Tag: Bitcoin

“Bearish” on Z-Cash

I recently made my 2017 predictions, and was asked why I was “bearish” on Z-Cash. I predicted a 25% chance that the price would rise, and a 75% chance that the market cap would do so, over the course of the year.

I’m not sure this is really bearish. First, after 2 months, there are currently about 375,000 ZEC minted, of which 300,000 are in circulation. (Block 40,000.) I’m not sure the exact schedule — it should only half after 840,000 blocks, in well over a year — but in 12 months, there should be 7 times as many coins. That means, by the end of the year, at current prices, the market cap would move from $20m to closer to $140m. So the market cap would need to increase significantly in order for the price to stay stable.

Is this implausible? No. But it would probably involve cannibalizing much of the dark-web market share from Monero, (and darkweb markets won’t necessarily switch to new coins quickly,) or a speculative price bubble that extends through the end of the year. I am bullish on Z-Cash over the longer term, but it’s riding on speculation now, and I’d be a little bit surprised if it managed to attract that large a market cap within the year. Because at some point, as more coins are generated and speculators stop pouring in money, the fundamentals take over from the speculators. Perhaps only 25% was overconfident — but I’m definitely not certain of an increase.

Expanding definitions and Obsoleting Industries

I’ve already explained why we can’t figure out if bitcoin is “really” a currency. But I think there is a lot more to say — because those 3 characteristics of money (Unit of Account, Store of Value, and Medium of Exchange) are not the only things that make money useful.

What else is needed?

Principally, gold stopped being used as currency directly because it was too hard to carry around as a currency — especially safely! But the gold standard was abandoned because the supply was too inflexible. Country’s economies started to expand much faster than their metal-backed currency, so that the value that existed was in excess of the medium of exchange for that value, and their needs for credit couldn’t be easily supplied with gold. This clarifies that these three tasks are not all a currency can do, nor is it the only thing we might care about. In fact, much before digital currencies, there were lots of things that we need that traditional forms of money don’t provide. Instead, systems were created to fill in the gaps, and these systems sprouted entire industries that software is getting ready to eat.

For example, we frequently need a system for measuring, processing, and communicating transactions. This is traditionally done by bookkeepers (not even necessarily accountants). I’ll refer to it as a “ledger of transactions” (4). Bookkeeping employs a couple hundred thousand people and costs around $50bn in the US alone. Under modern accounting principles, using third party verifiers, this system also allows an owner to provide a “proof of worth” (5) for a company or an individual. That’s accounting, (audit, not tax) and it employs another couple hundred thousand people and costs $100b. Both of these are bonuses that blockchain ledger currencies like bitcoin can provide, for example, using merkel hash tree signed proofs. Because of this, traditional businesses and currencies must rely on those large, expensive systems instead.

Next, we have more ancillary, non-currency systems that provide “tokens of ownership” (6) for non-currency goods, like real estate deeds or stock certificates. In order for these to be liquid and saleable, a “verifiable exchange market” (7) is needed, such as a county clerk for real estate, so that people can reliably sell their property without worrying that someone else will appear with a different deed to the property. If you’ve ever bought a house, you know the “title search” fee of $250+ you pay, instead of a 1 line query of a distributed blockchain database. And then you probably still need title insurance, in case the search missed anything.

The verifiable exchange can also provide a “transaction price log” (8) like the stock market’s ticker, where everyone can see the value of the goods currently being traded, and therefore be able to make decisions about whether to buy and sell. And all three of these can be accomplished using on-chain blockchain tokens, which track ownership, and the blockchain can show the prices paid for them.

We also want a “system of credit” (9) that allows for transactions that are contingent, risky, or require a future payment. This last is closely related to, and requires, a unit of account — but credit cards and most other typical forms of credit use outside systems for their unit of account. This is a feature that blockchain based currencies don’t do well, yet. Some smart contract platforms seem poised to allow, for example, collateralized loans, but the key difficult with extending credit via blockchain is that unsecured credit requires known identities, which blockchains don’t do. (If I lend money to you, then you stop paying me back and just start using a new wallet for your money, it’s not clear what recourse I have.)

