Let me start by saying that I’m not, at present, a long-term optimist on the alternative currency space. I’ll spell out my case for pessimism as clearly as I can here. My background is strong in economics and modest in the alternative currency space. I taught behavioral finance at Harvard for five years, game theory for one year, and international macroeconomics for three years. I once had the opportunity to buy the bitcoin poker site Seals with Clubs, in the summer of 2011, when bitcoin was $6. The price was not high, but I turned it down due to legal and regulatory risk. I bought $6k in bitcoin (now worth around $2.7 million) at that time, but lost all of it in a series of sports bets.
The reason I urge caution in bitcoin investing is very simple: the powers that be do not want it to succeed. They cannot have it succeed. Therefore, it will not succeed.
My view is really that simple. I’ll support it as best I can below.
A further part of my background with relevance: I was actively involved in shorting financial stocks in 2007-2008, and I was the primary research assistant for Michael Lewis’s The Big Short.
Our history of that era is littered with hindsight bias. The successful speculators we celebrate today had to have things go perfectly. They were betting on the failure of banks, and their counterparties were banks! As it happened, failure occurred at just the right measure; bank losses were astonishing, but small enough such that the economy survived (barely) and the government was willing to print money to cover the equity hole across the industry. The story is well known at this point; homeowners received no relief, but all counterparties were paid in full. Many of the people who bet huge on the financial system failing had a bet that looks like a negative freeroll: if the financial system had continued to do well, the bets would have suffered complete loss; if the financial system crashed, the counterparties couldn’t pay and no substantial gain would occur (or, worse, the crash would be so extreme that the meaning of financial wealth would change).
It’s my belief that a decision right now, to hold alternative currency rather than convert it to cash, shares similar aspects of a negative freeroll. For a decision to keep a substantial portion of your wealth in alternative currency or bitcoin to be right, a very particular course of events has to play out. What has to happen, essentially, is that governments as we know them fail over time and yet, as they fail, a decent portion of economic activity functions well, and alternative currency remains useful in this space. The likelihood of this, to me, seems very low.
Governments everywhere have what I call the “Sea of Red” problem. Imagine a talented analyst with a comprehensive spreadsheet that projects the future of US federal and state government finances. What is he sees at the moment is a sheet that has a lot of red in important places, but not a truly terrifying amount of red. The magnitudes of the red numbers are scary at present, but much scarier around 2025 and 2030, when Baby Boomers (the first of whom started to retire in 2008) are drawing heavily on Social Security and Medicare. They are so scary around 2025 and 2030 that the talented analyst concludes that the country might have to skate up to the very edge of disaster, even if the future plays out near perfectly.
Now, the reason I call this spreadsheet the “Sea of Red” is that, while it looks under the rosy scenario quite red, the real problem is that if you change almost any key variable, the spreadsheet becomes all red. If long-term growth and productivity rates are lower than generally anticipated, all the key numbers are red. If another financial crisis and accompanying bailout occur, all red. And, crucially, if interest rates rise from today’s insanely low, government-manipulated level, we have all red. So the only way we have a chance of things working is if the US government continues buying large quantities of its own debt, effectively funding its own operations, and does so in a way such that the debt-to-GDP ratio skirts up against disaster levels without going over. And, all the while, interest rates must stay low, lest the interest expense as a percentage of the budget balloon out of control.
So what we have is one hell of a problem. Effectively the government has to balance between absurdities and contradictions over a period of several decades. How does anyone fund retirement when the government funds itself through inflation, yet ensures that interest rates remain low? If the only protection against inflation is holding assets, and yet a small percentage of the population own all the assets, how does one prevent inequality from spiraling out of control? How can the high level of real economic growth that’s needed to prevented disaster in government finance be achieved in the face of the uncertainty created by extreme monetary policy?
What absolutely cannot happen, from the government’s perspective, during the management of this “Sea of Red” problem, is the government losing control of the currency. The government uses the currency to fund itself!! This cannot be lost. It simply cannot and will not be true that the government will watch bitcoin go from the current price of $2700 per coin, to a higher price of, say $8000 per coin, while other alternative currencies experience similar success, and have any reaction other than an intense desire to kill the space and limit alternative currencies' use in transactions. It’s a battle the government can’t lose, and therefore they won’t lose it.
