Money not only makes the world go round but it is also one of the two reasons that purely digital economies, like those that arose within videogame communities, are, so far, macro-economically irrelevant.

Nevertheless, one must have been living in a cave not to have heard of the latest fully digital innovation that has been on everyone’s lips in recent months: Bitcoin and other such digital cryptocurrencies. If the hype is to be believed, Bitcoin is the future of money, a mathematical solution to the problem of currency manipulation by unscrupulous politicians and unaccountable bureaucrats that the Internet has made possible.

So, what can we learn from Bitcoin, but also from in-game currencies about the present and future of money?

Let us begin with in-game currencies, like the Linden dollars in Second Life or the Interstellar Kredits in Eve Online. They are, analytically, similar to the POW camp’s cigarettes: exogenously supplied, by the game company, with a quantity that is fixed at any given moment in time and proportional to the average prices in the economy. The only difference is that, unlike in the POW camp where the money, or cigarette, supply was not only exogenous but also fixed, in-game currencies are exogenous but can vary dramatically as players keen to buy goods can convert real dollars or euros to these in-game currencies therefore boosting the in-game money supply at will. Game companies, essentially, play the role of central banks, increasing or decreasing the exchange rate between in and out-of-game money in a bid either to deflate bubbles or to re-inflate the economy after a bust.

All this is anathema to the Bitcoin enthusiasts. For them the task is to cut out the ‘middleman’, to institute a currency that is immune to manipulation by anyone, let alone a grey, unelected central banker. For them, the issue is not whether money will be digital or not but whether it will be as decentralised as the Internet or as centralised as Microsoft. Or Mastercard. Or the Soviet Union. Or the Federal Reserve System.

Before we delve deeper into the debates on Bitcoin and the Future of Money, allow me to state, for the record, my own take on Bitcoin:

  • Bitcoin is, above all else, a beautiful algorithm.
  • A brilliant answer in search of a worthy question.
  • A breath-taking solution to as yet undiscovered problems!

So, contrary to its evangelists’ grand proclamations, democratising and de-politicising money will not be one of Bitcoin’s contibutions to humanity, I am afraid. Indeed, it should not replace government issued money. Put simply, no de-politicised currency is capable of ‘powering’ an advanced, industrial society.

What makes the Bitcoin algorithm ‘beautiful’ is that it makes possible a decentralised network within which trust is built because everyone is monitoring everyone else. There is no sentry. No guardian. No Leviathan who may become tyrannical or fall asleep on the job (as regulators did prior to 2008). Instead there is a type of benign Benthamite Panopticon where everyone is kept honest because everyone else is watching every activity, every exchange, every transaction. It is truly splendid, in that regard.

BUT it is not a sound foundation for an alternative monetary system.

  • Why not? To begin with, it is tiny in size.
  • Its total global value in real money is less than the bailout money ‘given’ by European taxpayers to a smallish Greek bank last year.
  • So far, it is a digital tulip or, to paraphrase Keynes, it is a bubble on a whirlpool of speculation, rather than a bubble on a growing stream of enterprise.
  • Of course, BITCOIN enthusiasts will argue that what matters is its growth potential.
  • I am not convinced.

Bitcoin suffers from two separate problems: The Security Problem and the Economic Problem

  • The Security Problem is that a hacker can hack into your computer and disappear with your BITCOINs. And if you entrust your BITCOINs to an unregulated BITCOIN bank, it is the banker that may run away with your BITCOINs or be hacked himself – the equivalent of a bank robbery. The Mt Gox experience.
  • The Economic Problem is entirely separate. Whereas the Security Problem may wreck BITCOIN, if BITCOIN is not wrecked and grows into being macro-economically significant, it is BITCOIN that will wreck the economy. Why? Because it is designed to mimic the Gold Standard – the monetary system that caused one depression after the other, from the 19th Century until 1929, and which was replaced because capitalism cannot breathe under an exogenous quantity of money.

To see this, recall that Bitcoin’s value comes from its in-built scarcity and its exogenous quantity that grows on the basis of negative exponential function, that will see to it that the rate of growth diminishes until in a few years it hits zero.

So, if it catches on as a proper currency, rather than as a store of value, then, by definition, the rate of increase in the quantity of goods and services purchased will outpace the rate of increase in the supply of Bitcoins. Thus, the available quantity of Bitcoins per each unit of output will be falling causing deflation. And why is this a problem? Because even if all prices fall at once, people’s debt will not and a chain reaction of insolvencies will hit us, causing the worst fate of any market economy: Debt Deflation. Think Great Depression here in the United States, or Greece today

As long as our economies feature large debts, a macro-economically significant Bitcoin would be detrimental to stability, prosperity and economic growth. Video-game economies and Internet-based digital money, that are free from governments and states, are exceptionally interesting but, as long as they lack debt markets, they will remain peripheral to really existing capitalism.

