Of Bitcoins and Balance Sheets: The Real Lesson From Bitcoin

The monetary systems of nations operate on two types of balance sheet expansion:

  1. National, where the government spends into the economy expanding a national balance sheet
  2. (The sum of) banks’ balance sheet expansions, where bank loans create deposits

The asset side of both of the above are traded around as “money”.

The national government creates the numeraire for the system (the “Dollar” in the US, the “Pound” in the UK etc.) and in addition to spending directly in to the economy in that numeraire, the government allows a public/private system (publicly regulated private banking system) to operate with the same numeraire. This creates a single system for the public but in fact arises from two separate but linked balance sheet expansions.

But why do the tokens from either of these balance sheet expansions have and maintain value?

The government maintains the value of its balance sheet tokens by demanding that some of its tokens, once a year, must be paid back to the government. This guarantees that everyone in that nation will accept and value the tokens from the national balance-sheet expansion.

The tokens that arise from the public/private bank balance-sheet expansion maintain their value analogously – by the obligation to repay bank loans.

Together, the obligation to pay taxes and the obligation to repay bank loans maintain the value of a currency. Note that both of these rest on the government/legal system of a nation.

An organized, effective government with a sound legal system that does not use foreign currencies can always maintain the value of its currency. (Hyperinflations are always the result of governments and their legal systems becoming corrupted or destroyed in some way, and never the result of runaway money creation).

What does this mean for Bitcoin and other cryptocurrencies?

Bitcoin is not the result of a balance sheet expansion. There is no inherent obligation for repayment of bitcoin to any government (taxes) or to extinguish private debt (banking system). There is no in-built demand for bitcoin (or any cryptocurrency).

Bitcoin is worth zero dollars (or Yen or Pounds etc).

National currencies will always do two things 1) extinguish tax obligations and 2) extinguish private debt obligations. Even if you have neither, there are always enough people with tax and bank debts that you can be sure that your money will be voraciously sought after by merchants of all types. Unless we are in Mad Max territory, they will give you a loaf of bread for it.

Bitcoin is not part of a balance sheet. It does not inherently extinguish debt of any kind – neither a tax obligation nor a bank debt. Nor do other cryptocurrencies. Once the fad for them subsides, the realization that you can’t pay taxes or repay a debt with them will become evident and their true value of 0 will become evident.

Because they don’t understand money or balance sheets, bitcoin collectors and cryptocurrency creators don’t understand why their tokens are inherently worthless. They won’t understand why, when the fad passes, no one will be willing to take their play tokens for real goods.

The only benefit from the bitcoin fad may be a better understanding of the balance-sheet nature of national economies, and the relationship of this to the real resources of a nation. This will prove to be the real lesson from bitcoin. The sooner it is learned the sooner nations can get on with the real work of using their national balance sheets and good legal environments to improve the real economy.

_______

P.S.  A common refrain is that yes, Bitcoin and cryptocurrencies are worthless, but Blockchain is really a big deal.

Well, not so much…

The blockchain paradox: Why distributed ledger technologies may do little to transform the economy

Ten years in, nobody has come up with a use for blockchain

As I have said before – blockchain is going to turn out to be the Wankel engine of the finance world. Interesting concept but not that useful in real life, never quite filling a real need.


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28 Thoughts.

    • Right. If government money gets value from paying taxes, then a non-government money can get value from avoiding the payment of taxes.

  1. ‘Bitcoin is worth zero dollars (or Yen or Pounds etc).’

    Whilst I accept your intended meaning, the general interpretation of this statement is incorrect.

    Bitcoin, like anything else in life, is worth what someone else is willing to pay for it. Currently someone else is prepared to pay $15,000 for it so, for now, it is ‘worth’ $15,000.

    So long as those Bitcoin ‘tokens’ can be exchanged for dollar ‘tokens’ and then subsequently used to settle the tax demanded by government then Bitcoin will have a real and tangible value.

    In fact there will only ever be $21,000,000 bitcoin and more cannot be printed (unlike dollar tokens). It requires resources, skill and time to create one as opposed to paper and ink. It therefore seems likely that humans will increasingly have far more confidence in the value of a concrete bitcoin than the elastic value of a paper or electronic dollar or pound. In fact the only use these will have is that once a year you have to swap a fraction of a Bitcoin for the chosen fiat currency to settle you tax bill.

    • The key word is “somebody else”. It is worth what somebody else will pay for it. If you have an annoying piece of meat stuck between your teeth and you are a millionaire, you might buy a toothpick for $100, but to everybody else, it isn’t worth $100. It is worth what you can sell it for which at that point will be nothing.
      To me this is just too simple. Cryptos were made to avoid government controls and that will be the death of it. Once they crack down on users the value will drop to $0.

