Bubbles happen because people ignore economics and assume away reality in their excitement over a new idea. “Virtual currencies” could be the latest tech “economics of abundance” bubble in the making. Fans of abundance economics imagine that the free and open Internet’s near zero marginal cost of borderless transactions will ultimately slay traditional economics of scarcity.
Cyber-utopians imagine that currency, or money, is a simple function, like any other product or service that they have made openly available to everyone in the world at virtually no cost on the Internet. They imagine the only thing that matters with the business of money is how money is transmitted.
They assume creating money is just a coding and crowd-sourcing task. How hard could that be? What possibly could go wrong? It’s only money.
They imagine that if it is on the Internet, it is borderless; and thus is not under any sovereign authority. Thus they further imagine cyberspace virtual currencies enjoy a huge and disruptive relative cost and efficiency advantage over realspace currencies that by definition are all under the legal control of a sovereign country and thus subject to a slew of necessary, but costly and people-intensive sovereign financial obligations, responsibilities, accountability, laws, regulations, audits, compliance, etc.
The abundance economics hype is on for virtual currencies.
- “The whole world is your market,” with Bitcoin, said Gavin Andresen, Bitcoin’s lead software developer.
- “We are in land-grab mode,” said Fred Ehrsam, Coinbase co-founder.
- “The appeal of zero transaction costs is really strong and extremely disruptive…” said Jeremy Liew a Lightspeed Venture partner.
- “It’s completely crazy that money is not borderless,” said Chi-Hua Chein, a general partner at Kleiner Perkins the best known Silicon Valley venture capital firm.
The fatal flaw in this virtual currency bubble is that currency is just another open source app. Currency is no app. It’s legal tender.
Legal tender is an organizing principle of commerce in all sovereign nations.
Virtual currencies are not legal tender. The U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN), has wisely updated its guidance to capture the predictable problems with virtual currencies. FinCEN defines currency as “the coin and paper money of the United States or of any other country that is designated as legal tender… virtual currency does not have legal tender status in any jurisdiction.” [Bold added for emphasis.]
Why does legal tender matter?
Legal tender is required to settle debts and engage in legally enforceable contracts, two central functions essential to modern commerce. Legal tender is also the foundation of public and private capital markets, capital formation and investing. Legal tender currencies are essential for transacting legal international trade. At bottom, without legal tender currencies, modern markets, trade and capitalism could not work.
It is important to note here that many free and open Internet cyber-utopians don’t want modern markets, trade and capitalism to work. That’s one of the core long term goals of virtual currencies. They want to disrupt existing incumbents and capitalism, and replace them with a new more egalitarian cyber-society and digital commons where most everything is free (meaning no one needs to ask for permission or pay for what’s on the Internet), and open (meaning no private property), and where sovereign authorities can be ignored.
Virtual currencies are to money; what net neutrality is to bandwidth and spectrum; what Copyleft and piracy is to copyrighted content; and what open-source software is to proprietary patented software. They are all different cyber-battlefronts in the same Code War ideological struggle between cyber-utopians rule of code and those who believe in sovereign rule of law.
The term “virtual currency” is at least a misnomer and maybe an oxymoron, because it is by the U.S. Government’s definition not “real,” while currency is real. Law enforcement and financial regulators are wisely scrutinizing self-proclaimed Internet “virtual currencies closely.” They are peer-to-peer, decentralized and encrypted virtual currencies such as: BitCoin, Litecoin, Freicoin, PPCoin; and centralized, non-encrypted, virtual currencies Ripple and Ven.
Recently, U.S. federal authorities arrested five people of digital company Liberty Reserve for money laundering and being a “bank of choice for the criminal underworld” per the Wall Street Journal. And state banking regulators reportedly are ramping up their regulation and oversight of virtual currencies.
Not being legal tender will have huge ramifications directly for virtual currency administrators and exchangers, and indirectly for virtual currency users as well. Borderless, encrypted payment networks without sovereign government accountability naturally will be magnets for money laundering, cybercrime, tax evasion, fraud, etc.
At core the bubble-dynamic of virtual currencies like Bitcoin, which by design reward first-movers and the earliest adopters hugely disproportionately over an average participant, is that they share a fraudulent speculative element that we have sadly seen many times before.
- The infamous, Charles Ponzi’s “Ponzi scheme” that paid early “investors” with later “investors” funds, is similar to early “investors” of virtual currencies being rewarded by later “investors” excited by the hype of the early “investors.”
- Enron’s leadership of Enron, the infamous “smartest guys in the room,” basically invented a harbinger of virtual currency out of nothing, virtual broadband contracts, to hyper-inflate the public value of the company before it went spectacularly bankrupt and decimated the retirement savings of tens of thousands of Americans.
- Bernie Madoff defrauded many in a Ponzi-like scheme by pointing to the people who already had invested in his fund as comfort that everything was above board, when we later learned, that most everyone had assumed that those before them had done their due diligence -- when none had. This is similar to the current dynamic of how virtual currencies are being hyped – everybody is trusting the lemming ahead of them.
In sum, these virtual currencies are very likely to end badly.
We have seen this movie before, too many times. How badly they turn out will depend on how much runway law enforcement gives these modern day alchemists who are claiming to magically transmute worthless digital bits they conjured up in a software program, into virtual gold that they can exchange into real money -- for an additional commission.
No matter how much cyber-pixie-dust is sprinkled here or how many times speculators or Silicon Valley venture capitalists chant “disruption” and “innovation” that the virtual currencies purportedly embody, remember, alchemy is ultimately fraud whether it is perpetrated in realspace or cyberspace.
The old adage is true: you can’t get something for nothing – at least not honestly.
[Update 10-2-13: Per Business Insider: "Silk Road, the anonymous Internet marketplace best known as a destination for buying illegal drugs, has been seized by the FBI. ... The seizure netted 26,000 Bitcoins, worth some $3.2 million. ... Ross Ulbricht, 29, has been arrested as the head of the site... Ulbricht recently posted a manifesto of sorts on economic reform to his LinkedIn page:"
"Now, my goals have shifted. I want to use economic theory as a means to abolish the use of coercion and agression amongst mankind. Just as slavery has been abolished most everywhere, I believe violence, coercion and all forms of force by one person over another can come to an end. The most widespread and systemic use of force is amongst institutions and governments, so this is my current point of effort. The best way to change a government is to change the minds of the governed, however. To that end, I am creating an economic simulation to give people a first-hand experience of what it would be like to live in a world without the systemic use of force."]
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See www.TheCodeWar.org for The Code War Research Series:
Part 1: What is the Code War?
