{"id":18973,"date":"2017-12-28T11:50:29","date_gmt":"2017-12-28T16:50:29","guid":{"rendered":"http:\/\/www.megalextoria.com\/wordpress\/?p=18973"},"modified":"2017-12-28T11:59:16","modified_gmt":"2017-12-28T16:59:16","slug":"what-bitcoin-isnt-a-ponzi-unbacked-tulipmania","status":"publish","type":"post","link":"https:\/\/www.megalextoria.com\/wordpress\/index.php\/2017\/12\/28\/what-bitcoin-isnt-a-ponzi-unbacked-tulipmania\/","title":{"rendered":"What Bitcoin Isn’t: A Ponzi, Unbacked, Tulipmania"},"content":{"rendered":"

\"\"<\/a><\/h2>\n

\u201c[Bitcoin] won\u2019t end well, it\u2019s a fraud\u2026worse than tulip bulbs\u2026[but] if you were a drug dealer, a murderer, stuff like that, you are better off doing it in bitcoin than U.S. dollars.” ~ Jamie Dimon: CEO, JP Morgan<\/p><\/blockquote>\n

Headline:\u00a0JPMorgan Guilty of Money Laundering, Tried To Hide Swiss Regulator Judgement ~<\/strong>\u00a0via\u00a0Cointelegraph<\/a><\/blockquote>\n

Given the current, latest successive series of spikes to all-time highs for Bitcoin, the detractors are working overtime to make the case that the crypto-currency is a Ponzi, a scam, a phantasm, or, at the very least, a bubble. Oddly, many of these same detractors spend a lot of time cheerleading \u201cthe other bubble,\u201d that everything-bubble, stocks, bonds, real estate, even ETFs of ETFs, you name it.<\/p>\n

It\u2019s easy to make superficial apples-to-screwdrivers comparisons about why Bitcoin is doomed to fail until you really take some time to look into it. When I was first exposed to the idea back in 2013 and researched it, I realized that \u201cthis really is different,\u201d and the reason why was because of something John Kenneth Galbraith had once written which (until then) had invariably held up as true. In \u201cA Short History of Financial Euphoria<\/a>\u201d Galbraith said:<\/p>\n

The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version. All financial innovation involves in one form or another,\u00a0the creation of debt secured in greater or lesser adequacy by real assets.<\/strong>\u00a0<\/span>(emphasis added)<\/blockquote>\n

When one looks at history, this accurately maps every financial bubble from Tulipmania (which we will debunk as a suitable metaphor for Bitcoin shortly) right up to 2008 and beyond.<\/p>\n

However one place where it\u00a0isn\u2019t<\/em>\u00a0applicable is the phenomenon of Bitcoin. Crypto-currencies, at least at present, have no leverage and are near-impossible to purchase on credit. In other words, if asset bubbles get that way largely through leverage, and there is\u00a0comparatively<\/em>\u00a0no leverage in Bitcoin, then something\u00a0else<\/em>\u00a0has to be driving it.<\/p>\n

That said\u2026<\/p>\n

The Price of Bitcoin is a Side\u00a0Show.<\/strong><\/p>\n

Granted, at the moment it\u2019s a very exciting sideshow for those who are on the train. A long-time customer emailed me as I was writing this asking, \u201cAt what point has easyDNS\u2019 profits from accepting and holding bitcoin exceeded the actual operating profits of the company?\u201d I had never considered that, but some quick math revealed that even after cashing a chunk out to buy gold (not my greatest trade), that happened last year.<\/p>\n

But the price action around this isn\u2019t what is exciting about Bitcoin and the crypto-currency revolution. What is exciting is that the centralized, bankster-controlled monopoly over the issuance of money itself is finished. It\u2019s over. Even if they successfully manage to co-opt some major crypto-currencies or issue their own, Gresham\u2019s Law will assert itself as capital managers will select a truly decentralized crypto-currency wherein they control, or have the option to control,\u00a0their own private keys\u00a0<\/em>to safely store their\u00a0wealth<\/em>\u00a0while they\u2019ll use the government version to pay taxes, etc.<\/p>\n

