Bricks of gold, bits of code: the worship of things shiny and useless | FT Alphaville

Bricks of gold, bits of code: the worship of things shiny and useless

If the meteoric rise and fall of the cyber crypto currency Bitcoin this month teaches us anything, it’s the degree to which a market can be influenced by internet hysteria, viral marketing and propaganda.

There is no intrinsic value to a Bitcoin.

The asset class, in many ways, behaves just like gold because Bitcoins can never be consumed or destroyed. Indeed, they can only be hoarded or transacted.

If there is value to a Bitcoin (or gold, for that matter) it is tied both to its energy intensive cost of production and the computer protocol that keeps its units artificially scarce. Neither of which have value in and of themselves unless accompanied by a fanatical base of believers.

In some ways the movement is akin to a religion, one spawned from the foundation myth of the pseudonymous Satoshi Nakamoto, the mysterious architect of Bitcoin’s sophisticated programming. Followers are attracted by the promise of a new age of decentralised currency markets, in which Bitcoin reigns supreme — drawing authority from its complete lack of government supervision.

The anarchic philosophy is propagated on the internet by a counterculture vying for the hearts and minds of the disillusioned post-financial crisis generation — increasingly convinced that less government intervention is the best way forward.

But just like with any product being pitched by snake oil salesmen there is a twist. The marketing reads “fairer system for all” but the content — which is deflationary by design — serves only to concentrate wealth amongst the haves, ignoring the have nots.

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Proponents of Bitcoin (and gold) cry out for currency status.

But money is a hard thing to define. Core attributes include it being a stable store of value, a universal unit of account and a liquid form of exchange. Some have even argued it is a primitive version of technological memory.

If last week has shown anything, however, it is that Bitcoin is fundamentally flawed in all those areas. It is at best a speculative asset class resembling an investment in a high-risk technology stock and at worst an economically useless commodity. If not that, a money laundering scheme for the shadowy underground digital economy.

The problem lies in the rigidity of the source code, and its inherent inflexibility and volatility.

In a normal commodity market when prices go up, the mining industry responds by producing more to capture as much of the price rise as possible. This inevitably brings more supply to the market, leading prices to adjust lower. At that point miners rein in their supply and a new price equilibrium is set.

The only exception to that model is if speculators believe, for some reason — perhaps due to marketing — that miners will never be able to satisfy demand in the future even with increased production today. In that case speculators end up paying too high a price for the commodity’s delivery in the future, which incentivises miners to keep producing regardless. These supplies, instead of being consumed, go into financialised hoards — kept safe for the eventual day that consumption demand returns.

This is not dissimilar to the story of Joseph in the bible, and the way he encouraged pharaoh to hoard grain during the seven years of plenty.

With Bitcoin (and gold), however, there is never any possibility of consumption.

Furthermore, miners can never produce more to respond to demand shocks, making them even less responsive to real world events than the Opec oil cartel. When prices go up, production discipline is only maintained by the increasing complexity of the cryptogram puzzle, which must be solved to create new coins. If you crack the code you get to benefit from the high price. If you don’t, you have to invest in more computer power to be able to do so.

The cryptology ensures that supply is predictable and constant, leading prices to rise whenever there is a rush of unexpected speculative “retail” demand. Of course, if and when prices get too frothy, new miners can be encouraged to enter the production process, diverting demand from speculative inflow to production and in so doing correcting prices. (That is, if they are not inspired to start competitive systems like Litecoin, or Ripple outright.)

And the moment new miners arrive, established miners can also be tempted to exit creating the conditions for a perfect storm. In such a scenario the dam holding back the Bitcoin levee invariably breaks, and prices have no choice but to correct sharply lower and stay there — at least until a new Bitcoin cartel can be revived.

It is, all in all, greed and fear in its purest form.

It’s also no accident that the mechanics in play are very similar to those that apply to gold.

The only good thing that has come from all of this is debate about the nature of money and our modern economic system. It’s also arguably flagged a genuine deficiency in our existing current e-money infrastructure.

Hence why serious attempts should now be made to improve the universal payments system on a digital level.

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