Bitcoin's market power will grow as it is traded in futures markets.
Nathaniel Popper’s Digital Gold is a wonderfully researched, fast paced narrative of the beginnings of Bitcoin. As its subtitle, The Inside Story of the Misfits and Millionaires Trying to Reinvent Money, suggests, its emphasis is on the colorful cast of characters who got Bitcoin off the ground. In my last post, I described the mechanics of Bitcoin—a potential instrument of freedom from the state. In this post, I describe how the development of Bitcoin itself exemplifies another aspect of liberty– spontaneous order. Different individuals with different interests combine in ways no central planner could direct to transform an idea into a valuable commodity that may someday represent a sufficiently stable source of value to become a currency. It is the story of a Platonic form becoming a reality in the messy cave that is our world.
Bitcoin has no intrinsic value whatsoever. It began as an algorithm that generates tokens in cyberspace. Popper shows that in 2009 and 2010 computer geeks were the first group to take an interest. They mined coins and provided the computer power to verify transactions because they admired the algorithm not because they want to make money. It is an appreciation of beauty that gives Bitcoin its start,
These transactions remained more akin to a game with monopoly money. But another group—people who wanted to engage in illicit transactions– did find an actual value, exploiting the anonymity of Bitcoin. Ross Ulbricht met this demand by creating Silk Road where people could trade Bitcoins for drugs. He soon descended into even greater evil, offering contracts on the lives of potential informers. But his early adoption of Bitcoin demonstrates a strong version of Bernard Mandeville’s famous paradox: private vice can give rise to public virtue—helping foster a new repository of value.
Yet a third group provided further impetus to Bitcoin: ideological libertarians who liked the idea of a currency outside of government control. They were joined by people who are libertarian by necessity, such as those who live in nations which have currencies whose value as regulated by the government are radically different from their real value. Bitcoin became a useful mechanism to evade such currency controls. And as the coin gained value, speculators joined the merry band of Bitcoin owners, hoping that its potential as a currency would propel it to greater heights. They deployed more powerful machines to mine it and verify transactions. By 2013, spontaneous order had pushed up the value from essentially zero to a thousand dollars per coin.
But then the very success of Bitcoin threatened its initial promise. Its speculative value retarded its progress as a currency, because some of those who used it for exchange now wanted to hoard it in the hopes of further rises. And its greater value forced users to confront another problem. Your ownership of a Bitcoin is only as secure as your control of its private key. If you kept it on a computer, your computer could be hacked. If you wrote it on piece of paper, that paper could be lost. And thus a demand was born for middlemen who would hold your coins in their secure wallets.
But such middlemen needed ordinary law to define their rights and their customers’ rights. As Popper recognizes, the natural growth of Bitcoin, “a technology that has been designed in no small part to circumvent government power,” started to become intertwined with governmental authority. It is hard to keep a private law—Bitcoin’s algorithm—separate from all public law, as the private law creates more and more value.
And the fringe characters who were the early adopters and middlemen of a fringe technology were then replaced by sophisticated investors like the Winklevoss twins of Facebook fame and other veterans of Silicon Valley. But that replacement was necessary for Bitcoin to keep the trust of its users. Through spontaneous order, a beautiful concept has become a commodity that is itself generating serious startups. In the next post, I will consider whether this commodity is likely to become an actual currency.