December 3, 2018
When people talk about Bitcoin, they usually talk of economic bubbles, crypto-jargon, and irrationality. And also of investment scams, overnight millionaires and mind-bending losses. There is also talk of the hype about the hype, and this is often followed by the shaking of heads. But given how much of an impact Bitcoin has had on the investment landscape, finding an explanation that goes beneath the surface analysis typically provided by conventional finance merits investigation.
In 2009, Bitcoin software was made open source and the first bitcoins were mined by its creator, Satoshi Nakamoto, whose identity is still shrouded in mystery. Bitcoin was created to be a universal digital fiat currency–though it behaves more like a commodity in that the supply of bitcoin is fixed. A bitcoin is virtual in the sense that you cannot physically hold it in your hand, but each one is a specific, unique string of characters created by running a complex algorithm in a process called mining. Roughly simulating mining physical commodities, bitcoin mining requires an investment in energy, hardware and time, and increases in difficulty as more bitcoins are mined. Commodity scarcity has been programmed into the software; the total amount of bitcoins is capped at 21 million. Approximately 17 million, or 80% have already been mined.
Nakamoto alludes to the mistrust in a centralized banking system and the motivation for creating Bitcoin in his white paper in 2008, and clearly states it in his Bitcoin 0.1 release announcement in 2009:
The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts. Their massive overhead costs make micropayments impossible.
In contrast, Bitcoin was intended to resolve issues regarding devaluation of fiat currency manipulation (due to monetary policies that are assumed to cause inflation), be free of fraud, and be free of the electronic payment system transaction costs that existed in bank-based programs.
To understand Bitcoin and cryptocurrencies you need to understand cryptography and economics. But to understand the environment they were dropped into you also need to understand the anti-governmental counter-culture pseudo-economic rhetoric that has been growing towards mainstream acceptance over the past several decades. The values and suspicion expressed in the founder’s statement, and in the program itself, fit the anti-government ideology perfectly.
Stripped down to its bones, the essence of this ideology is the world is in constant danger of being controlled by a small cadre of very wealthy, powerful insiders who have been behind the scenes, manipulating governments and finance for several generations. They have infiltrated the U.S. government and have molded it to actively work against the good of the people. And centralized bank monetary policy is, as John Birch Society founder Robert Welch explains, “the means to steal continuously from the people by the debasement of our currency, on the part of the Federal Government.”
From this perspective, Federal Reserve monetary policy is the only cause of inflation, inflation is a deliberate tool for undermining the working class, and it is the responsibility of true patriots to rebel against this corrupt, malicious government. Disregarding economic history and the boom and bust cycles that were the result of using pure commodities as money for hundreds of years, the ‘return to the gold standard’ ideology also saw credit cards as a conspiracy to trick people one step further into handing over their freedom to these tyrants, as now their purchases and movements could be tracked with the goal of ultimately controlling them–especially those patriots that attempt to break free of the system.
The origins of this ideology can be traced back at least to the John Birch Society and Eustace Mullins’ 1993 reprint of his 1952 book, Secrets of the Federal Reserve, but the historical observer will note a remarkable resemblance to Hitler’s Jewish bankers which are based on anti-semitic beliefs that originated much earlier but then went through propagandistic development within the Third Reich.
From this illustrious history, we know that although these myths sound preposterous when held up to careful scrutiny, they are and have been accepted in a significant portion of the population. It is beyond the scope of this paper to discuss the clever and insidious ways in which conspiracy theories get introduced into popular culture but suffice it to say that an understanding of what drives those beliefs makes the resulting behavior appear more rational. When someone believes the world’s most powerful democratic government is infiltrated by evil forces that are plotting to destroy the wealth of its citizens, perhaps finding a haven for one’s cash that is outside its control doesn’t sound as crazy.
Bitcoin is promoted as a decentralized financial system that is beyond the control of governments and their corrupt, power-hungry tyrants. The supply is fixed, it cannot be manipulated through currency debasement. Transactions are secure and also anonymous–an individual’s privacy cannot be infringed upon and tracked. It is a perfect solution to an imaginary problem.
