The Problem With Crypto-Currencies

by Dmitry Orlov, Russia Insider:

They sound good, until you start examining the details …

Orlov is one of our favorite essayists on Russia and all sorts of other things. He moved to the US as a child, and lives in the Boston area.

He is one of the better-known thinkers The New Yorker has dubbed ‘The Dystopians’ in an excellent 2009 profile, along with James Howard Kunstler, another regular contributor to RI (archive). These theorists believe that modern society is headed for a jarring and painful crack-up.

He is best known for his 2011 book comparing Soviet and American collapse (he thinks America’s will be worse). He is a prolific author on a wide array of subjects, and you can see his work by searching him on Amazon.

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His current project is organizing the production of affordable house boats for living on. He lives on a boat himself.

If you haven’t discovered his work yet, please take a look at his archive of articles on RI. They are a real treasure, full of invaluable insight into both the US and Russia and how they are related.

There is a lot of attention currently being paid to cryptocurrencies. On the one hand there are those who claim that their rise in value is actually a symptom that conventional, fiat currencies are crashing. This begs the question as to why precious metals aren’t skyrocketing, and the usual answer is that their prices are being manipulated using the futures market that keeps “paper” gold cheap while “physical” gold is growing scarce; at some point these manipulations will stop working and gold will shoot up to $10,000 an ounce. (Sounds good to me!)

This also begs the question as to why, if fiat currencies are crashing, there isn’t much inflation at all. Even in countries that have been plagued with high inflation for decades, such as Russia, this is no longer a problem; there, inflation is now under 3%. There isn’t much inflation in the US either, provided you exclude from it all of the local extortion rackets: real estate, health care and education. (Armed robbery usually isn’t part of the basket of products and services used to compute inflation.) Hyperinflation is not hard to find (in Venezuela) but this is not commonly seen as a worldwide, systemic problem.

On the other hand there are those who think that cryptocurrencies are another type of tulip mania or South Sea bubble: just another irrationally exuberant event that will end with a resounding crash. The standard retorts are “Bah, humbug!” and “This time, it’s different!”

A more thoughtful retort is that Bitcoin (and other cryptos) are works of genius, based on the innovation of the blockchain (a sort of distributed ledger where every anonymous participant gets to verify every transaction) and the “proof of work” principle by which Bitcoin is “mined” using computers. In essence, instead of putting their trust in governments (which print money) and central banks (which really print money), Bitcoin users put their trust in algorithms, which are open source and defended through lack of public acceptance of any modification that might compromise them.

Cryptocurrency fans sometimes go on to say how cryptocurrencies are all about liberty and anarchism, cutting out the middlemen—the bloodsucking bankers and governments—and allowing people to trade one on one, simply by rubbing their digital wallets together and trusting the clever algorithms to sort it out.

This sounds good, until you examine some of the details.

First, bloodsucking bankers and governments are unlikely to be defeated by an algorithm, no matter how clever, because they use far less technical means to enforce their interests: security agencies, criminal investigators and prosecutors, tax auditors, courts and prisons.

Already, any use of Bitcoin is, under US tax regime, a potentially taxable transaction: if you got paid in Bitcoin and then bought something with it, and if its price went up in the meantime, then you get to pay 20% capital gains tax on the difference. With its promise of anonymity and its ability to transcend borders and circumvent fiscal and monetary authorities, Bitcoin has become a magnet for drug dealers, narcotraffickers, human traffickers, hackers/extortionists and other bad actors. If you use Bitcoin, you automatically end up on the radar of those who hunt for them.

And at a very simple level that should be easy for everyone to understand, if some government decides that Bitcoin is not its friend, it can simply ask you, nicely at first, to relinquish your cyberwallet to it. I doubt that too many of the Saudi princes that were recently disencumbered of much of their net worth while being tortured by Prince Mohammed bin Salman at the Ritz-Carlton in Riyadh ended up playing coy with their Bitcoin stash. Remember, Bitcoin is a popular instrument of extortion, and governments are the biggest extortionists in the world.

Worse yet, if a government decides that Bitcoin is its friend, it can ask, nicely at first, that all Bitcoin transactions be disclosed to it in a timely manner, complete with the tax ID of the party at each end of every transaction. This would be a clever way for a government to shift to using digital cash without having to pay for any of it. All it would have to do is order “compliance”; Bitcoin’s developers would then have to bring their architecture into compliance or risk prosecution for noncompliance. This seems like a cheap and cost-effective way to move closer to financial totalitarianism, placing every single transaction under the government’s microscope.

Second, few people have the technical savvy to understand all the intricacies of the protocols, and as the old saying goes, “A fool and his money are soon parted.” Your digital wallet can be stolen (hacked) or become corrupted, and there is no accurate estimate of the number of Bitcoins that will never be heard from again, making the current market capitalization claims less than reliable. Any world-savvy grandmother can sew a few gold coins into the hem of a grandchild’s coat as a safeguard against unforeseen expenses; but how many grandmothers, or grandchildren, would know how to do that with crypto?

Third, there is the matter of durability and access. Gold does not rust or tarnish. It can become lost, but then it can (at least theoretically) be recovered. A digital wallet, once corrupted, cannot be recovered. A single electromagnetic discharge from a sun flare or a stratospheric nuclear explosion from one of Kim Jong Un’s rockets can wipe out a huge amount of cryptocurrency. Network outages render cryptocurrencies inaccessible. How much Bitcoin trading went on in Domenica, Barbuda or Puerto Rico after the recent hurricane? Unlike a physical pot of gold, cryptocurrency is invisible and cannot be validated without special equipment connected to the internet. 

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