Bitcoin Confuses Alan Greenspan

Mainstream economists were trained to believe that currencies need to be managed by central banks. So this new form of money is...hard to grasp.

Bitcoin is valuable—its price has roughly doubled in the last month—because it's a technically superior form of money that governments and other institutions can't control. Mainstream economists, however, were trained to believe that currencies need to be managed by government-controlled central banks. So this new form of free-market money is proving…hard to grasp.

Alan Greenspan hasn't bothered to learn even the basic facts about bitcoin. On Wednesday, the former Federal Reserve chairman compared it to the "Continental" currency issued at the outset of the Revolutionary War, which ultimately lost all of its value because the government kept printing more of it.

"The amount of fiat currency kept rising," Greenspan said on CNBC, "and it's very difficult to tell to what extent bitcoin is fundamentally different from that, but I will say there are very considerable similarities." When asked if bitcoin will eventually be worthless, Greenspan responded, "It depends on how they handle the issue of the quantity that's being put into the market."

(psst…Chairman Greenspan…the supply of bitcoins is capped at 21 million.) pic.twitter.com/RjDZkvErYl

— Jim Epstein (@jimepstein) December 7, 2017

Wasn't there a CNBC producer on hand who could shout something into the economist's earpiece about how the supply of bitcoin is capped at 21 million, and that about 80 percent of all bitcoins that will ever exist are already in circulation?

The Yale economist Stephen Roach appeared on CNBC on Tuesday to alert us to his view that bitcoin is a "toxic concept" and a "dangerous, speculative bubble." Roach asked rhetorically, "Have you yet to see anybody with a bitcoin in their pocket?"

It's true that bitcoin isn't widely used as a currency (except as a way to circumvent capital controls and high import taxes). But Roach seems unaware of the reasons for that. For one thing, bitcoin is still in an early stage of development. Sending or receiving bitcoin today involves publishing the transaction to a shared public database called a blockchain, which is an extremely limited resource. (There are just 1mb of data available to record bitcoin transcactions roughly every 10 minutes.) Using this data to post a transaction means paying a significant fee, which makes it prohibitive presently to use bitcoins as pocket money. But there's a new technology in development, called the lightning network, that promises to solve this problem by letting users trade bitcoins in a peer-to-peer fashion without publishing to the blockchain. On Wednesday, lightning's developers released the first version of the protocol and did the first test transaction on the bitcoin network.

Roach is right that buying bitcon is "speculation" that the technology will function as promised and gain widescale adoption. But that doesn't make it "toxic."

A partial exception to the mainstream confusion over bitcoin is the Hoover Institution economist John Cochrane, who argues in a recent blog post that it has value because of its "convenience yield"—i.e., it has unique features as money. Like cash, it's hard to detect, so it provides users with a way around "aspirational laws that if enforced would bring the economy to a halt." It also "facilitates ransomware," "laundering money," and "getting money out of China." Overall, bitcoin is a tool to "avoid both the beneficial and destructive attempts of governments to control economic activity and to grab wealth."

That's all true, but Cochrane doesn't mention that bitcoin also provides a way to escape hyperinflation, which is how it's currently being used in Venezuela. Even the U.S. government prints money to finance debt and pay for the welfare-warfare state without raising taxes, thus distorting the natural rate of interest and fueling a ruinous boom-and-bust cycle. Bitcoin offers refuge from these distortions.

Cochrane also characterizes bitcoin as "an electronic version of gold," which is like calling the internet an electronic version of the post office. Part of bitcoin's "convenience yield" is that it's programmable money that's digitally native. In the future, it has the potential to facilitate machine-to-machine payments, permit "streaming money," provide a value layer to the internet, decentralize web services, and allow for the creation of financial contracts that can be executed in code.

The mainstream misunderstanding of this technology reminds me of a conversation I had a couple years ago with a prominent libertarian writer who has spent his career advocating a return to the gold standard. When I asked what he thought of bitcoin, he said "I don't get it" and changed the subject. We need a new generation of experts.