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  • What Bill Gates Gets Wrong About Cryptocurrencies 

    In a Q&A session on Reddit last week, Microsoft’s founder Bill Gates accused cryptocurrencies of causing “deaths in a fairly direct way,” leading to headlines such as this: “Bill Gates says crypto-currencies cause deaths.”

    Gates was, of course, referring to the fact that cryptocurrencies facilitate the purchase of illegal substances on the black market which sometimes leads to drug-related deaths. He also raised concerns about the negative consequences of the anonymity feature of cryptocurrencies, namely money laundering, tax evasion, and terrorism funding.

    As the creator of the most successful operating system in history, Bill Gates should know better than anyone that a piece of software (or, in the case of cryptocurrencies, a payment system based on a new technology) cannot be blamed for the use someone makes of it. Charging cryptocurrencies with drug-related deaths is comparable to accusing Windows of causing terrorism because terrorists are using Microsoft’s operating system to store documents on how to make bombs.

    The War on Drugs

    Leaving aside this comment, Bill Gates has a point: cryptocurrencies facilitate anonymous (pseudonymous, to be more precise) transactions, undermining the capacity of the State to enforce the law in relation to certain illegal activities. However, this isn’t necessarily a bad thing, at least in some cases.

    Let us take the case of drugs. In the U.S., the War on Drugs initiated by President Nixon in the 1970s appears to have resulted in more harm than good. Besides a clear violation of personal freedom, prohibition has contributed to an increase in drug overdoses, strengthening at the same time the role of violent cartels in drug-producing countries.

    From an economic perspective, the War on Drugs costs taxpayers around $51 billion annually. Since the onset of the War on Drugs in 1971, the U.S. government alone (excluding state and local government spending) has spent more than $1 trillion.

    The drug war has also had a tremendous impact on prison policies. In the period of 1974–2014, the prison population grew by about 600 percent. Even though it is difficult to measure the exact impact of the War on Drugs on this spectacular growth, we can state with certainty that a large part of this increase is due to the drug war. To justify this assertion, here is a number: in 1974, 41,000 went to prison due to drug offenses; in 2014, multiply the previous number by 10. (These policies had a severe impact on minorities, particularly black and Hispanic Americans.)

    If drug-trading using cryptocurrencies continues to grow, it could end up making government efforts to stop the consumption of illegal substances useless, leading to the end of the War on Drugs and paving the way for an eventual legalization. This might sound utopian, but legalization of marijuana also seemed unreachable a few years ago. Today, the sale and possession are legal in eight states and counting.

    What’s So Bad about Getting Around Government?

    How about tax evasion? First of all, it is not clear that tax evasion is immoral per se, as Bill Gates seems to assume. For instance, if law established that taxpayers must pay 95 percent of their income in taxes, tax evasion would be ethically justified as a means of retaining the earnings that one has rightfully earned. In developed countries, the tax burden is sufficiently high to at least cast doubt about the unethicality of tax evasion.

    Cryptocurrencies possess all the characteristics to become perfect tax havens: earnings are not taxed; anonymity is preserved; and operating with them doesn’t involve third parties, which implies that there is no intermediary through which government can address tax evasion issues in foreign countries.

    Faced with the impossibility of collecting as much in taxes as they do today due to a potential widespread use of cryptocurrencies, governments might be compelled to reduce the heavy tax burden they currently impose on their citizens. This, in turn, would reduce the size of governments, expanding the scope of personal and economic freedom.

    It is true that in other areas—terrorism, say—the ethics get even trickier. Cryptocurrencies could become a useful tool for those seeking to fund terrorist activities. On the other hand, they could also inhibit governmental mass surveillance programs (at least in relation to economic transactions), pushing governments to be more respectful towards privacy and efficient when it comes to targeting and dismantling security threats.

    In any case, a cost-benefit analysis of the impact of cryptocurrencies should be undertaken. Perhaps then opponents of the technology would be forced to concede the potential benefits of cryptocurrencies.

    Reprinted from Intellectual Takeout.

