July 2013

What if money were private?

One very correct answer is, simply: Money already is private. Sure, there’s the old familiar legal tender of the U.S. government, but the idea of money, and the practices that surround it, are not necessarily tied to the greenback. We all know how money works, and other things can certainly be used in the dollar’s place — if a buyer and seller agree. From there, if more buyers and sellers agree, the items they use may become a medium of exchange — a class of things held with the intention of passing them along in the market rather than using them directly.

Today, thanks to cryptography and computer networking, numbers can serve this purpose. That’s the promise of bitcoin, and, incredible as it sounds, it works. Shared verification across the network of users guarantees that no one spends a bitcoin twice. Cryptography means that users’ identities aren’t publicly tied to their purchases. Cryptography also guarantees that no one can generate fake bitcoins, either. Have any doubts? The code is open source. You can examine it for yourself.

But bitcoin isn’t foolproof. There are most certainly inefficiencies, pitfalls for the unwary, and opportunities for fraud, as there are in all known monetary systems. These challenges vary from one system to the next, and the question then becomes — which money is preferable, the public one, or this new private one, or perhaps some other? We would be remiss, as a libertarian publication, not to mention libertarians’ perennial favorite: the gold standard, combined with a regime of free banking. (It too has both advantages and disadvantages, of course!)

This month the Cato Institute’s own Jim Harper writes the lead essay, tackling the question of how private digital money works — and doesn’t. Here to discuss with him are computer security expert Dan Kaminsky, tech policy scholar Jerry Brito of the Mercatus Center, and economics graduate student Chuck Moulton, who is writing his dissertation on related matters.


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Lead Essay

  • Jim Harper reviews the traits that make a given class of items either useful as money or not. These are the traits that, for example, made gold and silver historically such widespread monetary standards. He finds that bitcoin possesses many of them to a very high degree, but that it very importantly fails on some. Bitcoin’s future is unclear in another respect as well: Established government and financial industry interests will do whatever they can to preserve what they view as their own turf. Still, the greatly increased use of digital currency seems inevitable to him in some form or another, and that form could well be private.

Response Essays

  • Dan Kaminsky argues that bitcoin’s success so far stems from the success of the Internet itself, and also from the failures of plain old money. Traditional payment methods all face serious challenges in our digitally connected world, and transaction costs to maintain our financial network make plain old money less and less attractive in contrast to its digital counterpart. But bitcoin isn’t perfect either, and the threat of large conglomerates abusing their power isn’t limited to plain old money. It can happen in the bitcoin network too.

  • Jerry Brito argues that bitcoin is far more than just money. It’s also a distributed-ledger payment system, which means it’s a lot like Visa, MasterCard, or PayPal, but with one key difference: There is no central authority managing the payments. As a result, bitcoin is open to becoming a lot more than “just” money. It can also be used as a token to represent claims on other items. As such, very small fractional bitcoins can function as bonds, stock certificates, property deeds, IOUs, or even decentralized futures markets. The full scope of these possibilities is vast, and we are only beginning to grasp the implications of bitcoin.

  • Chuck Moulton argues that bitcoin is a sound form of money. Its quantity is known, it expands at a known rate, and it will eventually stop expanding. As a result, fluctuations in the value of bitcoin are almost entirely a function of demand. Moulton suggests fractional reserve banking as a way of stabilizing bitcoin’s value. He goes on to suggest that nations might consider dollarizing to bitcoin as a way of preventing inflation, with the very significant caveat that “a second or third generation cryptocurrency may be the one to finally take hold.”

  • We are pleased to publish this contribution from Patrick Murck, Bitcoin Foundation General Counsel, who argues digital currency will disrupt traditional finance. This disruption is both very much intentional and likely to empower consumers who have not been able to take advantage of traditional financial services. Older financial system players are likely to resist, of course: They have a stake in the status quo.