the amount of bitcoins which would come into existence as a result of the computer processing performed. 

This calculation is naturally expressed in dollars as we are not yet aware of a utility company which accepts bitcoins as payment for electric bills.

It would then follow that bitcoin creation would slow as long as this price relationship exists.  We will ignore, for the sake of simplicity, the fact that a great deal of bitcoin “mining” is done via bots which use the electricity and computer processing capacity of unwitting hosts, which makes mining profitable for some at the expense of others, and simply state that bitcoin creation, on net, is currently a losing proposition.

The fact that the mining of bitcoins is not profitable should make the existing bitcoins more valuable in the future as the stock of bitcoins will either cease to be diluted will be diluted at a lower rate.  This would theoretically cause the value of bitcoins to increase until it again became profitable to “mine” them, which in turn would lead to an increased rate of dilution of the bitcoin stock and lower relative value in exchange, etc.

In this sense, the economics of bitcoins is similar to that of mining precious metals.  Another similarity that the bitcoin has to precious metals is that theoretically there is a logarithm which ultimately will place an absolute limit on the number of bitcoins in existence.  The logarithm places a mathematical limit to the stock of bitcoins in the same way that nature places a theoretical limit on the extractable amounts of precious metals which can be used as money.

However, bitcoins have a distinct disadvantage to precious metals owed to the fact that bitcoins require constant bookkeeping and auditing to maintain the integrity and therefore value of the bitcoin as money.  Precious metals, on the other hand, do not rely upon administrative functions to maintain their value and rely entirely upon their relative value in trade.

Further, we must assume that the bookkeeping and auditing needed to maintain the integrity of the bitcoin will increase exponentially as bitcoin production approaches its logarithmically imposed limit, just as the incentive to perform these functions (mining, as it were) continues to diminish.

Given this inevitable dynamic, it is unclear if the integrity of the system can be maintained once the incentive to maintain the integrity of the system, which is currently supplied by the ability to “mine” bitcoins, is removed. 

Having said all of that, it is now time to point out the obvious flaw in the bitcoin model, the flaw which lands bitcoins squarely in the realm of equity and makes them unfit for long-term use as money:  The threat of competing digital currencies which would surely come into existence if the bitcoin were to gain widespread popularity and acceptance.

Even with the digital checks and balances on production which are mathematically built into the bitcoin model, the bitcoin, like gold, silver, seashells, and fiat currency, fails to completely solve the happy problem which has no solution:

That the infinite increases in trade due to the increased division of labor in the world will require money and debt markets with the flexibility and dynamism that only a completely free money supply can offer.

Gold and silver may hit physical limits, bitcoins may be limited by logarithms, and debt based fiat currencies tend to collapse upon themselves.  This is proof that none of them, by virtue of physical and psychological limitations, completely fulfill the role of money for man.  They were never meant to.  

The determination of what will serve as money must be left in the hands of the people who are involved in trade.  Left to their own devices, we would be amazed at the speed and efficiency with which the problem of what is money can be solved.

In other words, let those engaged in trade decide what is most suited as money at a given time and allow them to trade with it without hindrance.

For it is not the costs associated in the production of a monetary unit which remove value from the economy, rather, the administrative burdens, unnecessary conversion costs, and the rigidity of an imposed monetary unit which deals mortal blows to trade and consequently the ability of all humans to flourish to the greatest of their abilities. 

Unnatural restrictions on the money supply, which solutions like bitcoin attempt to solve, are devastating to trade.  The destruction wrought by monetary hegemony should surpass hunger, poverty, and climate change as global concerns, for allowing a free money supply to operate would serve to eradicate all of these problems and their symptoms, namely social unrest, terrorism, and health care crises.

Imagine.

Stay Fresh!

David Mint

Email: davidminteconomics@gmail.com

Key Indicators for May 9, 2012

Copper Price per Lb: $3.70

Oil Price per Barrel:  $96.42

Corn Price per Bushel:  $6.41

10 Yr US Treasury Bond:  1.84%

FED Target Rate:  0.16%  ON AUTOPILOT, THE FED IS DEAD!

Gold Price Per Ounce:  $1,589

MINT Perceived Target Rate*:  0.25% AWAY WE GO!

Unemployment Rate:  8.1%

Inflation Rate (CPI):  0.3%

Dow Jones Industrial Average: 12,835

M1 Monetary Base:  $2,275,100,000,000

M2 Monetary Base:  $9,832,700,000,000