I have a column in the Times on bitcoins and their
implications for private money
Bitcoins — a form of digital private money — shot
up in value from $90 to $260 each after Cypriot bank accounts were
raided by the State, then plunged last week before recovering some
of their value. These gyrations are symptoms of a bubble. Just as
with tulip bulbs or dotcom shares, there will probably be a
bursting. All markets in assets that can be hoarded and resold — as
opposed to those in goods for consumption — suffer from bubbles.
Money is no different; and a new currency is rather like a new
tulip breed.
Yet it would be a mistake to write off Bitcoins as just another
bubble. People are clearly keen on new forms of money safe from the
confiscation and inflation that looks increasingly inevitable as
governments try to escape their debts. Bitcoins pose a fundamental
question: will some form of private money replace the kind minted
and printed by governments?
It has happened before. Pennies and halfpennies were effectively privatised by industrialists
in Birmingham in the 1790s. New industrial employers had to pay
workers in cash rather than kind, as farmers had done. But there
was a chronic shortage of small coins. The Royal Mint had given up
making silver coins because people melted them down when their
value as metal exceeded their face value and had stopped striking
copper halfpennies, which were too easily counterfeited.
So Thomas Williams, the owner of an Anglesey copper mine, and
Matthew Boulton, keen to put steam engines to work, offered to make
pennies for the government. Rebuffed, Williams made coins anyway.
Called druids, they were harder to fake or clip (because they had
raised rims) and cheaper to strike than state coins. Being
convertible into guineas and pounds at a fixed price of one penny,
they were soon accepted all over Birmingham and even in London.
By 1797 there were 600 tons of such tokens in circulation and
the counterfeiters were put out of business. The coiners started
making silver tokens too but a jealous Royal Mint lobbied
Parliament to outlaw the competition. It succeeded in 1818, three
years before it could produce new copper coins to match the high
standards of the private ones, so the coin famine resumed.
More recent private currencies — from Green Shield stamps and
air miles to Lewes “pounds” (designed to encourage spending in the
East Sussex town) — have been less ambitious than the Birmingham
tokens, whose story is told in an outstanding book Good Money. Its author, the economist
George Selgin, has now turned his attention to Bitcoins, which he
thinks come close to having the characteristics of an ideal
currency.
Bitcoins are virtual money created by a piece of computer
software designed to grind away inexorably producing them at a
decelerating rate — it halves every four years — until almost 21
million are in circulation, by which time the rate of production
will be extremely slow. About 11 million have currently been
“mined”. Private software writers can improve their “mining” rate
(by solving maths problems of increasing difficulty), but only at
the expense of competitors; they cannot increase the supply.
Thus, Bitcoins resemble “commodity money”, like gold or cowrie
shells, which rely on scarcity and indestructibility to be a good
store of value. Real commodity money is vulnerable to inflation if
there is suddenly a new discovery of gold — or deflation if there
is suddenly a demand to use the commodity differently. In theory
“fiat money”, such as we use today, avoids these problems — but
governments have always removed the check on supply by printing
money at whim to reduce debts.
There might be a way to cross fiat with commodity money and
capture the benefits of both. Selgin calls this “synthetic
commodity” money. Unlike fiat money it would have absolute
scarcity; unlike commodity money it would have no non-monetary use.
For example, a government could print paper money and then
ostentatiously destroy the lithograph plates to show that it would
never print any more.
In effect, this happened to the Swiss Iraqi dinar in the 1990s.
Saddam’s regime used high-quality money engraved in Switzerland and
printed in Britain. But during the first Gulf war in 1990 the
supply dried up because of sanctions. Saddam began to print dinars
at home, but these were easily faked, so they fell in value. The
Swiss dinars remained in circulation for many years (though growing
tatty) and held their value against the dollar.
Metaphorically, Bitcoin’s creators have destroyed the plates by
making it impossible for anybody to change the programmed supply.
So far that part of the experiment is succeeding, but Bitcoins are
not yet ready for prime time. A friend who acquired some is sitting
on a handsome profit, but finds the only thing he can exchange them
for in his nearest city is chocolate.
Selgin points out that to get an exchange network going from
scratch is hard enough when a new currency is fully compatible with
established money, as in Birmingham; or when it consists of a
commodity with other uses. But to do so using something with no
non-monetary uses, so no one ought to want it at all except as a
means of trade, should be almost impossible.
This only makes Bitcoin’s modest foothold even more impressive.
An appetite for new kinds of money is there. The use of mobile
phone credits as a currency in Africa, pioneered by M-pesa, is
another example, and has had as jealous a reaction from central
banks as Birmingham’s private coins did from the Royal Mint.
Remember the lesson of the Anglesey druids: private
entrepreneurs designed far better coins far more cheaply than
sclerotic bureaucracies. Entrepreneurial innovation among Bitcoin’s
imitators may yet solve the unsolved money problem — how to provide
a ready medium of exchange that is also a trustworthy store of
value.