Wednesday Briefs – 26 May 2021

THIS WEEK: Bitcoin Trust vs. Coercion; Belarus Etc.; Market Dilemma.

BITCOIN TRUST VS. COERCION

In his seminal white paper, the elusive “Satoshi Nakamoto” explains Bitcoin as a peer-to-peer electronic cash system. One of the main advantages of such a system is the ability to cut out the intermediary third party (usually a bank) and to transact directly peer to peer. The paper explains at length how the technological structure of Bitcoin allows users to achieve the same level of trust that was traditionally provided by a third party. In the past, that party vetted the authenticity of the currency and the trustworthiness of both parties. In the present, “a chain of digital signatures” is deemed trustworthy “as long as honest nodes collectively control more CPU power than any cooperating group of attacker nodes”. This geeky explanation is one of Bitcoin’s main weaknesses and it has limited its adoption by the general population. But this is not our topic.

Instead we take the explanation at face value and focus on the question of trust. The word “trust” appears 14 times in the white paper. Yet behind every currency and every transaction, there is not only trust but also coercion, the threat of force that is implicit in contract law. There is also, in every transaction, a policing of the channels through which transactions take place. It is noteworthy therefore that the words “coercion”, “force”, “policing” and “central bank” do not appear at all in Nakamoto’s white paper. The word “enforce” appears once, in the very last line of the conclusion as if the author made in extremis a concession to skeptics.

In the new alternate reality of cryptos, the trust that was provided by institutions is replaced by a technological construct. Government coercion and central banking are believed to be obsolete and irrelevant due to to the mechanics of this technology. Nonetheless, this technology is entirely dependent on the power grid and on broadband communication, both of which are ultimately secured ex ante by the state’s ability to patrol them, police them and regulate them. And they are secured ex post by the state’s power to punish any individual or organization that puts them in jeopardy. In other words, while cryptocurrencies may do away with the trust historically provided by third parties, they are still dependent on the trust and protection provided by the state. An awkward position since cryptos undermine nation-states’ own currencies.

The overriding point is that the US dollar is backed by the US Treasury and the might and faith of the US government, while cryptocurrencies are only backed by a technological model and rely on on an infrastructure that is also ultimately backed by the US government and other governments. That seems like a weak link in the chain of credibility.

So far, the appeal of Bitcoin has spread mainly thanks to four constituencies: tech savvy investors who understand and believe in the white paper, investors who try to jump on a good trend, closet revolutionaries who see cryptos as a way to upend the world order, and assorted hackers/pirates/traffickers trying to extract ransom in an untraceable manner. One limitation of this spread is that there are not enough of these people in society to make John and Jane Doe give up on the greenback and on its main sponsor, the United States Treasury.

The US and the dollar have been around for nearly two and a half centuries and have successfully navigated all the challenges and cataclysms that have occurred during that time span. It is unlikely that they will be upstaged and superseded by Bitcoin and other cryptocurrencies. Or to paraphrase Stalin’s cynical putdown of the Pope’s power: how many divisions has crypto got? how many aircraft carriers does Bitcoin have?

BELARUS ETC.

The reality that we are not living in the ether with crypto but still very much in a flesh, blood, germs, brick and mortar world intrudes on us on a daily basis, despite our dreams and visions of the seamless germless utopia (or dystopia) that is often portrayed in futuristic movies and that would allegedly get closer with blockchain and cryptocurrencies.

One of the way that this reality intrudes is through the use of force, be it authorized or unauthorized, and through competition among men and women vying for power and money all over the world. We are not merely trading algorithms seeking the most efficient outcomes. There are many among humanity who profit greatly from less trading and from less efficiency, and in some cases from the blockage of open channels.

Case in point is the forced landing of a RyanAir jet in Belarus this week, an act motivated mainly by a wish to maintain the political status quo in that country. Once you leave Silicon Valley, the United States or the rich world in general, the ambitions delineated by cryptocurrencies look decidedly first world. There are forces elsewhere that benefit from obstructions or breakdowns in the infrastructure of openness. This infrastructure includes the open skies of aviation (Belarus), the waterways of trade (Suez), the power and telecommunications networks (Texas blackouts), the energy pipelines (Colonial pipeline) etc.

MARKET DILEMMA

The stock market seems to be in a rarely seen dilemma. On the one hand, a lot of liquidity, a fading health crisis, and a double digit GDP recovery in the United States and Europe. On the other hand, threatening inflation, high valuations for US stocks and a worsening pandemic in other countries. This tension explains the sideway moves of the past few months with little certainty or confidence in either direction.

This will eventually resolve by one of the vectors above changing direction: waning liquidity, a return to steady state GDP growth of 2 to 3% or a clearer direction for inflation and the pandemic.

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