    Luis Pablo de la Horra

    Luis Pablo De La Horra holds a Bachelor’s in English and a Master’s in Finance. He writes for FEE, the Institute of Economic Affairs and Speakfreely.today.

    This article was originally published on FEE.org. Read the original article.

  • The Promise of Smart Contracts

    Jerry, we’re not just going to
    give you seven hundred and fifty
    thousand dollars.

    What the heck were you thinkin’?
    Heck, if I’m only gettin’ bank
    interest, I’d look for complete
    security. Heck, FDIC. I don’t
    see nothin’ like that here.

    Yah, but I — okay, I would, I’d
    guarantee ya your money back.

    I’m not talkin’ about your damn
    word, Jerry.

    Fargo (1996)

    Fargo is primarily a movie about promises, implicit and explicit. It asks whether we will keep our promises to others, even against our own self-interest. What makes the movie fascinating is that many of the promises aren’t backed by the court system, for very good reason — the deals are illegal. Fargo asks if we can trust each other even if there is no government force making us comply. In other words, can we make contracts in the state of nature? In 1651, Hobbes argued that we couldn’t:

    “If a covenant be made wherein neither of the parties perform presently, but trust one another, in the condition of mere nature (which is a condition of war of every man against every man) upon any reasonable suspicion, it is void: but if there be a common power set over them both, with right and force sufficient to compel performance, it is not void. For he that performeth first has no assurance the other will perform after, because the bonds of words are too weak to bridle men’s ambition, avarice, anger, and other passions, without the fear of some coercive power…”

    In other words, we need some external mechanism to enforce our promises, to make it so that other people can depend on our commitment. Making credible commitments is the foundation of business and society in general. Like Hobbes, we tend to assume that the government’s coercive power is the only way to create contracts. Nobel Prize-winning economist Oliver Williamson called this view legal centralism, the assumption that “the legal system enforces promises in a knowledgeable, sophisticated, and low-cost way” (Williamson, 1996, 121).

    Williamson and other Nobel laureates, such as Elinor Ostrom, built their careers on proving this assumption wrong. In many instances, the court system is costly and time-consuming, and sometimes corrupt. Moreover, people are often surprisingly able to enforce promises and maintain order in their own communities without government.

    Promises, Promises


    Trust is the bedrock of society. Without it, life would look a lot like Hobbes’ state of nature — constant suspicion, backstabbing, and insecurity. A person might make a promise, but given the opportunity, they might break it and pursue their own self-interest, a scenario which Williamson calls opportunism. However, business deals depend on being able to trust that a promise will be kept, otherwise our society would be limited to instantaneous exchanges. Fortunately, there are a number of mechanisms that can be used to secure a promise, all of which have advantages and disadvantages [1].

    For instance, we might depend on personal ethics and only make promises with people who have a strict moral code. The advantage of relying on personal ethics is that they don’t require institutions or outside coercion, but ethics also have a severe limitation: it’s difficult to know very many people well enough to trust them to do the right thing, and even the best people might break their promises.

    Another enforcement mechanism is reputation. Before making a contract with someone, we can ask around and find out how their previous interactions went. Reputation is extremely useful in small communities with repeated transactions since, if someone breaks their promise, they will be labeled untrustworthy and will be excluded from future interactions. However, reputation is more difficult to apply when interacting with strangers.

    Other enforcement mechanisms for promises include strategies like vertical integration in business (where opportunism is curbed through the alignment of incentives) and the use of collateral.

    The Internet Problem

    But the Internet, currently a state of nature if there ever was one, presents new difficulties. Personal ethics, of course, are always helpful, but there is no guarantee that a random stranger will be ethical. Reputation is more difficult because pseudonyms like email addresses and usernames are often used instead of true names. When a person breaks their promise, they can simply erase their history by creating a new pseudonym with a clean reputation.

    Being able to cheaply create a new pseudonym in order to dodge a bad reputation is called whitewashing (Nisan 2007, 682). There are various ways to handle the problem of whitewashing. One is to distrust all newcomers since they could have a new identity to hide a bad reputation. Another possibility is to ensure that any pseudonym is tied to a real person or business so that a bad reputation can’t be escaped.

