Why Bitcoin Isn’t Gold 2.0

24.09.2015

Bitcoin advocates like Erik Voorhees compare it to gold. They emphasize that in terms of technological criteria like uniformity, severability, unit cost, longevity, and transportability Bitcoin actually excels gold.

This is however a purely technical approach towards money inherent in neo-classical economic theory, and it leads its supporters to a conclusion that Bitcoin is gold 2.0.

Feasibility entails new vulnerabilities

Chasing the analogy with gold, Bitcoin advocates omit several important issues. Gold knows no trouble with double-spend attack, 51% attack, and other attacks. Gold has no open source code, which allows one to create bgold, shmold, or ugold at any time. Circulation of gold does not depend on electricity, computer capacities, and miner whims. As opposed to fiat currencies, gold can be used as both production means and consumer item.

Bitcoin advocates claim that it, as opposed to national currencies and e-money, has no third-party risk. When a commodity is bought not for gold, but for credit or fiat money embodying some obligations born by their issuer, third-party risk is present, indeed. Absence of any liabilities incurred on Bitcoin issuer, even obligation to receive it as a legal tender, is presented as an advantage making Bitcoin gold 2.0. But it is somehow equal to a statement that U.S. dollar, following its issuers declination to amortize it with gold, has become more gold-like than before. It is similar to a statement that following August 15, 1971, U.S. dollar has become gold 1.5. During Bretton-Wood currency system climax, dollar advocates insisted that dollar is as good as gold, and when the decline emerged, that dollar is better than gold.

The Robert Peel Act

The basic argument for the thesis of Bitcoin being gold 2.0 consists in restriction of Bictoins issuance, which makes it a commodity more limited than gold, and rather more than national fiat currencies. First, it was noted lots of times that Bitcoins supply, as opposed to supply of gold, is limited by its protocol that can be altered. Second, there is a question: is transition towards circulation of credit money, and then fiat money, actually necessary and caused by needs of evolving capitalist system, or is it just a coincidence and intrigues played by monopolists, socialists, or some other stakeholders? Back in 1844, Britain has passed Sir Robert Piles Act, which restricted Bank of Englands capabilities to issue bank notes not covering gold security. The act was initiated not by cryptoanarchists or conspirologists, but British bankers who understood that money supply limitation would result in increase of loan interest, especially during crisis, when demand for money flies to the moon.

Necessity for Money Supply Regulation

If not for the Gospel of Keynes that had legalized application of state monopoly to money issuance to stimulate aggregate demand, the capitalisms fate as a system would have taken a different turn after the Great Depression. One could say the same about the role of Quantitative easing and exchange swaps during the Global Financial Crisis. Absence of a central bank in Bitcoin environment doesnt mean it is not a mandatory market institution. It just means that Bitcoin economy hasnt suffered a crisis yet. Bitcoin supply rises according to forecasts, but its rates volatility is way higher than that of unpredictable national currencies. Relative stability of exchange value is one of the basic requirements for a commodity claiming the role of money, and if gold money had that feature due to relatively stable conditions of gold production, low volatility of modern fiat currencies rates would have been impossible without interferences by central banks.

Dark Side of Limited Issuance

Exchange value of gold is determined by labor expenses for its production, but do Bitcoin production labor expenses correlate with its exchange value? As long mining issues Bitcoins, one could tie its exchange rate to mining exprenses, but if Bitcoin issuance tends to zero, does it mean that its exchange value tends to infinity? Even antiques cannot do that. Bitcoin issuance will eventually cease, but mining will retain, and miners will cover their expenses by collecting charges. Thus, similarity of miner expenses to expenses of banking system for maintenance of non-cash money circulation will become evident.

Precious metal is the tangible medium for gold money, while in case of Bitcoin it is a block chain on a storage unit. Does Bitcoins exchange value correlate with its mediums production expenses? If not, Bitcoin is more like fiat money rather than gold.

Mining is compared to gold mining due to increase of Bitcoins mining difficulty. What does this mean? If difficulty is what we know it to be, then it does not grow but fluctuate adjusting to the system. If it implies twofold reduction of Bitcoins issuance every four years, then gold mining extent does not only reduce by two times every four years nay, it doesnt decrease it all, but only grows.

Moreover, the cryptocurrency claiming to be digital gold is named Bitcoin, not Bitgold. How come? Is it just because Nick Sabo has already claimed the name bitgold? Satoshi Nakamoto compares mining to the process of gold excavation, but still speaks about mining of coins. Are coins actually mined from the ground? Isnt it gold found in underground excavations that later is used for coin minting? Or coins and gold are conceptually the same?