  2. “In fact the only use these will have is that once a year you have to swap a fraction of a Bitcoin for the chosen fiat currency to settle you tax bill”

    And who you going to swap them with Tom? You may just find one day that no one wants to give you their Pounds or Dollars for your tokens anymore

  3. i hear you about the use of fiat, but what if people decided they did want to use bitcoin or another crypto as the main means of exchange, because they understood it was in fact far more trust worthy (inflation-proof) than the currency currently (over) created by the nefarious organisations in charge of the banks, governments and legal systems?

    remember when currency was actually backed by gold and sterling?
    a return to sound money is the only thing which can save the collapse of civilisation, though it seems there is little will to actually attempt this in most quarters.

    • Two hundred and fifty years ago Adam Smith pointed out that “bad” money always drives out “good”. In other words we always spend the flaky, inflating money in preference to the trustworthy, sound money.

      If you think BitCoin is more sound and more trustworthy than state money, you have your reason that it will never replace state money.

  4. Unfortunately that is same with any asset. They all involve risk of depreciation. The one that is guaranteed to be eroded is cash! It will roughly halve in buying power every 25 years.

    Maybe one day no one will want to give you fiat tokens (yes money is only ‘tokens’ too) for your house, car, gold, body… given a certain set of circumstances. I expect after the great plague you couldn’t give houses away.

    At the moment people are prepared to give you $15,000 dollars for a very limited production run Bitcoin. Sure in the future they may not give one cent. That doesn’t mean they should not be considered as good as or better than paper money. Ask the citizens of the Weimar Republic or Zimbabwe what they think of fiat paper currency.

    If retailers begin accepting Bitcoin (Amazon for example) then why would anyone want fiat currency other than for the yearly tax bill? There would be no other reason to exchange Bitcoin for fiat currency as the world would mostly tick along with crypto instead, without the need of costly exchanges between fiat currencies.

    Now that the Bank of England ‘promise to pay the bearer’ of a ten pound paper note exactly a ten pound paper note in exchange (rather than ten pounds worth of silver or gold), we should not value a ten pound note at anything more than paper. It is only the illusion of confidence that others value it (and that it is needed to pay taxes) that give it any ‘currency’.

    I would far rather the wording on the note ‘promised to pay the bearer’ £10 worth of limited production Bitcoin than ten pounds of infinitely printed coloured paper but perhaps others prefer promises of more paper tokens in return for their paper tokens (or plastic tokens).

    • “It is only the illusion of confidence that others value it (and that it is needed to pay taxes) that give it any ‘currency’.”

      This no different with gold or silver. Pretty rocks have no intrinsic value.

  5. “It is only the illusion of confidence that others value it (and that it is needed to pay taxes) that give it any ‘currency’.”

    Ah…but it IS needed to pay taxes…and bitcoin is not. Therein lies the difference. Get the UK to demand its taxes to be paid in bitcoin, and bitcoin becomes the currency of the UK.
    Until that day, sorry, but bitcoin after the bubble will be worthless.
    And the Pound will tick on as always…

    • Can you explain the fundamental difference then between bitcoin and gold – or rather, given that gold is required neither to pay tax nor to repay bank loans, why its fundamental value is not also zero ?

      • For the same reason copper or wheat etc have value as a commodity. Gold is a real thing with many uses as well as being valued in the way crystal or similar things are for its innate beauty.
        It is always potentially possible to settle debts with a commodity if it works out for both parties (like I bake a cake to pay my neighbour who mowed my lawn). It is just overall this is not an efficient system, nor can it do the many other things a balance sheet money system can do.
        Bitcoin is not a real object; worse, it is easily replicable (yes 21 million btc, but nothing stopping other similar or even identical copies)

  6. I think if you thread my text Clint you will see that I was indeed making that exact point to in your first two lines. No need for the Ah but or the capitalised IS as it just restates what I was acknowledging.

    U.K. Will always demand taxes in pounds and can have it in pounds. That’s not a problem. A small inconvenience to change from crypto to sterling once a year.

    The bubble analogy may well be correct. Time will tell. Can you afford not to be an early adopter of these limited edition ‘currencies’? I would take a 10% insurance policy against it and at least but some.

    • Maybe someone will maybe someone will not…but in fact what is the value?

      Is the the value what someone is want to pay (then BTC or fiat has an value) or it is usability (then BTc and fiat has limited value) or something third….but it is a bold statesmen that it will worth 0 (I think that no one knows how much it will be worth, the only sure thing is that it need to be regulated)…in the future maybe it will not be crpypto in today form but something will surly been.

      Regarding anonymity…Well BTC is just pseudo anonymous so if someone wants to locate who spent money he will do that…cash or offshore zones (where bay the way all mayor financial institutions has its representatives offers better anonymity)…

      Crypto is in the embryonic stage but saying that it is nothing it is just not truth it is definitely something…and i 20 or so years we will know what it is.

