A Fistful of Bitcoins: The Risks and Opportunities of Virtual Currencies

By Massimo Amato and Luca Fantacci

“Bitcoin poses the right question, but gives the wrong answer,” write Luca Fantacci and Massimo Amato in this lucid and highly original treatment of the cryptocurrency phenomenon. A Fistful of Bitcoins uncovers the paradoxes of the first “digital cash” to achieve global attention: a disruptive payment infrastructure married to a dangerous and deflationary monetary system. From the cryptographic protocols to the quasi-religious ideologies and the retrograde monetary theories supporting Bitcoin, the authors reflect on what Bitcoin gets right and disastrously wrong about our current monetary predicament. With implications for monetary theory and policy, the prospect of central bank-issued digital currencies, and the future of blockchain-based applications, this book will be of interest beyond economics, political science and management for a general public concerned about not just what money is but what money might and should become.

• Language: English
• Publisher: EGEA Spa - Bocconi University Press
• Release date: Nov 4, 2020
• ISBN: 9788831322102

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References

Introduction

The monetary and financial system in its current form is a problem. However, Bitcoin is not the solution. In fact, it risks widening the distance between money and labor, between finance and the real economy. Nevertheless, it has value as a provocation to rethink the function of central banks and to develop systems of complementary currencies that are truly able to promote, and not hinder, trade and investment.

This book is divided into five chapters. First of all, we will attempt to state as clearly as possible what bitcoin is, how its technology works, and how the technology translates into the construction of what appears to be, at the same time, a newfangled electronic payment system and an old-fashioned monetary system (Chapter 1). It is precisely this problematic aspect that has led us to study the political economy of bitcoin, that is, the causes and consequences of the spread of bitcoin as an alternative currency (Chapter 2). But bitcoin is not only a (would-be) currency; Bitcoin is also a technology susceptible to multiple applications in the commercial, legal, and political fields.*¹

Here as well, the promises of a better world are accompanied by alarming areas of darkness (Chapter 3). The fact that blind enthusiasm tends to prevail, seeing Bitcoin as a technological instrument of libertarian renewal, has led us to focus our attention on the ideology that supports and envelops it (Chapter 4). However, since the intention of the monetary reform implied by Bitcoin represents a demand that deserves being discussed, we will dedicate our concluding reflections to other ways of seeking monetary alternatives: complementary currencies (Chapter 5).

Disclaimer

The Authors have no long or short positions in bitcoin or other cryptocurrencies. They have, however, long expressed their dissatisfaction with the current monetary system, and have spent words and energy to make new monetary and financial forms possible, with a view to overcome the intrinsic flaws of money as we know it. This is a very long position, typical of a long-term investor (like Warren Buffet). We do not expect any particular personal result in the short-term, but we know that we are working in the direction of a reform that sooner or later will show its potential; not only thanks to the crisis of the current monetary model.

Although the Authors fully underwrite the entire text, we note that Luca Fantacci wrote Chapters 1 and 3, while Massimo Amato wrote Chapters 2 and 4. Chapter 5 is the result of a joint effort.

* Following widespread practice, we write Bitcoin capitalized when we refer to the technology for payment and encrypted registration of information, and bitcoin not capitalized when we refer to the currency that the technology creates and puts into circulation.

1   What Is Bitcoin?

Shall we say it immediately with a formula? Bitcoin is an extremely innovative and potentially very effective payment system associated with an antiquated and dangerous monetary system. This is our thesis, that we will now clarify and argue, starting with the advantages of Bitcoin as a payment system, to then discuss the main limits of bitcoin as a currency.

A cutting-edge electronic payment system

Just a new electronic currency?

Why should the invention of a new electronic currency cause such a stir? After all, we have been used to using such instruments for a while now. In our wallets, we have coins and paper money together with credit and debit cards. In stores, and even at vending machines at railroad stations, we can choose to pay with cash or card.

It could be said that electronic money began with Dee Hock, the inventor of Visa, over fifty years ago (Hock, 1999). Since then it has had tremendous success. The reasons are easy to understand: compared to cash, credit cards take up less room; we don’t need to exchange them at the border when we go abroad; they allow us to make remote payments by phone or over the internet; they make it possible to schedule periodic payments, for example through direct debit of our telephone bill. The advantages are not just for users, but for the authorities as well. Electronic payments are traceable, and therefore, provide tax authorities and police with a strong tool to fight tax evasion and unlawful trafficking.