The problem for the alternative currency holder is that there are really only two long-term outcomes. The first case is that the government succeeds in knocking down the price of alternative currencies and their use in transactions, in which case you’d be better off selling now. If there’s true doubt about governments' ability to do this, I’ll have to make that the subject of a later post, but to me there is no doubt. The other case is that is that government doesn’t succeed in curtailing activity in alternative currency and it continues to expand in importance. In this case you’re also fucked, as governments will not be able to fund and sustain themselves. There’s no alternative world where taxes will be paid and governments will function with bitcoin. That is not how governments work. Governments inflate. That is what they always have done. We live in an era where we will have to accept that they are going to inflate a bit more than the usual amount.
So, as noted, in the two key states of the world where you decide to hold bitcoin rather than convert to cash today, you’re fucked. The only scenario where things work out is a strange middle scenario where governments slowly fail, but it remains valuable for individuals to have alternative currency. I see this as a bit of a strange and unlikely special case.
Hey Brandon, good to see you blogging on here and look forward to seeing a logical voice from outside the echo chamber I fear most of us live in.
I don't have an economics background, so I am hesitant to respond, but I think there are a couple issues with your outlook of probable negative freeroll:
I don't really know how to address your point about governments being unable to fund and sustain themselves being terrible for crypto, but I think it is probably inaccurate; also in this case, the value of our cryptocurrencies (while they would be worth more than fiat) might be the least of our concerns.
I haven't been paying much attention to steemit the last few weeks, I assume the reward system has changed to something linear? My upvotes were worth about $0.20 previously, now much higher.
Yea you are right about the linear voting, also voting power has increase by a factor of five.
Edit: yep I can give myself 0.56 sbd
Re- your last point, see my book Setting Sun for the empirics on this. The US govmt is highly dependent on inflationary monetary policy as a method of funding itself; if alt currency largely took over, and inflation as a source of government funding was no longer an option, government finance would be in an impossible state. On the spending side, the problem is that most expense goes to transfer programs, which are hard to change. On the revenue side, the problem is that, despite trying many different tax regimes, some with tax rates much, much higher than today, the US government has been unable to raise much more than 20% of GDP as tax revenue. Also, presumably, heavy prevalence of alt currency would take away the option of a wealth tax (which I feel is a reasonable option and one that will be increasingly debated).
Points 1 and 2 don't change the fact that alt currency use is strongly against governments' interest. Given that alt currency use is against the govmt interest, they will seek to squash it. The mechanisms for doing this will tend to be random and unfair, but they can get it done in my opinion.
Hi Brandon, I agree with you on a few things, but I disagree with your conclusions.
The incentive for governments to squash Bitcoin and other digital currencies is indeed extremely strong. There's a common military formula to assess a threat... Threat = Capability x Intent. We know it's likely that governments have intent to destroy digital currencies, but their level of capability isn't completely known.
I did make the case in this piece: Bitcoin Paranoid, that governments are probably already attempting to infiltrate Bitcoin, using the weaknesses of the development team, perhaps paying them or threatening them. But crushing digital currency in general isn't so easy.
This idea of decentralised currency is already out in the open, so if one project such as Bitcoin fails, it's simple for another to take its place. Think of it like Internet file sharing. Napster was the first user-friendly system that offered this service, and when it was shut down there were Morpheus and Gnutella, and then they got shut down, and eventually we got BitTorrent, and governments are still trying to shut down torrent sites... They're not having a good time.
Napster was quite unsophisticated compared to BitTorrent, with a high level of centralisation, making it easier to shut down. Digital and decentralised currency follows a similar path. There was e-gold, and Liberty Dollars, Electronic Liberty Dollars. But they were all too centralised, and they got shut down. Now Bitcoin has been going for about 9 years, and it's pretty obvious that it's not so easy to shut it down. Now we have Dash and other currencies with decentralised autonomous funding, that are even harder to kill.
