Merry Xmas and Thanks for Reading

I started blogging about three years ago, initially very occasionally just on whatever happened to irk me at the time, but this year I became a bit more focused and dedicated to posting regularly on the themes of individual freedom and rights, government excess, and the dishonesty of those pursuing collectivist causes such as world environmental regulation. I've gone from having a handful of readers to over a thousand for some of my posts. I don't imagine my blogs have much impact except to reinforce the views of those readers who are already pro-freedom, but I hope I have made one or two people think afresh about accepting the current political orthodoxy of big government is always good. Next year I will continue to post, hopefully even more regularly than this year.

Thanks to all of you who have read my blog. Please continue to do so.

The Case for Bitcoin

I have taken an interest in bitcoin for several years now and when I first starting looking into it, pretty much no one else had heard of the digital currency and it was hard to find any useful information about it. So I got myself a bitcoin wallet and started to play with it.

Recently I've seen a great deal of ill-informed commentary on the subject such as this article by Louis Cammarosano that was linked on Peter Creswell’s blog. While Peter posted this response from guest blogger Paul Van Dinther, I don’t think the response goes nearly far enough in addressing the issues that have been raised, so I’ve decided to do my own post on the subject to destroy some of the myths that are surrounding bitcoin.

Bitcoin is a digital currency, not a payment service like PayPal. A currency is an artificial store of value. A currency can be based on a physical commodity, like gold, but even where this is the case the currency itself is artificial. Currencies do not have to be based on physical commodities and, in fact, almost all currencies in the world today are what is known as “fiat” currencies, meaning they are backed by law rather than by any physical commodity.

Bitcoin, you might be surprised to hear, is a commodity-based currency. What is the commodity that it is based on? Well, this is where things get a little complicated. It is based on a digital commodity that is the result of a complex computation. Like any physical commodity such as gold, the digital commodity requires physical effort to extract it. The physical effort in this case is the computing power required to calculate the next unique number in a sequence that is a bitcoin. One of the reasons that bitcoins are increasing in value is that new coins are getting harder to extract. In 2009 a bitcoin could be “mined” using a personal computer in about two weeks. Now it takes about a year and a half. This is because there will only ever be 21 million bitcoins and more than half of them have already been found.

The beauty of bitcoin is in that complex computation or algorithm that reveals the next coin. The algorithm is a cryptographic formula and, like most cryptography, it is extremely difficult to calculate one way but very easy to validate the outcome of the calculation the other way. Think of multiplying two prime numbers together - even two relatively large primes are quite easy to multiply especially if you have a calculator, but it is very difficult to do the reverse – factorising a very large product. Because it uses a cryptographic algorithm, bitcoin satisfies two security requirements - it is very difficult to hack (i.e. forge a valid bitcoin) and very easy for anyone to check whether any one bitcoin is valid. I won’t go into the details of how the algorithm actually works but it is sufficient to say that the worldwide network of bitcoin wallets effectively “votes” on which is the next valid coin in the sequence. You can probably forge a bitcoin if you knew what you were doing but within an hour of spending it (the time taken for a bitcoin to propagate to nearly every wallet in the world), everyone would know it was fraudulent.

But what if you were able to hack the algorithm itself so that your fraudulent coins were always recognised as the valid ones? That is possible, but over the several years that have passed since bitcoin was invented by the pseudonymous Satoshi Nakamoto, the collective minds of the world’s greatest hackers and, more importantly, some of the world’s leading mathematicians have not been able to reverse engineer the problem. 

So let’s examine each of the arguments that Louis Cammarosano makes against the digital currency. He claims that bitcoin has no intrinsic value but, as Paul Van Dinther points out, neither substantially does gold. The latter is worth what it is because of its rarity and the effort of mining it, not because it has some limited industrial uses in electronic circuits and to coat visors.

Cammarosano’s next argument against bitcoin is his contempt for “early adopter smugness”, a fairly hypocritical objection from someone who calls bitcoin a “faith-based/emotion backed currency”. He says you must believe in bitcoin in order to ascribe value to it. He admits the same applies to the US Dollar and all other fiat currencies. But, as I have said above, bitcoin is actually a commodity-based currency and its value is dependent on the rarity of the commodity, and this puts it above the US Dollar and all other major Western currencies.

He says it is “not really anonymous” because you can trace the trades through the physical delivery of goods that are purchased. Yes, of course you can as the founder of the drugs trading site, Silk Road, recently discovered. Bitcoin is certainly more anonymous than US Dollars and other mainstream currency transactions that must now be declared to the US government under its nefarious FATCA law (of which I have recently blogged).