Further, built on top of these systems, we have complex systems for many other features of the modern economy that are enabled by these various services and characteristics of money and related market systems. For example, fractional reserve banking relies on a “system of credit” for loans so that banks can have assets in excess of their reserves. For this to be trustworthy, we need (but don’t fully have) a robust “proof of worth” for these banks.

We have a repurchase agreement (“repo”) market that allows “tokens of ownership” (6) to assist the “system of credit” (9) which helps ensure liquidity on the basis of owned assets.

The Future

This large set of needs, combined with a healthy dose of historical path dependence, leads to the current complicated set of systems that are all intertwined. But as one 2016 Nobel laureate said, “The times, they are a changin’.”

Cryptocurrencies and Smart contracts have the ability to do all of these things. Definitions don’t dictate reality, they reflect it. Cryptocurrencies can do things currencies cannot, and focusing on the definitions is a red herring.

Problems Defining Money

There seems to be confusion about the functions of currency, and the definition of what money is. I’d like to explain why the confusion exists — and it starts with the fact that “Money” and “Currency” aren’t defined simply or clearly.

For something to be considered money by economists, it must have certain uses, or characteristics. Economists have identified three. It should be a;

  1. Unit of Account, which is used to measure value.

2) Store of Value, which is used to hold in order to ensure it can be used in the future.

3) Medium of Exchange, which is used to allow transactions without direct barter.

That last one is the one even critics agree bitcoin displays most obviously. But bitcoin definitely displays all three of these characteristics, to a greater or lesser extent. On the other hand, almost everything else can display these characteristics to some extent as well. The things historically used as money have been whatever does these function best.

Gold has served as a store of value for millennia at least, since it is a fairly compact and valuable item, and has intrinsic worth for its beauty. It was also of limited supply ensuring that it remained valuable, and it worked well as a store of value . Even before coinage, it was a useful medium of exchange, since relatively large amounts can be carried easily, and it is also divisible. Once coinage was created, this was still sometimes true, and Spanish pieces of eight were broken into pieces to allow this. Coinage also led to gold as a much more useful unit of account, no longer requiring careful measurement and sometimes difficult verification of its nature.

Other historical “money” was less well suited for some of these different tasks; Cattle was a great medium of exchange in ancient cultures, was easy to validate, and was a reasonable store of value over the short term. It was also a unit of account, but served this purpose less well. (They sometimes varied in value between different animals, and over time, and were not easily divisible — it tended to get messy when you split them in half.)

Now, many things fall into the grey area created by our linguistic imprecision in grouping these functions. This means that they are money, but aren’t perfectly suited for the purpose. Examples include the UN’s Special drawing rights, which are a unit of account (1) and a store of value (2), but not a medium of exchange(3). Similarly, banknotes (or fiat currencies!) and gold certificates are a great unit of account (1), and a very convenient medium of exchange (3), but their reliability as a store of value (2) is contingent on the trustworthiness of the issuer, which can vary.

Cryptocurrencies are great as a medium of exchange, since the transaction system is designed explicitly for transacting, and they are divisible into fairly small amounts. Their usefulness as a unit of account and store of value, however, is less clear. As exchange rates fluctuate, the reliability of these uses can be tricky. As Bitcoin has stabilized, this has become a less critical issue, but digital currencies lack intrinsic worth, so any stability is limited by trust. As noted, fiat as a store of value also depends on trust, albeit different; it’s trust in a central bank instead of a algorithm and a social agreement.

In terms of just these three characteristics, we seem to have nothing that works quite as well as gold once did, leading some to wonder why we don’t go back to gold. But this is a bad idea, because those three characteristics aren’t a full list of what we need from a currency — notably, gold has a fixed supply, not just a limited one, which has real downsides. (Not just nominal ones. But that’s a different discussion.)

In any case, I think that it’s obvious that nothing fits the platonic ideal of a currency. And arguing about definitions is a silly thing to do. (That doesn’t mean you can use words however you want!) Given the lack of a platonic exemplar, the question of whether to call something money is really just asking what the best trade-off is between different choices — and that’s subjective and contentious. Which, I think, explains the confusion I started with.

Added: But this confusion misses the point; Instead of arguing definitions, we need to look at expanding definitions and obsoleting industries.