When you say "It’s a battle the government can’t lose, and therefore they won’t lose it," you're assuming that they have the capability, and that's really not proven. The music industry can't stop file sharing, the movie industry... So how can you know that banks and governments will be able to stop an analogous technology?
To me, that doesn't sound like I'm fucked. Actually, that sounds good. Actually, that sounds like what Bitcoin was intended to do - to remove power from established power structures. New organisations are already beginning to take their places.
Here is a quote from Timothy May's "Crypto Anarchist's Manifesto", written around 1988, long before Bitcoin came along:
My only criticism of what May wrote here is that he didn't go far enough.
Churdtzu, Thank you for this reply! I think the form a government crackdown would take would probably be selective prosecutions. Govmts could simply start prosecuting large numbers of people involved in alt currency for crimes such as tax evasion. This is not to say that alt currency users are breaking the law more than others, it's just that every individual and business is subject to so many rules, and it's not uncommon for govmts to selectively enforce these rules towards particular ends.
I'm glad you're receptive to what I'm saying. I agree, governments probably will do that, and in fact they already have - Charlie Shrem, Ross Ulbricht, and going back, Bernard Von Nothaus for Liberty Dollars.
This definitely slows people down in digital currency, but it's unlikely to stop them. Many entrepreneurs will move to countries where there aren't relevant laws, or where the laws aren't likely to be enforced (sometimes you just gotta pay off the right people).
The US and other developed nations - especially English-speaking nations - tend to be the ones with the strictest financial regulations. (Well, not against big banks, but against new companies.) In these countries, the government is likely to get in the way a lot, and inhibit adoption.
Again, it's similar to prosecutions with file sharing. They prosecuted 12 year old girls for downloading 10,000 mp3s, and maybe a few people got scared... People in the US particularly don't like downloading without paying. But in literally almost every other country, people do it without fear of punishment. File sharing has been inhibited because of these prosecutions, but it certainly hasn't stopped. It's the same with digital currency.
Beyond that, one of the biggest fintech players right now is Citibank. Citibank has several fintech departments, one for consumers, one for business, and so on. It's possible that Citibank's fintech departments will be a target for prosecution, but I think you'll agree it's unlikely.
Nice first post. This is a well thought out anti-bitcoin argument. I am inclined to believe that this 'middle scenario' you mention where governments slowly fail and consequently bitcoin other crypto currencies gain market share and momentum is the most likely scenario. Bitcoin has a ton of momentum and as time wears on it will only get harder to do dislodge. I think the cat is out of the bag to a large degree. The concept of decentralized systems-once fully understood by the masses- will be too attractive to ignore. The projects being built on Ethereum-including this site for example-are just flat out jaw dropping and I am just hoping that governments embrace it and move forward rather than engage in a futile efforts to squash progress. We will see.
Maybe these technologies are too efficient for governments. A world of hyper-efficiency and rationality isn't really ideal for the survival of governments as we know them.
Here is a comment one of my buddies left me on skype. He needs to join Steemit!
Obviously Brandon is extraordinarily bright
but I think he makes the same mistake that I have seen other bitcoin skeptics make
Government is not a monolithic entity
there are many different governments around the world, each with different policy goals
It seems clear to me that bitcoin is going to get several more years of uninterrupted growth
Politicians aren't smart enough to see what Brandon outlines coming
Bitcoin is going to be quite large by the time the "Sea of Red" problem becomes apparent
It seems likely to me that entire countries, like Venezuela perhaps, will have adopted bitcoin wholesale by 2025, perhaps to the point of being their national currency
I think bitcoin has serious geopolitical significance at this point, and China may very well go all-in on bitcoin if the US tries to ban it. Also, it seems very likely that public blockchains will have a huge array of important non-monetary economic functions by 2025
The US government may not be able to throw the baby out with the bathwater
Finally, the global underground is enormous, and will grow larger if governments grow too rapacious while trying to fix the "Sea of Red" problem
Crypto is CLEARLY going to be the reserve currency of that market
Welcome to steem! You should check out some of GitHub markdown tutorials to make your posts look pretty.
I really like seeing content like this! Keep it up.