Jamie Dimon is wrong. Bitcoin is not a fraud

Bitcoin isn’t money either. It is a commodity

[NOTE: I wrote this piece yesterday for a friend. It has already become dated with the new developments in China and BTCC exchange]

On September 12, 2017, Jamie Dimon, most well respected CEO in US and current head of JP Morgan Chase the largest bank in US made the following comments about Bitcoin

Do we have traders who trade it? If we had a trader who traded Bitcoin I’d fire them in a second. For two reasons: It’s against our rules, and they’re stupid. And both are dangerous.
I’m going to be really clear in this one. Forget the blockchain, that’s a technology… But… the currency isn’t going to work. You can’t have a business where people can invent a currency out of thin air and think the people buying it are really smart. It’s worse than tulip bulbs, OK?
And honestly I’m just shocked anyone can’t see it for what it is. The only good argument I’ve ever heard for it — and there is one good one — there may be a market for it, particularly if Bitcoin can keep itself to 21 million coins, if you were in Venezuela, or Ecuador, or North Korea… or if you were a drug dealer or a murderer, you are better off dealing in Bitcoin than US dollars. You are better off bypassing the system of your country, even if what I just said is true. So there may be a market for that, but it’ll be a limited market.

Before we talk about his claims, let us see what impact his statement had on the four largest crypto-currencies when valued in US Dollars.

They tanked by almost 10% within 24 hours. For currencies that are supposed to free us from the tyranny of the incumbent financial elite, that was a disappointing performance.

Politics of Bitcoin

Jamie Dimon said that Bitcoin as a currency will not work because it is created out of thin air. But that is how the current monetary system works. The currencies that exist today are not backed by gold and/or silver. Central banks create it out of thin air (it is called fiat currency) and then commercial banks multiply it through the fractional reserve system of banking. After the financial crisis of 2008, central banks in the developed world engaged in “Quantitative Easing” which is a sophisticated way of saying that they created trillions of dollars of currency out of thin air and deposited it with commercial bank (with Jamie Dimon’s JPM Chase being one of the beneficiaries). So in a way Bitcoin is like existing currencies i.e. both are created out of thin air.

I hear some rumblings among bitcoin fans. They say, unlike existing currencies which can be issued infinitely, bitcoin issuance is limited to 21,000,000 bitcoins (referred to as “ceiling”), an enforced scarcity that will ensure that bitcoin value isn’t inflated away. However, forking of bitcoin into Bitcoin (BTC) and Bitcoin Cash (BCH) that happened in August 2017 did exactly that. By creating a new currency they doubled the ceiling to 42,000,000 coins (21,000,000 coins each for BTC and BCG) and instead of dividing the value of the original bitcoin between BTC and BCH, value of both currencies increased such that BCH, a currency which came into being in August 2017 is already third largest currency by “Market Cap”. Who is to say there will not be more forkings in the future. By unlimited forkings, unlimited number of various variants of bitcoins can be created.

Bitcoin fans continue to point out that bitcoin isn’t like traditional money as there isn’t any tyranny of government with bitcoin. In fiat it is the government which decides how much currency to print. Even if there is a forking in bitcoin, it is the investors who are deciding with their money. Well that is not the case. We can divide bitcoin stakeholders into three groups. Bitcoin developers (who maintain the code), miners (those who have invested time and money in setting up computer systems to sustain the blockchain and mine new bitcoins) and investors. Whereas miners and investors have invested actual hard cash in bitcoin and gain the most when bitcoin increases in value, the developers don’t get much out of it except for prestige. Whereas miners have some leverage in the direction bitcoin proceeds as they are the ones voting with their computing power, investors have little or no sway. If anyone wondered what caused the August 2017 forking, it was a disagreement between miners and developers on the future direction of bitcoin. Another such moment is arriving in November 2017 where miners and developers are in opposing camps. This pertains to doubling the block size which the miners want as it will increase the number of transactions miners can process in a block and hence more transaction fees for them. The developers are clearly against it (despite having agreed to it earlier) as they think this goes against their principles or principles of Satoshi Nakamoto (original creator of bitcoin/blockchain). Come November 2017, we shall see if bitcoin investors have exchanged tyranny of government with tyranny of code developers. There is a possibility we may see another forking in November and hence additional 21,000,000 million coins.

