Money Without Banks? October 30 2016

Bitcoin: Global and Anonymous Digital Money without Banks

As a means of controlling inflation, the renowned economist Milton Friedman once famously recommended that the US Federal Reserve be replaced by an automated system that would create money at a predetermined rate. Such a system, he hoped, would be free of political interference and would foster a more stable monetary environment for investors and consumers. He died in 2006. Had he lived just another three years, this farsighted economist might well have witnessed the beginning of his dream coming true.

We're so familiar with traditional paper and coin money, that we rarely pay much attention to what it really is and what is happening when we use it. We forget that the paper or coin is valuable only because a state guarantees its value on presentation and that the value is, literally, relative and variable. It is relative to the amount of money in circulation and the amount of goods and services we can obtain with it at any one time. In addition, its value is relative to that of other currencies. When we buy something with money, we hand that state guarantee to someone else in exchange for goods or services. The state also accepts the return of its own currency in the payment of taxes. For hundreds of years, the world's states were the principal issuers, guarantors, and regulators of all major currencies. Computers and the Internet, however, may soon change that game, and Bitcoin - a currency system that first appeared in 2009 - is likely to be the leading player.?

(NOTE: the capitalized word "Bitcoin" refers to the currency system, including the network and the software; the lowercase word "bitcoin" refers to the currency unit.)?

Bitcoin is a currency that's unique for five important reasons. First, it's virtual, which means that it exists only electronically. Traditional currencies are not virtual currencies because they exist physically as notes and coins, even if the value of those notes and coins is sometimes transferred electronically. Second, Bitcoin is not issued, guaranteed, or controlled by any state or group of states, or any other central authority.

Third, Bitcoin is a wholly software-based digital currency controlled by a decentralized peer-to-peer computer network. The network automatically monitors, verifies and approves all transactions. Instead of a note or coin, each bitcoin unit exists as a unique encrypted number. This type of digital currency is called a cryptocurrency. Each number is recorded in a shared database called a ledger that's visible to all users, and is the backbone of the decentralized ledger currency. The bitcoin is valuable only to its current owner because only that owner possesses the unique, secret "private key" encryption code associated with that bitcoin's unique number. That code is needed to transfer ownership of the bitcoin to someone else, and each valid bitcoin transfer is recorded in the ledger, guaranteeing that no one makes more than one purchase with the same bitcoin. The value of a traditional currency resides with whoever possesses the printed paper note or metal coin. The value of a bitcoin resides with whoever possesses the private key that enables them to transfer the bitcoin to someone else.

Fourth, Bitcoin transaction costs are a small fraction of those charged by operators of traditional payment systems like banks and credit card companies. In addition, Bitcoin is not subject to government charges like the stamp duties on credit cards and checkbooks that exist in some countries.

Fifth, Bitcoin users are anonymous and their transactions virtually untraceable. In addition, the distributed nature of the Bitcoin infrastructure means it's based in no specific legal jurisdiction. Not surprisingly, the system is attractive to criminals.

Strangely, nobody has claimed credit for creating this complex currency. The name most often associated with its creation is Satoshi Nakamoto, but this seems to be a pseudonym, which may refer to a man, a woman, or even a group of people. On the other hand, maybe it's Milton Friedman's ghost returned to Earth to ensure that his dream of a currency system that's beyond political meddling will finally come true.