On 11 April, it was reported that the ill-starred antagonists of the Facebook saga, the Winklevoss twins, had accumulated an $11m hoard of Bitcoins – the electronic money touted as an alternative to conventional currencies such as the pound, the euro or the US dollar.
Unfortunately for the twins, Bitcoin’s reputation as an innovative and revolutionary financial technology does not stand up. Advocates hold Bitcoin to be the world’s first virtual currency. Conventional money, it is claimed, was originally gold and silver coins. Then some bright spark had the idea that coin money could be lent and borrowed, and credit was born. Later still came the invention of banks – institutions that specialise in building superstructures of credit on the foundations of physical money. The result is that, today, we have a messy, mixed system, in which some of our money is virtual – for example, the deposits we keep at our bank – and some of it is physical, such as the coins and notes the bank is obliged to pay us if we want to withdraw those deposits in cash.
Bitcoin, the story goes, finally breaks free of this haphazard financial history. It is money that exists only in the ether. It consists of nothing other than bits of information, to which its users agree to assign value. Unfortunately, the history on which this exciting prospectus is based is wrong. The truth is that all money is virtual and always has been, because money is just a set of ideas: a concept of monetary value that can be applied to more or less anything; the rules for keeping credit accounts using units which measure that concept; and the principle that such accounts can be offset against one another. Money is simply transferable credit.
It is true that any number of physical things have indeed been used over the ages as currency – from precious metal coins to paper notes, strips of leather and even fish. But these are just tokens. It is what they represent – the underlying and ever-fluctuating balances of billions upon billions of virtual credit and debt relationships – that is, and always has been, money. So all money is virtual: you can’t actually see or touch a pound or a dollar – rather than a pound coin or a dollar bill – any more than you can see or touch a Bitcoin.
All right, its advocates will say, Bitcoin may not be the world’s first virtual money, but it is the world’s first private one. This is important, they argue, because money issued by the state is for fools. States have a long history of abusing their currencies. When they’re strapped for cash, they overissue money to pay their bills: witness the Bank of England, which has cranked out 375 billion freshly printed pounds since 2008 and now owns a quarter of all government debt in gilts. When booms turn to crashes and banks go bust, states impose arbitrary taxes on people’s savings to pay for the clean-up. Just ask wealthy Cypriots, who have seen 60 per cent of the value of their bank deposits vanish overnight. Fortunately, the miracles of the internet allow private money, for the first time, to compete with conventional money. At last, there is a way to escape the monetary debauchery of the corrupt state.
Again, the truth is a bit different. The habit of improvising private moneys in order to avoid the currency of an irresponsible or predatory sovereign is as old as finance itself. Private moneys are everywhere today, from community currencies such as the Brixton and Bristol pounds to the credit chits issued by babysitting circles. In Switzerland, there is a private credit money – the WIR – used by nearly 60,000 businesses that settled close to £890m of payments in 2011.
But if Bitcoin is neither the world’s first virtual money nor its first private money, what about its most important claim of all, the thing that got the Winklevosses involved – the claim that while a central bank running the printing presses at full blast is certain to destroy the value of conventional money, the strictly hard-coded limit on Bitcoin issuance will make it the only money that can keep your nest egg completely safe?
At stake here is the central question about money: what determines its value? The answer does not support Bitcoin’s ambitious claims. If money is transferable credit, it is just a promise to pay. The value of such promises is not governed by the laws of supply and demand which determine the price of goods in the market. Like any other kinds of promises, their value derives from the trustworthiness of the issuer.
That the supply of Bitcoins is capped is not in itself relevant. What matters for Bitcoins, as for any other kind of money, is whether people trust its issuers to make good on their promises.
This is where private moneys always show their limitations – and where the money issued by the state enjoys an almost insuperable advantage. Private moneys work when their users are like-minded souls who share a common ideology. The limits of that shared ideology are the limits of that private money. The only issuer that embodies an ideology universal enough to make its money good for payments anywhere is the state.
There has been only one exception to this iron rule of financial history. There is one set of issuers who saw long ago that the royal road to the universal circulation of their private money was to strike a deal making them an integral part of the state. If the Winklevoss twins want their $11m investment to bear fruit, they should be hoping that Bitcoin achieves something similar. We taxpayers should be praying it does not, because the one glaring exception to the rule that private money can never grow too large to be a problem is the money issued in its trillions every day by banks.
Felix Martin is a macroeconomist and bond investor. His book, “Money: the Unauthorised Biography”, will be published by the Bodley Head in June