Cryptocurrencies cannot be understood even a little bit by anyone who thinks money is real, solid, or “backed by” anything other than human trust in institutions whose stability is always uncertain. A U.S. dollar is “backed by” “the full faith and credit of the United States.” But what exactly does this mean?
It means considerably more than you think. All money is illusory. All money is created out of thin air. Gold coins are not money until they have the emperor’s face stamped on them. Without that, they are just metal slugs. A valuable metal, to be sure, owing to its many useful properties, once merely decorative, now industrial as well.
All money is just an accounting system. That’s it. It’s a way of saying “I gave you 12 units of wheat flour”, of which you can later spend 3.7 units to purchase a chicken. Money is just a way for exchanges to take place across time and distance and different kinds of products and services. It’s just an accounting system, a portable, self-documenting ledger (if it’s in your account or in your pocket, you own it).
Yes, it is based on faith, but faith in what? Faith in the continued stability of the accounting system. How is that stability achieved? In the case of the US dollar, it is achieved by the military might of the United States, yes, but also the police and court systems which work to minimize crime and enforce contracts (extremely fundamental to the stability of any currency), the continued robustness of the overall economy of the United States (and to a great extent, the world), and not least to the underlying intrinsic value of all the natural resources and built infrastructure and goods and available services owned or hosted by the United States.
Think of that last one as the book value of the US. At minimum, all the dollars in circulation (not just the notes and coins, because those are merely records, but all the dollars) could, if nothing else, be redeemed in exchange for selling the land, mineral rights, water rights, buildings, and well, stuff in the United States. Even at fire sale prices, this is a staggering amount of value.
Yes, it’s true that the Federal Reserve, the Treasury, and the banks work in concert to create the money supply, but remember, that’s just the digits used to count the value of all the stuff. The Fed targets 2% inflation, which is a slow, but stable, erosion of the value of the dollar over time. Put another way, it is simply a slight annual increase in the money supply over and above the increase that would be necessary to “count” all the new value that has been produced by the total economic output of the country over the last year. If the economy is growing in value, the money supply must increase to keep pace, or else you would have deflation. So yeah, the government prints money to keep up. Or they just have the banks do it.
So what is the value of Bitcoin based on? Sure, the shared expectation of its continued usefulness as a medium of exchange by its users, like any other form of scrip. Apart from that? Not a damn thing. There are no underlying assets that could be sold off if push came to shove. None. By it’s distributed nature, even the servers that keep track of it don’t belong to the central issuing agency of Bitcoin, because there isn’t one. It’s not that it doesn’t have an army to defend itself. It’s that it doesn’t exist at all.
This is why Bitcoin is so incredibly volatile. Sure, the US dollar goes up and down, like other national currencies, but compared to Bitcoin, USD is like the Rock of Gibraltar. Look what happened during the Great Recession. The US was being swallowed by an economic black hole. The government intervened in a variety of imaginative (some quite unsavory) ways to stabilize the economy. If they hadn’t done that, the currency could well have dropped 80% vs other currencies, and it might have taken an extra decade or two to recover. Who will intervene to prop up Bitcoin in an emergency? Nobody. Bitcoin holders would just eat the loss.
The fact that Bitcoin relies on a blockchain to keep very careful track of ownership is meaningless if the value of each Bitcoin can be $1,000 one day, $10,000 the next, and $0 the day after that. I don’t care if you can demonstrate the precise provenance of your Bitcoin if it’s so unstable that I’d rather just barter, thank you. Extreme volatility is the death of any currency. Just ask the Papiermark:
Oh, and what happens after the 21 millionth Bitcoin is mined and no more are ever created? Assuming the real world economy keeps growing, Bitcoin will enjoy permanent deflation, at an uncontrolled rate. Instability is built in to the Bitcoin plan from the beginning. That’s stupid. That’s as stupid as using the gold standard. For the same reason. You do not want a currency whose creation is not under government control. If you can’t trust your government to be a responsible steward of the currency, that’s a separate problem.