On the other hand, over the years, electronic money has not succeeded in fully replacing cash. Despite the regrets of our friend Geronimo Emili,¹ who for years has promoted the spread of electronic payment systems, there are still good reasons for the survival of cash. Electronic payment technologies offer simplification and are subject to continuous technological improvement, allowing for making payments through smartphones or contactless cards, but cash maintains its advantages. First of all, it’s accessible to everyone, without the need to have a bank account or an electronic device.² Secondly, payment in cash is anonymous; there is no need to tell anyone either the identity of the payer or of the beneficiary, or the reason for the payment. It allows for hiding not only from the authorities, but also from companies, for which data relating to payments represents a goldmine to study and profile consumption habits, movements, and lifestyles. It is a way to protect privacy.

Physical money and electronic money coexist precisely because they have different characteristics. According to the circumstances, we can choose to use one or the other considering their particular advantages.

But there cannot be advantages without disadvantages, and thus the choice between one or the other is a possibility, but also a constraint; not only can we choose, but we must choose whether to use cash or electronic money.³ We can’t use both at the same time – or better, we couldn’t. Then came bitcoin.

Digital cash

Bitcoin is the first effective form of digital cash. It combines the advantages of electronic money and cash.

Like a bank transfer, it allows for remote payments; like a cash payment, it is (almost) instantaneous and entails no costs for either the payer or the receiver. Think of how such a tool could facilitate remittances from immigrants. With bitcoin, they could easily transfer savings to their family members, without having to pass through slow and costly intermediaries.⁴

Like a banknote, it is anonymous. It does not require the disclosure of the identity of the counterparties or of the reason for the payment; but being digital, i.e. being merely a number, divisible and multipliable at will, it allows for transfers of any amount, from micropayments of just a few cents to the settlement of international trade operations. There is no need to think of unlawful trafficking or tax fraud. The benefit of anonymity could also help circumvent prohibitions imposed by illiberal regimes, for example on capital movements or women’s labor, as a means of pressure for those prohibitions to be removed in a formally adequate manner.⁵

Like a payment card, Bitcoin makes it possible to pay any amount securely and in real time any place in the world; but like cash, it does not require the prior intervention of an intermediary to certify the availability of the funds and authorize the transaction. Hence transaction costs for the users are greatly reduced. For bitcoin, they are on average 1 percent of the value of the transaction, compared to 2-4 percent for traditional electronic payment systems, and the 8-9 percent of remittance services that do not use the banking system (EBA, 2014, p. 16).⁶ In addition to the costs, the removal of intermediaries also entails an elimination of the associated risks, such as operative, solvency, and liquidity risk (Bank of England, 2014a, p. 10).

The challenge to the dominant system

This seems to be the principal and essential merit of Bitcoin, claimed as such by its developers and supporters: to free electronic payments from the need to pass through the banking system, allowing for direct transfer of electronic money between users (peer-to-peer), without delays and without charges. From that perspective, Bitcoin presents itself as a radical form of disintermediation, that entails the subtraction of a typically public function – the management of a payment system and the related accounting – from a typically private operator – the banking sector.

From this perspective, Bitcoin’s date of birth takes on a symbolic value. The system was conceived by Satoshi Nakamoto⁷ in 2008, an annus horribilis for the global financial system, when the explosion of the Global financial crisis, with bankruptcies and bailouts, exposed the banks increasingly as the holders of a detestable oligopolistic power, the usurpers of a common good, the beneficiaries of undeserved state assistance, made necessary by the fact that they perform an essential public function, but one they seem increasingly inadequate to perform.

The first transaction in bitcoin took place on January 3, 2009. As a demonstration of its date of birth, and even more so of the context of the moment, the first accounting registration of the system – emphatically dubbed genesis block – contains a reference to a headline that day on the first page of the British newspaper The Times: Chancellor on brink of second bailout for banks. Therefore, bitcoin was born in open conflict with a monetary system that appears increasingly willing to support the banks and less and less able to support exchanges and real investments.

In the gloomy picture of a global financial meltdown, Bitcoin presents itself, and to a number of fervent supporters appears, as a promise of liberation. Thanks to Bitcoin, it is no longer necessary to make use of an intermediary to preserve and transfer one’s own money, or to spend and save it. Thanks to Bitcoin, we can be free of the yoke of the banks, escaping from their control and impositions. Anonymous, instantaneous, and secure payments, from the smallest to the largest, from the closest to the farthest, are now available to everyone, even those who do not have a bank account or a credit card.

Why Bitcoin has not (yet) triumphed

In light of its many merits, one might ask why Bitcoin has not reached a stronger position with respect to traditional payment systems. Why do we still use MasterCard for payments online, if bitcoin is priceless? Why do immigrants still trust Western Union to send money home, accepting costly commissions and long delays, when their money could arrive fully and immediately using Bitcoin? Why have the masses not definitively abandoned the money used by banks, that is costly and inefficient, to embrace this new money of the people? Why hasn’t everybody stopped worrying and learnt to love bitcoin? Is it because of technical obstacles? Inertia? Fear of change? Obtuse attachment to tradition, that is bound to be overtaken by the inexorable advance of progress?