      Honestly this article is looking something like that you ask taxi driver (in this case some sort of banker, broker etc…) about uber (in this case crypto)…

  7. FWIW, from what I hear, Bitcoin has become expensive to “mine”, and transaction costs, which were quite low, have become substantial, so that Bitcoin is losing its value as a medium of exchange. Owners of Bitcoin are holding it, partly in anticipation of future gains, but partly because of the cost of selling it. If this is true, then Bitcoin may end this way. Bitcoin becomes almost wholly a store of value as exchange dries up. With hardly any demand for Bitcoin as a medium of exchange, it becomes a collectible. But as a collectible it is almost worthless, like the old casino poker chips I have in a drawer somewhere. Then demand for Bitcoin collapses entirely.

  8. Good analogy – all the cryptos are going to be EXACTLY like your old casino poker chips (and Chuck E Cheeses game tokens, old raffle tickets, etc). Things that in an exact place, time and environment were given value, but only ephemerally. They are not part of the ongoing real world system of government we have. Crypto people should grow up and get to the real work of making the real monetary system better, better way to spend their time and effort

  9. Hi Clint,

    I think we will have to agree to disagree.

    I found your link to your article through the guardian comments section so presume you to consider yourself to hold liberal values, probably including freedom of expression and freedom of speech.

    I am therefore surprised to see that you are happy to publish your own comments but not my very polite reply to Gene last night. Instead you just leave my reply to Gene seemingly hidden whilst publishing your own reply about ‘growing up’. I am not sure if the irony of that strikes a chord with you?

    There are a lot of very smart people who have clocked what is occurring with crypto currency, the winklevoss twins being the well publicised ones. However the very bastions of the financial system you love so much are also onboard and invested such as Ben Bernanke and Scmidt. Billionaires like Bill Gates and Richard Branson and Warren Buffett are also invested. To tell these people to grow up is surprising.

    I was not one of those who got in at the very lowest valuation but I did read the Guardian back in 2011 when they called the collapse from $30 a coin the inevitable bursting of a bubble. The article is still there if you want to look with lots of comments mocking those who had invested at $30 a coin. Many of those early adopters are multi millionaires now.

    It’s the infinitely printed paper notes and coins that are going to become the analogical poker chip. The ‘proof of work’, limited run crypto coins are nothing like poker chips at all.

    It could well be that it is bubble territory now but it could be that there is plenty of room to run yet. The banks themselves are wising up to crypto and the big ones are now using ripple. If that doesn’t sound any kind of alarm bell for you then nothing will.

    Watch the 45 min movie ‘money as debt’. If your faith in money and the financial system is as strong as it seems then watching the movie will hold no fear for you.

    Finally, crypto has freed me from the work that you suggest I get back to. I now get to go to bed late (as you have seen) and get up when I want. I am no fool though as you would paint me. I have crystallised some of the gains (temporarily in to ‘money tokens’ prior to property purchases) and then missed out on further rises as a result. Although it is easy to kick myself for doing this I think it is important to diversify and ‘a profit is only a profit when it is taken’. By the way there are many property developers in the Emirates who would not even need me to buy property in money. They want Bitcoin direct. The only reason I have changed some to money is because the property investments I want are not in the Middle East.

    Yes I do now advocate for crypto but not because I think it was a get rich quick gamble but genuinely because I think they are the future currency of the earth and a way of getting back to a form of ‘gold standard’ that can’t be eroded by profligate government money printing or ‘quantitative easing’.

    Feel free to not publish this as well Clint. It’s your blog after all. Kim Jong Un would be very proud of suppression of opinions different from his own. Do they have Universities in North Korea?

  10. Hello Tom, I do not edit my comments, they go directly on here. Maybe you hit a button wrong or edublogs glitched… Please repost any reply to Gene if you like, I am not stopping any posts. Best, Clint

  11. Apparently, even at present Bitcoin can only handle around 7 transactions per second. (By comparison with ten of thousands of transactions per second by Visa or Mastercard.) In that case we can probably forget Bitcoin as a medium of exchange.

  12. Apologies if you are not blocking my post to Gene. Maybe it is indeed an Edubook glitch. I don’t have a copy so cannot repost and cannot type it again.

    I posted just before 01:00 am GMT and then at 01:23 GMT received in my email inbox a notification of your ‘grow up’ post.

    To me it clearly looked like you must have seen just my email from thirty minutes prior and responded without allowing my email to be shown. Unless you too are a night owl like me.

    The times on the edublog listings seem all over the place with some (as displayed now) coming from the future!