Exchange Value of Money and Trust

Coins and gold are not the same. Coin is an ingot of gold of pre-established weight and purity, which essentially facilitates its usage in trading, as no one has to weigh and test each ingot one should just count the coins instead. This is the essence of revolution of coins. This revolution is based on trust towards mint and its capability to mint coins resistant to fraud. One can always test the coins quality by weighing it and examining its purity, which takes much less expenses than minting of that coin. This asymmetry of expenses resembles asymmetrical proof-of-work cryptography. Satoshi Nakamoto points out that proof-of-work provides fraud protection for the block chain: records cannot be changed without performance of the whole computation amount.

Even though gold coins are somehow restrained by trust towards mints, its exchange value is based not on trust but on value of its gold medium, quality of which may be tested at any time. A mint cannot change value of gold. Trust associated with credit and fiat money is of different nature, as their exchange value is related to particular obligations by their issuer. Moreover, fiat money is associated with greater trust than that available to credit money: fiat money issuer does not undertake to amortize it with a pre-determined amount of some commodity, as they do in case of credit money; the issuer just undertakes to exchange it for indefinite amount of indefinite commodities.

Therefore, Bitcoin as fiat money having no issuer obligation is associated with even greater trust.Coin minting requires certain expenses, so mints charge some fee. Miners, in their turn, also charge fees for transactions, and one may also see some similarity with gold coins mining. However, revenue they get from selling Bitcoins created ex nihilo, still resembles segniorage of fiat moneys issuer.

One could object that a miner had spent energy and computation capabilities to create those coins. Its true, but mining will not disappear even when Bitcoins issuance will cease. Therefore, mining certainly has nothing to do with mining of digital gold or minting of digital gold coins from digital gold. If any analogy has to be given, mining is re-minting of one coin into a different one, when name of the coins owner is re-carved. It looks like stone coins of the isle of Yap, not coins of gold. Mining is in fact minting of blocks from transactions, but blocks are not coins, and transactions are not gold.

Miners and Cash Nature of Bitcoin

Decentralized issuance of Bitcoin is carried out in the form of reward to miners, which allows one to make transaction processing free and motivate miners to play fairly. It is a clever solution, but the mechanism as is is not necessary for mining whose essence consists in creation of chain of blocks reflecting the coins history as of the moment of its creation. How exactly this coin is created, is another story.

Miners are engaged in discharge of remittance orders in fact, thats what banks or central entities on e-money environment do. The difference is that you have to trust not to a single entity, which is licensed and amenable to law, but to anonymous majority of fair miners constrained by no obligations whatsoever. Does such transition signify decrease of required level of reliance on the system?

Satoshi Nakamoto defines a digital coin as a chain of electronic signatures. It resembles a chain of direct endorsement, though a promissory note bearing those signatures moves directly from the buyer to the seller, while Bitcoin first comes to a miner (being in fact a third party), and then the transaction has to be confirmed by the network. Theoretically, a payer may be a miner, but in reality its more like exception, rather than a rule. A promissory note, as signature-bearer, is passed from a buyer to a seller, while block chain bearer is not. Property rights for block chain medium is not synonymous to property rights for Bitcoins, and passing of Bitcoins is not synonymous to passing of block chain medium. It has nothing to neither with gold, nor with gold coins.

It resembles circulation of non-cash money through accounts in a bankers ledger. The only difference is that everyone in Bitcoin network may have a copy of the ledger, and the accountancy is performed not on behalf of a person, but on behalf of the coin. The most essential difference between Bitcoin and non-cash money on bank accounts consists in the fact that Bitcoin is actually cash. As opposed to private money, Bitcoins are not a monetary liability issued by commercial banks that the issuer undertakes to amortized by pre-dtermined amount of cash in the form of a Central Banks notes. Technically, Bitcoin is not cash, but in terms of economy it is cash, as essentially it is not monetary signs, but money itself.

That is why Bitcoin is not gold 2.0, but fiat 2.0. It is the fundamental feature of Bitcoin that allows one to consider it as the next stage of money evolution. Just like U.S. Dollar ceased to be the sign of money, which was gold, and turned into money, having severed ties to gold, nowadays account records cease being monetary signs or non-cash money, and become real cash money. Moreover, if national currencies are just in progress of that transition, Bitcoin has already performed it.

This article is also available in Russian

Dmitriy Bondar exclusively for ForkLog

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Tags: Bitcoin, economics, gold