The answer is simpler, and at the same time more precise: the new has not triumphed over the old, because Bitcoin is a payment system that, unlike the banking system and credit card circuits, does not allow to transfer euros or dollars or other currencies, but only… bitcoins!⁸ Bitcoin is not only a payment system, but also a currency. Bitcoin (with a capital B, according to the conventional use, to indicate the technology and the payment system) can be used only to transfer bitcoin (with a lowercase b, to indicate the currency). If we want to benefit from the advantages offered by Bitcoin as a payment system, we also need to use bitcoin as the currency. And if we want to understand why Bitcoin has not become universally affirmed as the new standard for electronic payments – and especially, if we want to see if it will ever be able to do so – it is necessary to look at its other side, i.e. the way bitcoin performs basic monetary functions.

An outdated currency

Monetary creation

Using bitcoin does not only mean searching for a cutting-edge technology to transfer money. It means using what presents itself as a new currency, for all intents and purposes. It means having bitcoins, denominating prices in bitcoins, stipulating contracts in bitcoins and transferring bitcoins to pay those prices and honor those contracts. Bitcoin is not only a vehicle for the transfer of purchasing power, but it is a unit of account, a means of exchange and a reserve of value. In a word, money.

We will have to return later to a broader discussion of how bitcoin performs these monetary functions, and whether it is up to the delicate tasks required and thus can truly be defined as money. We will ask if the goal of creating a new currency has been reached, and how, to what extent… and at what price. For the moment, let’s assume the intention is good, and try to evaluate its significance.

As a currency, bitcoin challenges the heart of the system. It raises the stakes. It is not only the payment system that is called into question, but the monetary system. The attack is not limited to the well-nourished and entrenched system of banks, credit cards, and other intermediaries, but is aimed directly at the headquarters of the monetary system, the central banks. Bitcoin aims not only to replace the channels through which money flows in the economy, but also the very source of monetary creation itself. Bitcoin technology is not just about transferring purchasing power; it’s about the power to create it.

), similar to the dollar (USD and $) and the euro (EUR and €). The message is clear: bitcoin is a currency… but different.

An asset without a liability

Bitcoin differs from the money of central banks not only, and not principally, because it is immaterial, intangible, and abstract. Bitcoin has another characteristic that distinguishes it from any other currency we use today, i.e. the bank money created by commercial banks and the coins or paper money issued by central banks: bitcoin is an asset for those who hold it, without at the same time being a liability for anyone else. The money I have in my bank account is an asset for me, part of my wealth; but at the same time, for the bank it is a liability, a debt, that binds it to convert my credit (the money I have in my account) into cash.

All of the electronic money we have known until bitcoin is in actual fact a credit; a number, registered in my account at a bank, that gives me the right to withdraw a corresponding amount in cash. Bitcoin, on the other hand, is an electronic currency that does not have the nature of a credit. As we will see later, like bank money, bitcoin is also a pure number registered in an account book, but it does not express the right to obtain a sum in cash.

The money created by banks, despite being credit in a strict sense, is considered money (it is included in the monetary aggregate conventionally indicated as M1), and is thus similar to the money issued by the central bank (i.e. the monetary base, M0), precisely because bank money (bank accounts, deposits) can be converted into central bank money (banknotes and coins) on request, at any time. If I have money in my bank account, if I have a credit towards my bank, all I have to do is go to the ATM machine and make a withdrawal in order to get cash. On the other hand, though, even cash is not just an asset, as it may seem at first. In fact, banknotes and coins are recorded among the liabilities of the central bank that issues them. Now, that liability no longer corresponds to any payment obligation, since about fifty years ago, when the convertibility into gold of the dollar and any other currency was suspended (Amato and Fantacci, 2009, pp. 115-128). However, as central banks continue to record coins and banknotes as liabilities, they remain legally, statutorily, required to answer for their value, governing their issue in such a way as to keep their purchasing power reasonably stable.

From this perspective, bitcoin is more similar to gold than to legal currency. Gold, in fact, is an asset for the person who holds it, but a liability for no one. So there is good reason that bitcoin has been called digital gold (we will come back to this in Chapter 2). The holder of bitcoins, like the holder of gold, is a creditor without debtors. This is an apparently privileged position, with absolute power, but it hides a weakness, and a form of radical dependency. Like gold, bitcoin has actual purchasing power only if there is something to buy and someone willing to receive bitcoins or gold in exchange for something (more) useful.

Now, the value of official currency depends on the commitment by the central bank not to issue too much money, and the mandatory acceptance of the currency for the payment of taxes and private debts. As we will discuss further below, central banks can violate their obligations by issuing too much money and causing a loss of its internal value (inflation) and/ or its external