Whatever state-issued \u201cdigital cash\u201d comes out in the near future, I\u2019m suspecting it will be centralized with mandatory private key custody or escrow. When that happens, it shouldn\u2019t even be called crypto-currency. Call it something else like \u201cpseudo-crypto\u201d or \u201cfauxcoin\u201d to differentiate.<\/p>\n

Given the mostly bad analogies and unfounded criticisms being leveled at Bitcoin, let\u2019s first take a serious look at what Bitcoin isn\u2019t. Then, in Part II we\u2019ll look at what it\u00a0is<\/em>\u00a0and\u00a0why<\/em>\u00a0it’s different.<\/p>\n

What Bitcoin\u00a0Isn\u2019t<\/strong><\/p>\n

\u201cBacked by\u00a0nothing\u201d<\/strong><\/p>\n

This is the go-to criticism for people who simply don\u2019t understand that crypto-currencies are based upon mathematics, zero-trust, open-source, and consensus. They think that bitcoins can simply be created \u201cat will\u201d and are backed by nothing.<\/p>\n

They also say that as if the world\u2019s reserve currency, the US dollar, isn\u2019t, literally, \u201cbacked by nothing\u201d and hasn\u2019t been since 1971; and as if it can\u2019t be created at will, which it most certainly has, with a vengeance.<\/p>\n

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Source: St. Louis Fed<\/p>\n

Indeed, as Galbraith continued in our earlier passage:<\/p>\n

This was true in one of the earliest seeming marvels: when banks discovered that they could print bank notes and issue them to borrowers in excess of the hard-money deposits in the banks\u2019 strong rooms.<\/p><\/blockquote>\n

All fiat currencies today really are backed by nothing and can be created at will (that\u2019s what the word \u201cfiat\u201d actually means), and perhaps unbeknownst to many, we are right now in a protracted, global currency war. Every nation is \u201cracing to the bottom,\u201d trying to devalue their currency against their trading partners so they can:<\/p>\n

    \n
  1. give their exporters a competitive advantage<\/li>\n
  2. pull stronger currencies in to make money on the exchange, and<\/li>\n
  3. service their ever expanding debts back with devalued, cheaper currency<\/li>\n<\/ol>\n

    This is why everybody\u2019s purchasing power is going down despite tenured academics and central bankers incessantly complaining about \u201clow inflation\u201d and political spokesmodels always talking up a \u201cstrong currency.\u201d<\/p>\n

    Bitcoin Isn\u2019t:<\/strong>\u00a0\u201cBacked by nothing.\u201d<\/em>
    \nWhat Is?<\/strong>\u00a0The USD and every other fiat currency in the world.<\/em><\/p>\n

    \u201cBitcoin is a Ponzi\u201d<\/strong><\/p>\n

    The idea that Bitcoin or most crypto-currencies are \u201ca Ponzi\u201d is easily debunked by understanding what a Ponzi actually is.<\/p>\n

    As observed in\u00a0CryptoAssets<\/a><\/em>\u00a0(Burniske & Tartar, 2017), it\u2019s very simple:\u00a0new investors pay old investors.<\/em><\/p>\n

    It is important to realize that in a Ponzi, the earlier investors are literally paid with funds being injected by the new investors in a \u201cflow through\u201d fashion (as distinct from later investors having to pay higher prices to earlier ones to induce them to part with an asset).<\/p>\n

    As long as the number of new investors and, thus, the influx of funds is growing at a rate faster than the payouts to the earlier investors, the Ponzi scheme thrives. When the expected payouts exceed the rate of input, it dies.<\/p>\n

    One doesn\u2019t have to look very far to find mechanisms that fit the definition exactly:\u00a0Social security programs are all classic ponzis.<\/em>\u00a0The demographic reality of today is that with the entry of the \u201cBaby Boomer\u201d generation into retirement, given that the subsequent generations are so much smaller in size, additionally penalized by falling real wages,\u00a0growing taxation, decaying purchasing power\u00a0of their money, and returns on any savings they can eek out suppressed into negative nominal yields\u00a0\u2014 this Ponzi is in its terminal phase.<\/p>\n

