Sunday, 18 September 2016

Bitcoin is a rival central bank – sort of.

Which is possibly why Russia and some other countries have banned Bitcoin.

Central banks (CBs) issue a form of money which has value for various reasons. One is that taxes must be paid using that type of money. That creates a demand for that type of money. Also that type of money is legal tender.

Bitcoin is similar to central banks as of a century or more ago in that base money in those days consisted of gold, which of course has to be dug up out of the ground. I.e. work has to be done to come by that base money. Likewise those wishing to come by entirely new Bitcoins have to do work. (Incidentally I’m not an expert on Bitcoin, so I may get something wrong here.)

Not only is Bitcoin similar to CBs for the above gold standard reasons, but it is also similar to today’s “non gold standard” CBs in that SOME OF the new base money obtained by the private sector is obtained via work: i.e. the government / central bank machine creates and pays that money to firms which do work for government (build roads, schools, warships, etc).

So is there any merit in having two CBs running side by side: your national CB and Bitcoin? Well as far as one of the main merits of Bitcoin goes, the low costs of blockchain, that’s something CBs can easily copy. And some of them are activity considering doing so right now. So the low cost point is not a reason to let Bitcoin continue.

Second, there’s the attraction that Bitcoin has for criminals. That’s clearly not a merit.

Third, there is a vital function that traditional CBs perform which Bitcoin type CBs will never perform, far as I can see, which is thus.

Given a recession, CBs and governments increase what MMTers call “Private Sector Net Financial Assets”, which induces the private sector to spend more. (PSNFA equals government debt and base money). One way of doing that is traditional fiscal stimulus: government borrows $X and spends it back into the private sector, plus it gives $X of bonds to those it has borrowed from. Hey presto: PSNFA rises by $X.

Alternatively, the CB and government can simply do helicopter drops to the extent of $X. There again, PSNFA rises by $X.

But suppose there’s a recession, and there’s a Bitcoin type CB up and running. Would the latter PSNFA solution work? Well it probably would – at least to a limited extent. That is, any unemployed person with a knowledge of Bitcoin could do work and dig up Bitcoin metaphorical gold as a way of making a living.

Unfortunately only about 1% of the population have the requisite knowledge. Moreover, Bitcoin mining consumes significant amounts of energy, and given global warming, that’s the last thing we need to do.

In contrast, a traditional CB can create money to the tune of a hundred times the value of all the Bitcoins in existence by simply clicking a computer mouse while consuming about a thousandth of a kilowatt hour.

Conclusion: there’s no contest. The Russians are right to ban Bitcoin. However we owe a debt to those who set up Bitcoin for showing us how blockchain can be made to work. 

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