    Anyhow, Gene. Bitcoin has no intrinsic value. Money has no intrinsic value either. Both have instrumental value (a means to an end). The reason to be wary of money though is that it is elastic and can be produced by profligate governments who deplete its value and buying power. It is no longer a proof of work, backed by any asset or rare. Bitcoin is rare and a proof of work.it is also not under the control of corrupt politicians with one eye on being reelected and making financial decisions accordingly.

    Please watch ‘money as debt’ for 45 minutes and see if any of the points strike you as valid. I found it very eye opening many years ago and it has made me very distrustful of fiat currencies. Fortunately crypto has emerged at the right time to assuage many of my worries in this regard.

  13. Sorry about the post confusion again, I don’t know why it disappeared – I am happy to have heated debates as long as in the end we all are basically civil – it is fine to disagree and I wouldn’t block anyone who is debating honestly, and I appreciate your comments even if we disagree.
    And yes, I come from the future and know the future price of bitcoin! 🙂 lol

    As far as that video, I have seen it. Although some do think it is completely wrong, I also happen to think that those who watch it and start questioning aspects of money are on a good track – mainstream economists after all literally do not understand Quantitative Easing, that there is no loanable funds system etc etc so they have no credibility anyway. However, that video is also wrong, albeit in interesting ways. I would suggest trying to follow the actual accounting of how our money system works – which is neither the way that video says NOR the way mainstream economists say it works. A good place to start might be here http://heteconomist.com/exercising-currency-sovereignty-under-self-imposed-constraints/
    although I am sure others could list other sites, and if I think of any I will add them in.
    Kind regards, Clint

    PS and here http://heteconomist.com/overt-monetary-financing-in-terms-of-simplicity-and-transparency/

  14. Thanks Clint.

    The money as debt video has some critics but many of the assertions put forward are correct. The majority of people believe when they borrow money that they are actually borrowing another saver’s money or that they bank are going down to the vault and finding the money.

    Is there any way you could explain to me what you like so much about the current monetary system and fiat?

    I have given a good account of my liking for crypto and I genuinely don’t see how one can advocate for fiat.

    I understand it when paper money is receipts for fractions of gold in an audited government safe but I do not understand the attraction at all when it is decoupled from any asset as it is now.

    The thing that troubles me most about fiat currencies is that if you hold them for long enough you lose your wealth. I don’t even mean centuries. Let’s just go back a decade to 2007 / 2008 (just before the crash) and magically offer you ten things you can win game show style.

    1. £1000

    2. £1000 worth of Bitcoin

    3. £1000 worth of gold

    4. A classic motorcycle

    5. A classic car

    6. A luxury flat in Kensington

    7. A run down house in Bristol

    8. A £1000 tracker fund for the FTSE

    9. A $1000 tracker find for the Dow.

    10. £1000 worth of Zimbabwean Trillion dollar notes (essentially a shipping container full of them)

    It’s your lucky day and you win all of the prizes. You keep them till 2018. It’s a very diverse basket of assets. You meet with your broker and he tells you that they have all done fantastically well with the exception of one. Which one has performed the worst? Which one always performs the worst?

    It really is a sincere question. Why defend a currency and system which in modern times destroys savings and dramatically depletes the working man’s purchasing power? What am I missing?

    Also what do you think happened to the value of the shipping container of Zimbabwean Trillion Dollar notes? Have a look on eBay. It is the exception that proves the rule.

    • Well, even if you could realistically trade your paper for bits of gold, the value of that gold was defined, not floating. If all money became a true proxy for gold (or any other commodity) whose value is allowed to float, it becomes unworkable, or at least very difficult.

      Also – choose a different timeframe, and gold is a loser. So is Bitcoin, so are the stock funds. So fiat money isn’t the value-hemorrhaging disaster you make it out to be; in most circumstances, it loses value in a slow, stable fashion, and stability counts for something.

      Even with gold-backed base money, you are still living mostly on bank-created credit; you just have interest rate issues, money creation limitations, and deficit spending limitations. And for this, the government has had to spend real resources to obtain this backing gold. That comes from your economy’s production, which means it comes out of your own pocket. And it still isn’t nearly enough to back all of the M1 dollars that we all think of as our pile of money.

      Fiat dollars are representations of debt; that counts as “backing” in a functioning economy, where there is sufficient incentive to repay one’s debts and be productive. Bitcoin’s “backing” is far shakier – it’s a promise of limited availability coupled with the hope/expectation that it will be widely accepted as payment. Governments could put an end to that with the stroke of a pen.

  15. Clint, I think your argument is that cryptocurrencies like Bitcoin are inherently worthless because they are not issued in a way which creates a corresponding demand for the currency caused by the need to repay.

    Couldn’t one design a cryptocurrency with a built-in repayment requirement, like a tax? Wouldn’t it then have value, in your sense?

    Would a mutual-credit cryptocurrency (i.e. designed like a LETS) have value in that sense?

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