    So why don’t we just create a global reputation system connected to our real-life identities? China is doing just that. As Wired explains, people with low ratings (including those who speak out against the government) will be punished in nearly every aspect of their lives: slower internet speeds, restricted access to restaurants, and the removal of the right to travel. They will have extreme difficulty being hired, renting apartments, and getting loans. In other words, a global reputation system can become less about trustworthiness and more about allegiance to authority.

    It’s clear that many of the enforcement mechanisms are hard to apply to the Internet. Personal ethics are ideal but unreliable. Reputation systems that attempt to enforce societal or organizational norms must be carefully designed lest they turn into “basically a big data gamified version of the Communist Party’s surveillance methods” (Botsman 2017).

    Lastly, laws cannot be easily applied to people in different countries, since each geographic jurisdiction has its own separate legal system, and there’s little chance of forcing a person from the Internet (especially if they are anonymous) to appear in court in a different country.

    A Tool Is Only Good if It’s Useful


    It is important to realize that all of our enforcement mechanisms are merely tools to be used when helpful. Like a hammer or a screwdriver, each tool might apply in a different situation. Moreover, like tools, our enforcement mechanisms are subject to innovation. For hundreds of years, since Hobbes, we’ve tended to think of contracts as legal agreements that must be enforced by the court system. However, court enforcement is only one of many ways to enforce promises, and we need to hold open the possibility that we can improve on it.

    As public choice economist Gordon Tullock pointed out, “We tend to forget that there is such a thing as technological progress in contracts. People discover new ways of making agreements, and over a period of time we obtain considerable benefit from this sort of technological progress” (Tullock 1970).

    One such example of technological progress is the invention of smart contracts. Smart contracts are a new mechanism for enforcing promises, allowing us to make credible commitments with each other on a blockchain, including commitments with strangers in other countries. To be clear, smart contracts are not legally enforceable, but that’s part of their unique advantage. Smart contract commitments are enforced outside of the law, outside of legal jurisdictions, without government enforcement.

    Given that our legal jurisdictions are primarily tied to our geographic location, and many countries have frail or unreliable legal institutions, this is a huge societal advance. It means that given an Internet connection, someone from one of the poorest countries in the world can make business deals and credible commitments with someone in the US as easily as if they were American. By creating trust where there was none, the world will be opened like never before.

    Smart Contracts

    The idea of smart contracts originated in the mid-90s when programmer and legal scholar Nick Szabo published a series of articles explaining their potential [2]. Like a vending machine, smart contracts rely on machinery for enforcement. However, instead of using physical machinery, smart contracts are literally code that runs on a blockchain, a kind of open, distributed ledger that runs on the computers of thousands of users, and which has no central authority.

    Contrary to their name, smart contracts have nothing to do with artificial intelligence. “Smart” refers to their self-enforcing quality. Smart contracts are immutable, meaning that the code by default cannot be changed. For the purposes of the contract, this is a good thing, since it’s impossible to break a promise if you have no opportunity to do so.

    However, for programmers, immutability presents a special challenge. All code has bugs, and code that cannot be altered needs to be written carefully to try to minimize the number of mistakes since the bugs can’t be fixed after the fact. Thus, writing a smart contract is like trying to write code for NASA — correctness matters a great deal, and the consequences of bad code can be dire.


    A smart contract might be as simple as a transfer of money from one account to another after a certain time, or it might be very complicated. However, one major limitation is that smart contracts can only transfer digital assets that are defined on a blockchain, such as cryptocurrencies. This might seem like a show-stopper given that cryptocurrencies aren’t yet widely accepted, but transferring money subject to certain conditions is all that many contracts do. Also, even contracts that include actions with physical objects can potentially be enforced by putting up bonds that will be lost if the promise isn’t kept.

    Another limitation is that smart contracts cannot access outside information unless it is written to the blockchain. For instance, a smart contract by itself has no access to weather data. To condition a contract on the temperature, for example, there must be a third party that takes the data from a weather API and writes it to the blockchain in a way that is accessible to other users. This trusted data source is called an oracle.