    (Given that these exacerbating headwinds which face later generations can be summed up with the phrase \u201cfinancial repression,\u201d it is only logical that capital would \u201cflee\u201d to some asset or currency which appears resistant to them.)<\/p>\n

    Granted, the current ICO craze probably includes some Ponzis. The\u00a0Cryptoassets<\/em> book<\/a>\u00a0describes the\u00a0OneCoin Ponzi<\/a>\u00a0as well as how to spot a Ponzi in crypto-currencies. I would have been hesitant to even call OneCoin a crypto-currency at all. It wasn\u2019t open-source and had no public blockchain.<\/p>\n

    In Bitcoin\u00a0and other true crypto-currencies, early holders are not receiving bitcoin from later entrants. In fact, quite the opposite is happening. Later entrants must entice earlier ones to part with their bitcoin. Since bitcoin cannot be created at will, it must be mined at a rate that drops over time (this year approximately 640K new bitcoin will be mined, about 3.8% of the total supply).<\/p>\n

    Demand for bitcoin is simply outstripping the supply of new coins being mined (for reasons we will discuss in Part II). If said price action rises dramatically (like, for example, Bitcoin suddenly became the highest performing asset class in the world) then a feedback loop would occur. Ever higher prices would be required to induce earlier holders to sell.<\/p>\n

    Bitcoin Isn\u2019t:<\/strong>\u00a0A Ponzi<\/em>
    \nWhat Is?<\/strong>\u00a0Social Security<\/em><\/p>\n

    Tulipmania<\/strong><\/p>\n

    What is described above is the same dynamic that occurs in any \u201cbull market,\u201d as buying begets more buying and \u201cfear of missing out\u201d kicks in. It is said that one of the most accurate gauges of \u201chappiness\u201d correlates closely to how much wealth one has when compared to one\u2019s brother-in-law. Alex J Pollock describes it in\u00a0Boom and Bust: Financial Cycles and Human Prosperity<\/a><\/em>, as \u201cThe disturbing experience of watching one\u2019s friends get rich.\u201d<\/p>\n

    The trick would be to have some understanding of when a strong bull market has crossed into bubble territory. One of the more popular analogies for Bitcoin is Tulipmania: the financial bubble that occurred in 1630s Amsterdam with none other than tulip bulbs. Bitcoin is compared to Tulipmania so often that I decided to take a closer look at Tulipmania to see if the comparison was valid.<\/p>\n

    What I found was that most of what we know today about Tulipmania is superficial and self-referential, deriving primarily Charles Mackay\u2019s chapter on Tulipmania in his seminal\u00a0“Extraordinary Delusions and the Madness of Crowds<\/a>”\u00a0(1841). It is a scant 9 pages an purely anecdotal, describing ridiculous prices paid by the otherwise pragmatic and level-headed Dutch, and then it all just blew up like all bubbles do.<\/p>\n

    Finally I found Anne Goldgar\u2019s\u00a0Tulipmania: Money, Honor and Knowledge in the Dutch Golden Age<\/a><\/em>, which is the most in-depth investigation\u00a0of the rise and subsequent fall of Tulipmania extant today. In it we learn about the circular references that went on to inform our present time about Tulipmania:<\/p>\n

    If we trace these stories back through the centuries, we find how weak their foundations actually are. In fact, they are based on one or two contemporary pieces of propaganda and a prodigious amount of plagiarism. From there we have our modern story of tulipmania.<\/p><\/blockquote>\n

    She traces the lineage of MacKay\u2019s chapter:<\/p>\n

    Mackay\u2019s chief source was Johann Beckmann, author of Beytrage zur Geschichte der Erfindungen, which, as A History of Inventions, Discoveries and Origins, went through many editions in English from 1797 on. Mackay\u2019s chief source was Beckmann was concerned about financial speculation in his day, but his own sources were suspect.<\/em><\/p>\n