One may retort that perhaps it would be a godsend to re-configure market economies so that they are debt-free. But let me remind you that debt is to capitalism that which Hell is to Christianity: seriously unpleasant but absolutely necessary.

Capitalism unleashed incredible productive powers by reversing the three stages of economic activity. Under feudalism, the three stages came in the sequence of production, distribution, financialisation. Peasants produced agricultural commodities – that’s production, then the Sheriff would come in to claim the Lord’s share – that’s distribution; finally, the Lord would sell his surplus food in local markets for money part of which would be lent out – that was financialisation.

This sequence was turned on its head by capitalism: First came debt, or financialisation, as the entrepreneur borrowed money to hire the means of production from landlords, labourers and suppliers. Second came distribution, as the entrepreneur would hand over these borrowed funds to the landlord, as rent, to the workers, as wages, and to the suppliers, as returns to their capital. Production would now be the final stage, with the resulting commodities being sold in markets and the entrepreneur, if he was lucky, keeping the residual, or profit.

The reason why capitalism multiplied productivity by a huge factor, thus creating incredible wealth (but, paradoxically, also unprecedented poverty) is because of this reversal of the sequence, placing finance, or debt, at the top of the queue. It was as if the entrepreneur put her hand through the timeline, grabbing some value that was not yet produced from the future, bringing it to the present, putting it to good use in the production process so that goods could emerge that would then be sold so as to return to the future the value taken away from it – with interest!

Debt, ladies and gentlemen, is of the essence for really existing capitalism. While too much debt, like too much of anything, can be a terrible thing, it is the case that No debt, No capitalism! This is why the fantasy of a future with stateless money, like Bitcoin or some variant of it, is dangerous: its in-built deflationary tendency makes debt unsustainable. And it is also why our videogame communities, despite the highly sophisticated economies that they have generated, remain macro-economically irrelevant, as they lack debt markets and, indeed, labour markets

One last wrinkle is perhaps worthwhile at this stage: we have a tendency to misunderstand money’s role in society. To think of it like the cigarettes that Radford analysed in the context of his POW camp – as some commodity whose durability and divisibility allowed to turn into money. 

Archaeological evidence of accounting books, dating to 3500BC and unearthed in Mesopotamia reveals that the ancient accountants had painstakingly carved a log of who owed what to whom, of how much grain each resident within some temple jurisdiction had stored at the communal warehouse, of how much barley was owed to those working in the temple. What is beguiling is that the unit of account often took the form of silver coins that, in fact, did not even circulate (or had not even been minted). Indeed, everyday use of coins as a means of exchange was not witnessed for several thousands of years after it they were used to record debt obligations.

So, once again, we see that debt is at the heart of monetised and macro-economies. Unless digital economies develop debt markets and digital crypto-currencies overcome their deflationary tendencies, which make debt unsustainable, the future of money will continue to feature Central Banks – even if it is circulates entirely via digital wallets.

Having said that, it would be precisely wrong to claim that the beautiful Bitcoin algorithm is irrelevant from the perspective of monetary policy. As one who has been engaging in the Eurozone debates, it occurred to me recently that Bitcoin-like technologies could be utilised profitably to liberate Europe’s member-states from the straitjacket of the Gold Standard-like design of the euro. Bitcoin, while deflationary and Gold Standard-like itself, can inspire a strategy for ending the monetary asphyxiation of many proud European nations.

To this effect, I have recommended that member-states organize their own crypto-currencies based on future tax credits expressed in euros. FTCoins, or Future Tax coins, as I called them, could provide:

  • a source of liquidity for the governments that is outside the bond markets, which does not involve the banks and which lies outside any of the restrictions imposed by Europe’s Central Bank
  • a national supply of euros that is perfectly legal in the context of the European Union’s Treaties, and which can be used to increase benefits to society’s weakest members or, indeed, as seed funding for some desperately needed public projects
  • a mechanism that allows taxpayers to reduce their inter-temporal tax bill
  • a free and fully transparent payment system outside the banking system, that is monitored jointly by every citizen (and non-citizen) who participates in it courtesy of a Bitcoin-like blockcain or public ledger that allows everyone to keep tabs on the quantity of these FT Coins that the government issues.

In summary, while Bitcoin is not the future of money, and in-game currencies are easier to manage than the euro or the dollar because these economies are macro-economic simpletons, Bitcoin’s technology offers us opportunities for creating new instruments that are supportive of existing monetary policy. Indeed of democratising state money without replacing it.

We still have not worked out the best way of utilising these algorithms. It is the reason I called Bitcoin a beautiful algorithm that offers brilliant solutions to problems we have not yet articulated.

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