    There Are Advantages and Drawbacks

    Smart contracts have many limitations. However, we tend to forget that the courts have limitations as well. We shouldn’t compare smart contracts to an idealized version of court-enforced contracts. When we view both critically, it becomes clear that court-enforced contracts have intrinsic flaws. First, access to the court system is rationed, and there are many people waiting for their turn simply to use the service. This means that cases may take years or even decades. Because of the slowness of the courts, businesses often use private arbitration clauses in their contracts that allow them to settle out of court.

    Another often-overlooked limitation of the court system is that because the court is an external third party, it can only guess at the true damages if the contract is breached. This is problematic because the court system determines what will be given to the aggrieved party.

    Unfortunately, simply asking the aggrieved party how much the performance of the contract was worth to them isn’t going to work — they have no incentive to be honest in reporting their damages. Therefore, the court system tries to use its best judgment to determine what the damages are, but as Georgetown Law professor Randy Barnett points out, “Any assessment of legal damages attempts to quantity or objectify that which is actually subjective and essentially unmeasurable…” (Barnett 2010).

    The solution is for the parties to write their valuations explicitly in the contract, as liquidated damages. However, the courts may decide not to enforce these if they think they are unfair. Thus, even in countries with the best institutions, court-enforced contracts have intrinsic limitations and paternalistic aims.

    Smart contracts are not legal contracts, and in many cases may not be a good replacement for legal contracts. However, they are a valuable new tool in our limited toolbox. They allow us to make commitments — even with strangers — without government enforcement, something many, for hundreds of years, have assumed was impossible. In the next few decades, smart contracts will give people around the world the power to make agreements with each other despite corrupt and broken institutions, and so transform the lives of millions.


    1. In Order Without Law: How Neighbors Settle Disputes (Ellickson 1991), Yale Law Professor Robert C. Ellickson studied how cattle ranchers in rural Shasta County, California enforced their promises, and categorizes some of the constraints on behavior thusly: personal ethics, contracts, norms, organization rules, and law. Anthony T. Kronman, also a Yale Law Professor, wrote about the ability to make contracts without using court enforcement in Contract Law and the State of Nature (Kronman 1985). He describes a number of devices, such as “hostages,” collateral, hand-tying, and the alignment of incentives by union.
    2. One of the primary pieces is Formalizing and Securing Relationships on Public Networks (Szabo 1997).

    Works Cited

    1. Barnett, Randy E. The Oxford Introductions to U.S. Law: Contracts. Oxford: Oxford University Press, 2010.
    2. Botsman, Rachel. “Big data meets Big Brother as China moves to rate its citizens.” WIRED. November 28, 2017. Accessed February 05, 2018.
    3. Ellickson, Robert C. Order Without Law: How Neighbors Settle Disputes. Cambridge, MA: Harvard University Press, 1991.
    4. Hobbes, Thomas, and J. C. A. Gaskin. Leviathan. Oxford: Oxford University Press, 1998.
    5. Kronman, Anthony T. “Contract Law and the State of Nature.” Journal of Law, Economics, & Organization 1, no. 1 (1985): 5-32.
    6. Nisan, Noam, Tim Roughgarden, Éva Tardos, Vijay V. Vazirani, and Christos H. Papadimitriou. Algorithmic Game Theory. New York: Cambridge University Press, 2008.
    7. Szabo, Nick. “Formalizing and Securing Relationships on Public Networks.” First Monday. September 1, 1997. Accessed February 05, 2018.
    8. Tullock, Gordon. Private Wants, Public Means: An economic analysis of the desirable scope of government. New York: Basic Books, Inc, 1970.
    9. Williamson, Oliver E. The Mechanisms of Governance. New York: Oxford Univ. Press, 1996.

    Reprinted from Libertarianism.org.

    Kate Sills

    Kate Sills

    Kate Sills holds degrees in Computer Science and Cognitive Science from UC Berkeley.