    He relied chiefly on Abraham Munting, a botanical writer from the late seventeenth century. Munting\u2019s father, himself a botanist, had lost money on tulips, but Munting, writing in the early 1670s, was himself no reliable eyewitness. His own words, often verbatim, come chiefly from two places: the historical account of the chronicler, Lieuwe van Aitzema in 1669, and one of the longest of the contemporary pieces of propaganda against the trade, Adriaen Roman\u2019s Samen-spraech tusschen Waermondt ende Gaergoedt (Dialogue logue between True-mouth and Greedy-goods) of 1637. As Aitzema was himself basing his chronicle on the pamphlet literature,\u00a0we are left with a picture of tulipmania based almost solely on propaganda, cited as if it were fact.\u00a0<\/em>(emphasis added)<\/blockquote>\n

    Goldgar helps the reader in pursuit of truly understanding Tulipmania by rewinding to the late 1590s when there were no tulips in what is now Holland, or, in fact, the whole of Europe. Gardens were purely functional, designed for growing food, herbs, or medicinals. Then tulips and other curiosities began coming into the country and Europe from merchant vessels trading in the Mediterranean and Far East.<\/p>\n

    The \u201cflower garden\u201d arose for the first time, and it was spectacular \u2014 giving rise to an entire movement of collectors and aficionados whom, in the early days, were, as a rule, well-to-do. In later years, more people sought out, and then speculated in, the tulip trade not only to profit,\u00a0but to lay their own claims on what they perceived to be a higher economic class or status.<\/em><\/p>\n

    \n

    \"\"At the risk of over simplifying her work, the tulip trade became intertwined and inseparable from, art.<\/p>\n<\/div>\n

    The collecting of art seemed to go with the collecting of tulips. This meant that the tulip craze was part of a much bigger mentality, a mentality of curiosity, of excitement, and of piecing together connections between the seemingly disparate worlds of art and nature. It also placed the tulip firmly in a social world, in which collectors strove for social status and sought to represent themselves as connoisseurs to each other and to themselves.<\/p><\/blockquote>\n

    The more I delved into understanding Tulipmania, the more I couldn\u2019t escape thinking that the analogy was much more applicable to a different \u201casset class\u201d which did enjoy a momentous bubble in recent times, but it wasn\u2019t Bitcoin or crypto-currencies. To belabor my point, Bitcoin was impelled not by art, beauty, or any semblance of collectibility, but emerged\u00a0primarily as a resistance to financial repression.<\/em><\/p>\n

    Something that\u00a0was<\/em>\u00a0driven by uniqueness and fostered an aristocratic in-club all its own and, until recently, enjoyed stratospheric price action was the\u00a0aftermarket in domain names<\/em>. This isn\u2019t the place to conduct a post-mortem on that bubble, but suffice it to say that the distinct characteristics of domain names more closely resembled that of tulip bulbs than Bitcoin does. (For the reader interested, I have written at length about the domain aftermarket\u00a0here<\/a>\u00a0and\u00a0here<\/a>.)<\/p>\n

    Bitcoin Isn\u2019t:<\/strong>\u00a0Tulipmania<\/em>
    \nWhat Is?<\/strong>\u00a0Domain names.<\/em><\/p>\n

    If Bitcoin isn\u2019t a digital fiat backed by nothing, nor a Ponzi, nor Tulipmania, then what is it? Why has this come out of literally nowhere to become the strongest performing and fastest growing asset\/currency in the world?<\/p>\n

    When I started writing this article, I wasn\u2019t sure myself. I had to go back through my library and look at history and try to find some antecedent for what was happening. After looking back through the origins of money itself and working forward, I still wasn\u2019t any closer to a mental model that \u201cworked.\u201d<\/p>\n

    Then, around 2 a.m. the other night, I woke up with the idea that I was looking in the wrong place, and it hit me with such force that I had a hard time getting back to sleep \u2014 even though I had made an \u201coff the cuff\u201d tweet that captured the basic idea of it a few weeks earlier (which I can\u2019t find now).<\/p>\n

    I\u2019ll take you through it in Part II. But in the meantime, I\u2019ll leave you with another megabank CEO whose take on all this is very different from Jamie Dimon\u2019s. Goldman Sachs\u2019 CEO Lloyd Blankfein here muses on why it\u2019s entirely plausible that money may evolve from being based on fiat to being based on consensus. These are some truly extraordinary remarks coming from a man in his position.<\/p>\n