Economics of Bitcoin

In Economics, money or currency has two main functions: it is a store of value and a medium of exchange. There is also a third of one: unit of account i.e. prices are quoted in a currency. We can clearly discard the third one as a function not served by bitcoin. With the volatility of bitcoin price, no one quotes their services in terms of bitcoin. All prices are quoted in USD/Euro/GBP but you can pay in equivalent bitcoin at the prevaling exchange rate.

Theoretically, money derives its value from the backing given to it by government as legal tender as well as currency in which the government accepts tax payment. Moreover, the function of currency is to facilitate transactions, trade etc. When governments issue money and increase money supply, they do not do it so that people can hoard it in their bank accounts. Their purpose is to nudge corporations towards making new investments and people to spend money which will result in economic growth and eventually more tax revenues from the government.

Below is a beautiful blogpost about “What is Money?” It tells you that Money is what people construe to be money. So if people treat bitcoin like money, then bitcoin is money. But I am getting ahead of of myself.

Does Bitcoin serve the same purpose as money? The answer is clearly no. With the way bitcoin price was increasing, no one (with the exception of censorship resistors and drug buyers to which I will come shortly) was buying bitcoin to carry out transactions. Everyone bought bitcoins to hold (bitcoiners use the term “HODL”) and to benefit from the price increasing trend. For example, why would you convert your 2,000 dollars into bitcoin and then use those bitcoins to buy a 2,000 dollar car if you think that the value of your bitcoin holding can be 3,000 dollars or even 10,000 dollars tomorrow. And why would I sell you a car for bitcoins if I have to convert bitcoin back to dollars to pay for the sales tax and purchasing a new car in dollars. What if value of bitcoin decreases between the time I sell the car and the time I buy a new one. I will have to come up with the difference. Unless everyone moves to bitcoin for their transactions, it is a very inefficient medium of exchange and only good for speculation.

Most of the people who are investing in bitcoins are investing in it for price increase similar to how people invest in stocks or gold. But stocks get you dividend or at least ownership share in the underlying business and gold has some intrinsic value as jewelry and its heritage. Bitcoin doesn’t have any such characteristics.

Is there any value in bitcoin?

We have learnt that bitcoins can be created infinitely by forking, are susceptible to tyranny of developers or miners and most of the time it is highly inefficient medium of exchange. Is there any economic value in bitcoin? Answer is yes. When you store money in a bank or transact money through a bank or deal in government currency, the government can seize your money. But bitcoin exists on a blockchain which is a distributed ledger with no single point of failure and secured by a private key which is known only to you. If no one knows your private key, no one can have access to your bitcoins. Secondly, bitcoins are sent and received over blockchain i.e., they don’t go through international monetary system. Hence, there is no way that a government can seize the money while in transit either. As such, it makes a lot of sense for people who are trying to bypass government regulations to use bitcoins. Hence, majority of people who use bitcoin for transactions are those who ply in drug trade, smuggling and people who are trying to bypass foreign exchange regulations imposed by their government. It was used to bypass censorship when Visa / MasterCard refused to serve WikiLeaks under pressure from US Govt, WikiLeaks set up a bitcoin address to receive funds in bitcoin. Hence, bitcoin has value for people who are trying to prevent governments to control their wealth and income.

However, blockchain is a transparent ledger as one can see all the transactions that have taken place since the beginning. With the computer resources governments have at their disposal, they can trace patterns and use them to identify suspect accounts and if the buyer/seller isn’t careful with his precautions, governments can find out who is engaged in illicit activities and apprehend them (though whether they can access his/her bitcoins depends on how if they are able to get access to his private key).

For most us law abiding citizens, we keep our money in exchanges such as Coinbase etc. These exchanges ask for your ID and hold the private keys on our behalf. They also share information with government agencies and if they receive an order from government to seize and handover your bitcoins they will do so. By using an exchange, we have almost defeated the most prized benefit of bitcoin.

Conclusion

There are newer cryptocurrencies such as Monero and Zcash which while keeping a public blockchain try to anonymize the transactions by aggregating them. If those, who use bitcoin for illicit trade move to other currencies that give them more anonymity, there isn’t any value left in bitcoin. Or if the miners who are sustaining the blockchain decide that they have had it with tyranny of developers, the miners will cash out their bitcoins and move to mining other currencies which will bring down the value of bitcoin significantly. Can this happen? Yes! Will this happen? Probably not.

The purpose of this piece was to highlight the characteristics of bitcoin which receive very limited or no coverage in mainstream media.

Good luck investing in bitcoin.

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