A Conversation on Bitcoin

Bitcoin, cryptocurrency, Chile, Ripple
Jason Benjamin - flickr

Bitcoin, cryptocurrency, Chile, Ripple


(Last month, the Chilean webzine El Libero interviewed Larry White about Bitcoin and other cryptocurrency topics.  Here is the English translation of Larry's conversation with Juan Pablo Couyoumdjian.)


1.  Bitcoin is a class of “crypto-currency,” but what, exactly, are these crypto-currencies?  How do they emerge?  And why?

LHW: Cryptocurrencies — Bitcoin and its competitors — are digital assets, secured by cryptography, that can be circulated from peer to peer like currency.

Like government fiat money, they are not redeemable at a fixed rate for any commodity or other money.  Unlike government fiat money, there is no issuer with discretion to increase the quantity at any time.  In the case of Bitcoin, the number of Bitcoin units is programmed to increase at slow and known rate.  In the case of Ripple, the top competitor, all the Ripple units to be made were made at the start.

Bitcoin originated (and remains) as a public-interest non-profit project by a programmer (who's identity is not known) who wanted to create a tamper-proof private non-state currency.  Some other cryptocurrencies arose similarly, by other groups of programmers who introduced improved designs (faster, more robust, more user privacy).  Once Bitcoin rose to prominence and considerable market value at the end of 2013 (the total value of all Bitcoins currently held is about US$3.4 billion), private for-profit competitors like Ripple and BitShares and Nxt came along with advanced designs and full-time development and promotion teams.

2.  These currencies are not only used as mediums of exchange, but also represent a sort of speculative investment, am I correct?  Is this what leads to their price-swings?  In effect, their “price” reflects their purchasing power, doesn’t it?

LHW: Bitcoin can be used at a number of websites, and at some brick-and-mortar businesses, to buy goods and services.  Payment processing companies like Bitpay are making it easier for shops to take Bitcoin.  But as far as I can tell, most transactions in Bitcoin and other cryptocurrencies are inter-currency speculative trades: US dollars for Bitcoins, Bitcoins for dollars, Chinese yuan for Bitcoins, Bitcoins for other cryptocurrencies, Dollars for Ripples, and so on.

Because the quantity of Bitcoin does not respond to the rise and fall of demand for Bitcoin, the price varies.  That is indeed why the price of Bitcoin has been volatile.  Although the price has retreated from its December 2013 peak, today’s market value is more than double that of two years ago.

3.  What type of regulation do these markets in digital currencies require?  What is the current international experience in this sense?

LHW: The most important regulation is by competition.  The cryptocurrency issuers provide openly all the information the public needs to trust them.  The source code of Bitcoin’s program (and that for other cryptocoins) is available online, as is the “public ledger” that records transactions.  Anyone can check to see that the quantity of coins in circulation is exactly what the program calls for.

The exchanges where cryptocurrencies are bought and sold (led by Bitstamp, Coinbase, Cryptsy, and Kraken) compete on fees, convenience, and security.  Concern about security has improved since hackers stole millions of dollars’ worth of BTC from the mismanaged exchange Mt. Gox, which was then the third largest, in February 2014.

I don’t see that the markets would benefit from legal restrictions imposed by governments.  Although the imposition of legal restrictions is often called “regulation,” it almost never actually makes markets more regular.  Cryptocurrency markets are still evolving.  They need freedom to discover and pursue the most beneficial technologies.

Restrictions vary across countries.  The United States’ government has begun burdening cryptocurrency providers, both Bitcoin exchanges and proprietary cryptocurrency issuers like Ripple, with anti-privacy rules.  The US government insists that any business exchanging cryptocurrency with US customers must be licensed as a “money services business” on the grounds that it could be used for funds transmission and thereby (like a bank) for “money laundering.”  To comply, a business has to collect identity data on its users (“know your customer” rules) and report “suspicious” transactions to the government.  Ripple recently paid a heavy fine for not complying promptly enough.

4.  You have been a long-time scholar of alternative monetary institutions.  To what extent does this development represent a new market innovation in the monetary field?

