A screen displays a headline banner reading “Bitcoin Hits Record High” while a trader works on the floor of the New York Stock Exchange (NYSE) in New York City on Wednesday. (Photo: Reuters)
As the price of Bitcoin hits new highs, cryptocurrencies are here to stay. What consequences will this have for money and politics?
Money depends on trust. It is only accepted in exchange for goods and services because people can safely assume that others will accept it in the future. This applies to the US dollar as well as to gold. To argue that cryptocurrencies like Bitcoin are just a game of trust – or a speculative bubble, as many economists have pointed out – is to ignore their popularity.
Still, cryptocurrencies lack the stable institutional foundations necessary to build public confidence in them. So trust rises and flows, making it fragile and volatile, as the wild spins of Bitcoin have amply demonstrated.
In addition, with Bitcoin and other cryptocurrencies that rely on “proof-of-work” mechanisms, transactions must be continuously verified and logged in a decentralized ledger (in this case based on blockchain). This requires millions of computers to work continuously to update and verify transactions – a work that is incentivized by the ability to be rewarded with re-minted bitcoins.
The energy consumption in these “mining” operations now exceeds that of a medium-sized country such as Malaysia or Sweden. Now that the world is awakened to the dangers of climate change (and our response to it so far), this massive waste should make Bitcoin highly unattractive.
And yet, despite its volatility, fragility, and massive carbon footprint, five factors have conspired to make Bitcoin an attractive proposition for many people: its political narrative; the criminal activities that it enables; the seigniorage that it distributes; today’s techno-optimism; and the desire to get rich quick, at a time when there are few other economic opportunities. Let’s look at each one in turn in reverse order.
We live in a time of dwindling economic prospects. Even employees with a university degree can no longer rely on a stable job with good and increasing pay. When economic opportunities are so tight, plans to get rich quick become especially tempting. Unsurprisingly, there is now an entire industry devoted to telling people that by investing in Bitcoin, they too can cut gold. Money has poured into cryptocurrency because millions of people in the United States and around the world think they can get significant returns on it.
The narrative of massive returns for amateur and retail investors from a cryptocurrency corresponds to our technology-obsessed age. We are constantly told that technological ingenuity creates a brighter future. And on the surface, it can’t be denied that Bitcoin is a marvel of technological innovation.
It took real creativity and mastery to create such an intricate decentralized system that could function without oversight or government enforcement.
Seigniorage, or the extra purchasing power given (typically to governments) by controlling money supply, is another factor in Bitcoin’s appeal. When the US government circulates new currencies, it can use it to buy services or pay off its debts. The prospect of Seigniorage is very attractive and probably explains why there are now more than 1,600 cryptocurrencies. In the case of Bitcoin, the lack of a centralized authority means that seigniorage is being distributed, which provides an incentive for mining efforts (which are now carried out by more than a million people around the world).
A dedicated source of demand can help a new currency create a solid base. For cryptocurrencies in general, and for Bitcoin in particular, this anchor is firmly anchored in the criminal world. In its early days, the demand for Bitcoin was increased by dark websites like Silk Road, which enabled all kinds of illegal transactions. To date, criminal activity accounts for almost half of Bitcoin transactions, according to some estimates.
Each of these four factors artificially boosted Bitcoin. Obviously, the economic ills of our society will not be solved by people making money with Bitcoin. The prevailing techno-optimistic mood has not been confirmed in the real world either. And all the advantages that the distribution of seigniorage through mining brings with it are more than offset by the massive waste of energy.
That leaves the political argument for Bitcoin. Will it free us from inadequate state power over the economy? Not really.
True, the US Federal Reserve acts mysteriously at times, and the Wall Street bailout during the 2008 financial crisis was rightly viewed as an inside job benefiting banks and bankers at the expense of ordinary people. The desire to reduce the overwhelming power of politicians and decision-makers is therefore understandable.
But bitcoin is not the answer. It appeals to a childlike libertarian ideology in which a lone genius fights an overbearing state in order to free individual excellence. In fact, the real person – or people – who designed Bitcoin and wrote their inspirational manifesto under the pseudonym Satoshi Nakamoto deserves the label “visionary” even more than the fictional John Galt (hero of Ayn Rands Atlas shrugged).
But the vision itself is pure fantasy. The risk that Western governments will create runaway inflation or undermine the international monetary system is negligible. The real existential threat today lies in political polarization, the disentanglement of democracy and the inability of democratic political systems to keep economic elites and authoritarian politicians in check.
A new currency will not solve these problems. Measures are needed to ensure that politicians, bureaucrats, Silicon Valley and Wall Street tycoons act responsibly. This requires democratic participation and active civic engagement. Gimmicks like Bitcoin distract from the actual work that needs to be done.© 2021 Project Syndicate