    This article was originally published on FEE.org. Read the original article.

  • How a Bitcoin System is Like and Unlike a Gold Standard

    Many commentators have compared Bitcoin to gold as an investment asset. “Can Bitcoin Be Gold 2.0,” asks a portfolio analyst. “Bitcoin is increasingly set to replace gold as a hedge against uncertainty,” suggests a Cointelegraph reporter.

    Economists, by contrast, are more interested in considering how a monetary system based on Bitcoin compares to a gold-standard monetary system. In a noteworthy journal article published in 2015, George Selgin characterized Bitcoin as a “synthetic commodity money.” Monetary historian Warren Weber in 2016 released an interesting Bank of Canada working paper entitled “A Bitcoin Standard: Lessons from the Gold Standard,” which analyzes a hypothetical international Bitcoin-based monetary system on the supposition that “the Bitcoin standard would closely resemble the gold standard” of the pre-WWI era. More recently, University of Chicago economist John Cochrane in a blog post has characterized Bitcoin as “an electronic version of gold.”

    In what important respects are the Bitcoin system and a gold standard similar? In what other important respects are they different?

    Similarities and Differences

    Bitcoin is similar to a gold standard in at least two ways. (1) Both Bitcoin and gold are stateless, so either can provide an international base money that is not the creature of any national central bank or finance ministry. (2) Both provide a base money that is reliably limited in quantity (this is the grounding for Selgin’s characterization), unlike a fiat money that a central bank can create in any quantity it likes, “out of thin air.”

    Bitcoin and the gold standard are obviously different in other ways. Gold is a tangible physical commodity; bitcoin is a purely digital asset. This difference is not important for the customer’s experience in paying them out, as ownership of (or a claim to) either asset can be transferred online, or in person by phone app or card.

    The “front ends” of payments are basically the same nowadays. The “back ends” can be different. Gold payments can go peer-to-peer without third-party involvement only when a physical coin or bar is handed over. Electronic gold payments require a trusted vault-keeping intermediary. Bitcoin payments operate on a distributed ledger and can go peer-to-peer electronically without the help of a financial institution. In practice, however, many Bitcoin transactions use the services of commercial storage and exchange providers like Coinbase.

    The most important difference between Bitcoin and gold lies in their contrasting supply and demand mechanisms, which give them very different degrees of purchasing power stability. The stock of gold above ground is slowly augmented each year by gold mines around the world, at a rate that responds to, and stabilizes, the purchasing power of gold. Commodity (non-monetary) demands also respond to the price of gold and dampen movements in its value. The rate of Bitcoin creation, by contrast, is entirely programmed. It does not respond to its purchasing power, and there are no commodity demands.

    Difference in Supply Mechanisms

    Let’s consider supply in more detail. Secularly, annual production of gold has been a small percentage (typically 1% to 4%) of the existing stock, but not zero. Because the absorption of gold by non-monetary uses from which it is not recoverable (like tooth fillings that will go into graves and stay there, but unlike jewelry) is small, the total stock of gold grows over time. Historically this has produced a near-zero secular rate of inflation in gold standard countries.

    The number of BTC in circulation was programmed to expand at 4.0 percent in 2017, but the expansion rate is programmed to fall progressively in the future and to reach zero in 2140. At that point, assuming that real demand to hold BTC grows merely at the same rate as real GDP, Bitcoin would exhibit mild secular growth in its purchasing power, or equivalently we would see mild deflation in BTC-denominated prices of goods and services. (Warren Weber’s paper similarly derives this result.) This kind of growth-driven deflation is benign, but the difference is small in real economic welfare consequences between a money stock that steadily grows 3% per year and one that grows 0%.

    The key difference in the supply mechanisms is in the induced variation in the rate of production of monetary gold in response to its purchasing power, by contrast to the non-variation in BTC. A rise in the purchasing power of BTC does not provoke any change in the quantity of BTC in the short run or in the long run. In Econ 101 language, the supply curve for BTC is always vertical. (The supply curve is, however, programmed to shift to the right over time, ever more slowly, until it stops at 21 million units).