LHW: The traditional form of private money, as discussed in my first book, Free Banking in Britain (1984), consisted of banknotes and transferable account balances, which are IOUs (debt claims) for the bank that issues them, redeemable at a fixed rate in a more basic money like gold or silver.

Bitcoins and other cryptocurrencies are not IOUs.  I call them IOU-nothings.  This is something entirely new.  Instead of a value guarantee, backed by a contractual commitment to give the holder a certain amount of basic money on demand, Bitcoin offers a quantity guarantee.  The holder knows its value can’t be hyper-inflated away because the number of Bitcoins is governed by a secure program.  The assurance is similar to that provided by the numbering of artists’ prints.

But with a quantity that does not respond to demand, the price of Bitcoin (in US dollars or Chinese yuan) must do all the responding to changes in demand.  This makes the price of Bitcoin quite volatile.  We don’t know yet whether this price volatility will stop cryptocurrencies from catching on as a commonly used means of payment.

5.  Price stability has been said to be a fundamental element of any free society.  What is, according to your view, the best way to achieve such stability?

LHW: I think this question isn’t rightly posed.  In my view a free society means that people can use whatever kind of currency they prefer.  We shouldn’t pre-judge that they prefer a currency that produces a stable price level.

Other things equal, most people prefer a currency that better holds its value, but that doesn’t mean that government should try to stabilize the price level.  Instead it means that most people are likely to prefer a currency that gains value, over one that merely holds its value roughly unchanged.  Historically, the best money we’ve had for holding its value was the classical gold standard in countries without a central bank.  Where money was privately provided by multiple private banks, all legally bound to honor their contracts, no one bank could declare the suspension of gold redeemability.

Central banks are notorious for breaking their promises to keep a fixed rate between the local currency and gold, or between the local currency and some external currency.  And nobody can sue them for breach of contract, because they have sovereign immunity.  So the best way to achieve a monetary system where people have the kind of money they want, I would say, is one where there is free competition among currency issuers.  A system of free banking. I would expect the currency banks issue to be redeemable for gold, or dollars, or Swiss francs, or something else, depending on historical context.  Or I might be wrong, and something like Bitcoin might emerge as the most popular money.

6.  What do you think about Chile’s “monetary constitution”?  Chile has achieved monetary stability through an independent Central Bank; do you feel this is a robust institutional design?

LHW: In recent decades Chile has had lower inflation than its neighbors, especially Argentina, which is good for Chileans.  But I don’t know how robust the “monetary constitution” will prove itself to be when a fiscal emergency arises.

I note that peso banknotes have many zeroes on them, which suggests that inflation was a problem not too long ago.  The independence of any central bank is always limited by the fact that the bank is a creature of the government, which can take back the independence at any time.  In a fiscal emergency, especially under fiat money systems, formerly independent central banks tend to lose their independence and begin printing money to pay the government’s bills, more money than is consistent with low inflation.  Is your current government dedicated to fiscal prudence?


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  • http://vikingvista.blogspot.com/ vikingvista

    BTC are not extensively loaned (and reloaned) out, as was gold during free banking, or USD today. But if BTC were to replace the USD to a significant degree as a base money for banking, would you not expect market regulation of bank notes and deposits that are denominated in BTC to considerably stabilize the price of BTC? Is there any reason BTC could not be as satisfactory a base money as gold or USD?

    • Aajaxx

      I think regulation trades long-term stability for short-term stability, the thinking being "In the long term, we're dead anyway" (or, in the case of the politician, "In the even less long term, I'm retired from office.)

      • http://vikingvista.blogspot.com/ vikingvista

        I think you are right, but by "market regulation" I am referring to the price mechanism, not police action.

    • Frank Wiebe

      It is not necessary for base money to expand and contract to maintain price stability. The biggest reason for cryptocurrency instability is that the total value of any supply cryptocurrency is so low that any rich person has enough money to visibly bid the price up by making a purchase or dumping them.(a small amount of demand moves the market) If bitcoin had a market size like that of gold, silver, or most national currencies it would be just as stable as them. Metaphor: Adding or removing a bucket of water from a bathtub changes the water level more than Adding or removing the same amount from the ocean.

