Gary North wrote up an article today titled Bitcoins: The Second Biggest Ponzi Scheme in History. Having bought into the bitcoin “craze” about a year ago, I feel obligated to write back a response to some of the misconceptions he propagates in his article. Those misconceptions are not unique to Mr. North; others have expressed the same concerns, and they are relevant enough to deserve a thoughtful response.
Before I begin, I do need to thank Mr. North for all he’s done over the last few decades. I’ve been reading his books for over twenty years, and much of my thinking has been shaped by words he’s written. I write this from a perspective of great appreciation for the work he has tirelessly performed for the world for years.
Mr. North divides his article into two major sections: The first is an overview of Ponzi schemes, and the second is a defense of the Austrian theory of money (Austria here refers to the theories articulated by a number of Austrian economists in the early part of the 20th century, and not to anything about Austria’s actual economy.)
Is It Really Fiat?
The first misconception is evident almost immediately when he writes that the designer(s) of bitcoin “made it out of nothing. Think ‘Federal Reserve wanna-be.’” Sadly, Mr. North starts off with a cheap shot by comparing Bitcoin to fiat money, without actually comparing the two. He simply makes an assertion that since both are made from “nothing”, they therefore share the same flaws. However, this is not the case. While Federal Reserve notes (i.e. “U.S. Dollars”) are made from nothing, their nothingness is intrinsic. A small group of people are authorized to create dollars as quickly as they desire. (In the past, they were limited by how fast the printing presses could actually create the money, but as most dollars are electronic today, that limiting factor is no longer in effect.)
Bitcoins, however, cannot be created arbitrarily. Built into the design is a known rate at which bitcoins are created, divided out to groups of people mining those new bitcoins. Those miners are choosing to spend their existing capital on mining hardware, with the hope that their investment will output bitcoins into their wallet. This is no different than gold mining companies investing capital to access difficult to reach gold veins. The key is that no one in the world can create more bitcoins than the protocol allows, and that number is known throughout the bitcoin creation lifecycle. This is in such contrast to the Federal Reserve that the comparison is clearly unfair. (This is not intended to be a full explanation of bitcoin mining. Mining is currently an industry in itself and one I’ve educated myself on and chosen not to get involve with.)
Early Adopters vs. Mr. Ponzi
Mr. North does go on to talk about early adopters, and I share his concern. The smart people that have analyzed the public bitcoin ledger called the “blockchain” have speculated that the small group of people who were the early adopters may have in their possession up to 1.2 million bitcoins, with a current market value of $1.3 billion. More important than the dollar values is that they may be controlling 10% of the currently mined bitcoins. (As an aside, I have the same concern about unbalanced distribution of gold reserves, so this problem isn’t unique to bitcoin.)
First, due to the nature of bitcoin mining, the balance of coins held by the initial group will grow smaller as a ratio of the whole over time. While this in no way assures that the value will be distributed to the common man, it does mean that the system was designed to increase the distribution of bitcoins among the user population. This can’t be said of the dollar, which is designed to centralize wealth in the hands of the governments and banking system.
Second, the same criticism can be made of gold and silver. Precious metals are currently in the hands of “early adopters” (being defined as anyone who bought before I did). Those early adopters made a lot of money watching the price of gold increase since the early part of the last decade. This benefit to early adopters is fundamental to those who get in early on a good idea. Eventually, though, the early “mania” cools off and the value becomes more stable. We’re simply in the vertical part of the economic S-curve, and it will flatten out, just like Facebook stock and gold prices. There’s no evidence that a crash is an inevitable result of a quick increase.
Calling this a Ponzi scheme is disingenuous, and Mr. North should know better.
The Origin of Money
North’s section on the origin of money is right on, and I agree with every word. However, I believe he undermines his later conclusion in his own words:
In that book, Mises argued, as Menger had before him, that money arises out of market transactions. That which did not function as money before, now functions as money. Something that was valuable for its own sake, most likely gold or silver, becomes valuable for another purpose, namely, the facilitation of exchange. [emphasis mine]
He later writes “The central benefit of money is its predictable purchasing power. [emphasis his]” If that’s the case, then why would he use gold and silver as an example previously as examples of money? If we look back at the purchasing power of gold over the last few years, we see it fluctuate from $300 ten years ago to a peak around $1900 last year. Yet, I don’t recall seeing North state that this ridiculous rise in the price proves its lack of value. In fact, he says just the opposite.
So, a person can buy money by the sale of goods or services, set this money aside, and re-enter the markets in a different location or in a different time, in the confidence that he will probably be able to buy a similar quantity of goods and services.
Tell that to the people who lost a quarter of their gold value in the last two years. Any criticism he makes of bitcoins needs to be applied equally to any other wealth storage that he actively promotes. Stability is a good thing, but stability comes as a result of good fundamentals. If the nature of an instrument promotes stability, as it does with precious metals and bitcoins (and doesn’t with dollars and beanie babies), then stability will result. The fundamentals of bitcoin are provably sound, and therefore, I believe that this will result in stability. This is the same belief that draws me to gold and silver, and away from fiat money.
(Sadly, I’m seeing a lot of historical gold defenders like Peter Schiff and Gary North badmouthing bitcoin. One does need to take their protestations with a grain of salt, since bitcoin is clearly a competitor in the gold market in which both are heavily invested.)
The Fundamental Misunderstanding
Finally, let’s consider the statement Mr. North makes that evidences his complete failure to understand bitcoin, undermining any attempt that he makes to discredit bitcoin as a currency.
The price will soon be too high for most people to buy one Bitcoin. What I think is going to happen next is that somebody is going to start a Bitcoin mutual fund. You will be able to buy fractional shares of a Bitcoins. Maybe you can get in for $250.
When purchasing public shares of a company, investors are usually limited to purchasing a minimum of one share (ignoring things like DRIPs and fractional shares). For example, Apple Computer is currently trading at about $550 per share. In order for an individual investor to buy a share, they would need to pull together as much as a single share costs in order to buy that fraction of the company. In Apple’s case, that would be 1/900,000,000 ownership of the company.
However, it is already as easy to purchase a fraction of a bitcoin as a full bitcoin. Since a bitcoin is currently divisible to eight decimal places, the currently value of the smallest part unit of a bitcoin right now is only worth 1/1000 of a cent.
Mr. North’s failure to grasp this concept explains his failure to understand the biggest benefit of bitcoin over other tangible wealth containers like gold. Even Peter Schiff’s hawking of the Valcambi CombiBar demonstrates gold’s divisibility problem. One gram of gold is currently worth about $50 and is smaller than my fingernail. As wealth storage, gold works pretty well, but for any daily usage, gold is practically useless. Bitcoin, on the other hand, was designed from the ground up to facilitate instant, provable value transfer to a very granular level. Mr. North refused to even evaluate this aspect since he’s so focused on the cost increase.
I appreciate that Gary North took the time to write what he did about bitcoin, and I think there are warnings that many of us who have transferred some of our savings into bitcoin should heed. Proverbs 11:13 says “Wealth gained hastily will dwindle, but whoever gathers little by little will increase it”, and there are plenty in the bitcoin community who are ignoring that wisdom. While I think there is a reason why the price of bitcoins are rising outside of the speculation, I do look forward to seeing the price stabilize. I would encourage Mr. North to educate himself on the fundamentals of bitcoin, look beyond the speculation, and reevaluate his thoughts.