    By contrast, a non-transitory rise in the purchasing power of gold brings about some small increase in the quantity of monetary gold in the short run by incentivizing owners of non-monetary gold items (jewelry and candlesticks) to melt some of them down and monetize them (assuming open mints) in response to the rising opportunity cost of holding them and to the owners’ increased wealth. The short-run supply curve is not vertical. Still more importantly, this rise will bring about a much larger increase in the longer run by incentivizing owners of gold mines to increase their output. The “long-run stock supply curve” for monetary gold is fairly flat. (I walk through the stock-flow supply dynamics in greater detail in chapter 2 of my monetary theory text.) The purchasing power of gold is mean-reverting over the long run, a pattern seen clearly in the historical record.

    Because its quantity is pre-programmed, the stock of BTC is free from supply shocks, unlike that of monetary gold. Supply shocks from gold discoveries under the gold standard were historically small, however. The largest on record was the joint impact of the Californian and Australian gold rushes, which (according to Hugh Rockoff) together created only 6.39 percent annual growth in the world stock of gold during the decade 1849-59, resulting in less than 1.5 percent annual inflation in gold-standard countries over that decade. For reference, the average of decade-averaged annual growth rates over 1839-1919 was about 2.9 percent.

    Predicting Supply

    As a result of the long-run price-elasticity of gold supply combined with the smallness and infrequency of supply shocks, the purchasing power of gold under the classical gold standard was more predictable, especially over 10+ year horizons, than the purchasing power of the post-WWII fiat dollar has been under the Federal Reserve.

    As I have written previously: “Under a gold standard, the price level can be trusted not to wander far over the next 30 years because it is constrained by impersonal market forces. Any sizable price level increase (fall in the purchasing power of gold) caused by a reduced demand to hold gold would reduce the quantity of gold mined, thereby reversing the price level movement. Conversely, any sizable price level decrease (rise in the purchasing power of gold) caused by an increased demand to hold gold would increase the quantity mined, thereby reversing that price level movement.”

    Bitcoin lacks any such supply response. There is no mean-reversion to be expected in the purchasing power of BTC, and thus its purchasing power is much harder to predict at any horizon.

    Describing gold supply, Warren Weber writes: “Changes in the world stock of gold were determined by gold discoveries and the invention of new techniques for extracting gold from gold-bearing ores.” This is not well put. Changes in the world stock of monetary gold come about every year from normal mining. Gold strikes and technical improvements in extraction brought about changes in the growth rate (not the level) of the stock.

    Historically, the changes in the growth rate were not dramatic by comparison to changes in the postwar growth rates of fiat monies. As often as not, the changes in gold stock growth rates were equilibrating, speeding the return of the purchasing power of gold to trend from above trend. As Rockoff noted, some important gold strikes (like the Klondike in the 1890s) and some important technical breakthroughs (like the cyanide process of 1887) were induced by the high purchasing power of gold at the time, which gave added incentive for prospecting and research.

    The phrase from John Cochrane quoted above is part of a sentence that reads in its entirety: “It’s an electronic version of gold, and the price variation should be a warning to economists who long for a return to gold.” From the consideration of the mean reverting character of the purchasing power of gold, by contrast to Bitcoin’s lack of such a character, we can see that the second half of Cochrane’s statement is incorrect.

    The inelastic supply mechanism that produces price variation in Bitcoin should give pause to those who predict that Bitcoin will become a commonly accepted medium of exchange. It says nothing about the purchasing power of gold under a gold standard.

    Reprinted from Alt-M.

    Larry White

    Lawrence H. White is a senior fellow at the Cato Institute, and professor of economics at George Mason University since 2009. An expert on banking and monetary policy, he is the author of The Clash of Economic Ideas (Cambridge University Press, 2012), The Theory of Monetary Institutions (Basil Blackwell, 1999), Free Banking in Britain (2nd ed., Institute of Economic Affairs, 1995), and Competition and Currency (NYU Press, 1989).

    This article was originally published on FEE.org. Read the original article.