      • http://vikingvista.blogspot.com/ vikingvista

        Prices are discovered through bidding. So, variability in bidding will result in variability in prices.

        You are right, that a market that is small relative to individual participants can result in a relatively large bid and therefore price variability. Probably more responsible for Bitcoin’s current price variability, however, isn’t relatively large bids, but intermittency of bids. Because Bitcoin isn’t yet a money (it is not a common enough medium of exchange), people don’t often use it as a money, but rather as a speculative investment. This is also one reason the price of gold has varied so much since monies left the gold standard. Being a money, means that it is in widespread constant use, producing a more uniform bidding and price level.

        But even true long established monies (e.g. USD before and after cessation of the gold standard) can have unexpected large price variabilities. Even if the quantity of money *available* for circulation is fixed, the demand isn’t, and the actual amount circulating (contributing to bidding) is not either. Large variations in hoarding/dishoarding can result in large variations in bidding and effective supply. Likewise, people’s demand for money can vary. These changes might pervade the economy, as during a recession, or result in regional scarcities.

        It is this latter price stability that I was referring to in my question–changes in effective supply and demand of a true established money (fiat or not). In a mature economy, with a mature banking system, hoarding is aggregated and converted to loans, and through relending up interest rate gradients quickly finds its way to areas of high demand. Thus, a mature banking system smooths out the price level of a true money.

        At least, that is what I suppose, and so that is the question I was asking the experts.

        The question then, is can Bitcoin achieve price stability without a mature banking system to direct idle funds to where they are in most demand? Perhaps the true success of Bitcoin as a money won’t be seen until there is widespread aggregation and lending of idle Bitcoins. That is, Bitcoin will be money when banks receive Bitcoin deposits and lend them out.

        • Frank Wiebe

          If a currency reaches a level of stability that makes people comfortable with creating fixed prices in terms of it and absorbing fluctuations in costs I don't see how it would be necessary to have some additional reservoir into which money can expand and contract. people's savings can absorb the shock of a decrease in demand below the fixed price and the price fixing will increase overall price stability at that point. I have no clue about what else can be done to further increase price stability at that point and it isn't necessary for there to be any banking institutions to get things at least that far.

          • http://vikingvista.blogspot.com/ vikingvista

            "If a currency reaches a level of stability that makes people comfortable"

            The question is, can that happen with a rigid currency? I don't know that it has ever really been tried to a significant extent, given that banking has been around for centuries. But we do know that artificially imposed rigidities exacerbate recessions, as we see with central banks and their pro-cyclical policies. We also see that currency flexibility in a price-directed banking system can stabilize a monetary and financial system, as seen in Canada throughout the Great Depression.

          • Frank Wiebe

            The thing is, those recessions occur after a credit expansion has depleted the savings which in my description are needed to wait through periods of low demand until a period of high demand comes. And just incase you're wondering I'm talking about the normal price setting that occurs in the market that prevents the price of a coffee from fluctuating day to day. Sorry I was not clear.

          • http://vikingvista.blogspot.com/ vikingvista

            But a credit expansion doesn't deplete savings, it allocates savings. A *systemically misdirected* credit expansion can allocate savings into soon to be bankrupt ventures and in that way deplete savings (recession), but that requires a systemic misdirection–credit expansion alone doesn't do it. Without a central monetary authority, such misdirection would likely be less frequent and less severe, but probably not irradicated. Also, it would do nothing for regional and temporal money scarcities.

            I understand you expect Bitcoin savings to carry people through market variability. But it is the expert allocation of savings through banking that greatly facilitates and makes effective such savings.

            Coffee is a good example of a commodity with widespread continual use (though obviously not as widespread or continuous as a money). But without a banking system to allocate more savings to coffee production as coffee industry supply and demand shocks occur, how do you imagine the scarcity and price of coffee could remain stable through such shocks? Sure, equity speculation helps, but most of that is accomplished through lending.

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  • Kevin Dowd

    Very nice article Larry

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