He says bitcoins are “not limited in supply” because the 21 million bitcoins can be subdivided infinitely. This means that bitcoin can endlessly deflate and can still be used to purchase small value items, and actually this is a highly desirable attribute of a currency and one that we haven’t seen in Western currencies since they were gold-based in the early 20th century.

He says there is “no customer service if something goes wrong,” unlike “PayPal, Visa, MasterCard, and AMEX services that will refund their users’ money if a transaction goes wrong.” But of course his examples are not currencies but rather payment services, and good luck to you getting your value back when the US Dollar tanks as it is soon to do. And he is wrong on the point that bitcoin holdings are uninsurable.

Finally, he says bitcoins can be stolen or lost or even manipulated in value. He is correct in that the coins are only as secure as the digital wallet they are kept in and that big players like governments could manipulate the market value of bitcoins. But is he seriously saying that these attributes don’t apply to every other currency in the world?

In conclusion, the only risk I see with bitcoin is that the algorithm might be broken, but this gets less likely the longer it exists unbroken and while I am not totally convinced it will remain forever impregnable (e.g. who knows what quantum computers could do?), I think bitcoin is already a viable alternative to the fiat currencies of thieving governments who continually debase their value. 

Wealth Inequality in America

Recently a friend of mine posted the following video on Facebook. Normally I wouldn't bother too much with watching a video on wealth inequality - I've heard all the arguments ad infinitum from the Occupy Wall Street crowd - but I paid attention to this because my friend who posted it used to be the New Zealand head of a major American IT company and is about as far from an Occupy protestor as you could get. I watched the video and decided that it made a fair point - the United States has a very inequitable distribution of wealth - and I decided to write a blogpost about the subject, but not before I'd looked a bit further into the issues shown on the video.

Like many of the claims made by the Occupy movement, the facts of the matter aren't quite as straightforward as the video makes them out to be, as the following critique video makes clear.

In spite of the validity of the critique, I'm sure the overall point made in the first video is sound - America has become more unequal in the last few decades. The video also implies (but doesn't provide any statistics to support the implication) that economic mobility has been reduced. This is, I suspect, a bigger problem for America than increased inequality per se.

British journalist Jonathan Freedland, who was The Guardian's Washington correspondent for five years, revealed a remarkable statistic about America in his book, Bring Home the Revolution, that reveals the United States really is the land of opportunity: of all the people in the bottom fifth of the US income scale in 1975, only 5 percent were still there in 1991. In other words, within a decade and a half, 95% of America's poor were poor no more. What is more, one third of those bottom-fifth families had moved into the top half of incomes within a generation. Another statistic that supports this picture of economic mobility is that four out of five American millionaires made their wealth from scratch.  The figures in Britain are substantially the reverse.  This is what makes America what it has been - the land of opportunity. But Freeland concedes that by the time he published his book in 1998 the trend was slowing and I suspect that since then it has slowed further.

Personally, I think income inequality does not particularly matter so long as people have the opportunity to improve their lot. The natural state of human beings is abject poverty - subsistent living. The beauty of the free market is that it allows people to improve their situation by using their abilities to produce goods and services that they can trade with others who produce other goods and services, thereby improving the lot of everyone. Even the lowly labourer benefits because he can use his labour to produce higher value goods (e.g. assembling iPhones) and get greater rewards for his labour than he would get in subsistence work. But the system depends on 'churn', i.e. the ability of people to improve their lot - the labourer saves up and sets up a small business or funds himself through night school and uses his qualification to get a better-paying job. Contrary to what Socialists believe, it really does work and the statistics Freeland quotes in his book proves that it worked for the United States.

Why has it stopped working? Well, I think the answer is simple - capitalism has become crony capitalism. America today is a place where if you are big and powerful enough (i.e. "too big to fail"), the government will support you and bail you out when you make bad decisions. The big guys get the subsidies, the tax breaks and the preferential regulatory treatment, whereas smaller businesses and the middle class salary and wage earners get the regulations, the compliance costs and pay the bulk of tax. The system acts as a brake on economic mobility. When the big guys are protected from failure and the little guys prevented from succeeding, it is no surprise that there is little economic churn. The Occupy crowd blames capitalism, as if America still had some form of genuinely free market economy, but it does not. Capitalism is not to blame, it is government that has perverted the free market and created crony capitalism by allowing its favours to be bought and sold. It is only a return to free markets and government 'of the people for the people', rather than of and for the powerful, that will solve the problem of increasing inequality.