Bitcoin also came with technology-based jargon like blockchains, public ledgers and smart contracts that pushed up against the backward-looking culture it was seeking to rescue. In a testament to the fear generated by the conspiracy-based beliefs, that resistance was pushed through. The result was a combination of reliance on a technology that was poorly understood and a fear of government regulations; it was a perfect environment for true believers and scam artists to thrive.
It is very difficult to estimate how many people fall into this category, as non-weighted polls and small sample sizes interfere with solid results, though estimates vary between 2 and 8% of the population. At the height of the trading bubble, 16.3 million Americans were actively buying and selling bitcoin. From April to December of 2017, the price of bitcoin shot from $1,100 to over $19,000. The speculative financial bubble that Bitcoin became is a legend unto itself, but the underlying ideology that launched this virtual phenomenon has received scant attention.
How well did bitcoin hold up to its promise? First, as a trusted “store of value,” price volatility has rendered bitcoin useless. Nakamoto’s criticism of “waves of credit bubbles” caused by centralized bank policies are nothing compared to the losses an average investor would have incurred trying to use bitcoin as a safe haven. After setting its record high at nearly $20,000 per coin in December of 2017, bitcoin has lost more than 70% of its value and is currently trading at approximately $4,000. Ironically, the term HODLer, used to describe individuals wishing to use bitcoin as a buy-and-hold safe haven, is an acronym for Hold On for Dear Life.
Second, while the core Bitcoin software is highly secure and has proved fraud-resistant from its inception in 2009 to the time of this writing, Bitcoin-related services have not. The reality of using bitcoin as currency means that trading is done on unregulated exchanges and there have been many exchanges that were prone to outright fraud and several others that were hacked. Ultimately, to be secure, one would have to store bitcoin in an offline hardware wallet but the bitcoin would have to be transferred to an exchange to be used for purchasing–which makes it non-functioning as a currency.
Third, the exchanges charge transaction fees. While the bubble was growing and trading was popular, high fees had rendered micropayments unfeasible. Recently, fees have dropped sharply–as a result of technological innovations in requiring less computing power and time. However, the fees are still set by market forces and as the price of bitcoin has recently dropped, so has transaction demand. If bitcoin were to become popular again and demand was to increase, there is no regulation in place limiting the fees–another strike against bitcoin as a functioning currency.
Therefore, as a technological breakthrough, Bitcoin fails at achieving its goals. This has given rise to other cryptocurrencies that have been developed to remedy those shortcomings; some of those programs have merit, some are outright scams and some fall between the two categories. Without a strong technical background in both computing and economics, it is very difficult to discern between them and the entire cryptocurrency frontier has been aptly described as the Wild West. Yet within the ideology, the myth of ‘Bitcoin as Savior’ is still pervasive and detractors of bitcoin are portrayed as agents of the corrupt government forces.
To the question, is Bitcoin a pyramid or Ponzi scheme? The answer varies depending on how you define it. Fans will tell you that by some definitions the Social Security system can also fall into the category of a Ponzi scheme, as do dollars printed by the U.S. Federal Reserve. Bitcoin can certainly function as a Ponzi scheme, as can any investment instrument. More blatantly, as cryptocurrencies became popular, many pyramid and Ponzi schemes that openly advertised themselves as such were created, to the point where cryptocurrencies and ICOs (Initial Coin Offerings) became synonymous with pump and dump schemes.
However, one does not gain insight into the phenomenon of Bitcoin by viewing it as a pyramid scheme. At its outset, Bitcoin was not created to be used as a vehicle to defraud anyone. It can be seen more accurately as an anarchist rebellion against a perceived tyrant–the misunderstandings of a complex economic system, the mistrust that existed on the part of those that feel victimized by it and the opportunities that exist for those willing to exploit the combination precipitated the conditions for this rebellion. This is the type of fraud where the victims are convinced that the institutions put in place to protect them are actually causing them harm, so they willingly shield themselves from regulatory institutions and in turn, trust those exploiting them. The implications of this ideology reverberate beyond speculative finance and sales schemes, as it is a related ideology that is driving the takeover of the Republican party today.
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