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Bitcoin Obliterates "The State Theory Of Money"

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By Jon Matonis
Wednesday, April 3, 2013

Once you get past the childish title, the recent bitcoin piece
from Karl Denninger raises some issues that warrant consideration from
bitcoin economists. Denninger is an intelligent student of the capital
markets and his essay deserves a serious reply.

The economic contribution of his essay is that it represents the thesis advanced by German economist Georg Friedrich Knapp in The State Theory of Money (1924), an expose advocating the Chartalist
approach to monetary theory claiming that money must have no intrinsic
value and strictly be used as tokens issued by the government, or fiat
money. Today, modern-day chartalists are from the school of thought
known as Modern Monetary Theory (MMT).

Without getting into the intrinsic value debate, this is where I
strongly depart from Denninger, because if we accept the thesis that all
money is a universal mass illusion, then a market-based illusion can be
just as valid or more valid than a State-controlled illusion. What
Denninger and Greenbackers and MMT supporters
reject is the notion that monetary illusions themselves are a
competitive marketplace, falsely believing that only the State is in a
‘special’ position to confer legitimacy in monetary matters.

Regarding this issue of State-sanctioned legitimacy, bitcoin
as a cryptographic unit seeks and gains legitimacy through the free and
open marketplace. It is not a governmental instrument of legal tender
that requires regulatory legitimacy and coercion by law in order to gain

Therefore, the path to widespread adoption of bitcoin
hinges on three primary market-based developments: (a) robust and
liquid global exchanges similar to national currencies that can offer
risk management via futures and options, (b) more user-friendly
applications that mask the complexities of cryptography from users and
merchants, and (c) a paradigm shift towards “closing the loop” such as
receiving source payments and wages in bitcoin to eliminate the need for
conversion from or to national fiat.

Even after graciously accepting Denninger’s definition of what the
ideal currency would be (which I don’t) and searching for any economic
nuggets of value, his arguments can be distilled into four main
criticisms of bitcoin as a monetary instrument. First, bitcoin does not
provide cash-like anonymity. Second, bitcoin transactions take too long
for confirmations to be useful in everyday transactions. Third, bitcoin
exhibits irreversible entropy.  Fourth, the decoupling of the stateless
bitcoin from the obligation of monetary sovereigns is considered a fatal

Now that we identified the objections, let’s take these in order.

On the first point surrounding bitcoin anonymity, Denninger only
embarrasses himself with this criticism. By default, bitcoin may not
offer anonymity and untraceability like our paper cash today, but it is
better described as user-defined anonymity
because the decision to reveal identity and usage patterns resides
solely with the bitcoin user. This is far superior to a situation where
users of a currency are relegated to seeking permission for their
financial privacy which is typically denied by the monetary and
financial overlords. Also, his capital gains tax issue is a non-starter
because it’s a byproduct of a monopoly over money.

His second criticism of a lack of utility in the ‘goods and service
preference’ due to timing of sufficient block chain confirmations has
some merit. However, advances have been made in the use of green
addressing techniques
that solve the confirmation delay problem by utilizing special-purpose
bitcoin addresses from parties trusted not to double spend.

Denniger’s third criticism that bitcoin
exhibits irreversible entropy is confusing. Typically, entropy refers
to a measure of the unavailable energy in a closed thermodynamic system
that is also usually considered to be a measure of the system’s
disorder. In the case of bitcoin, I suspect Denninger is taking it to
mean the degradation of the matter in the universe because of his
explicit comparison to gold. While it is true that bitcoins lost or
forgotten are ultimately irretrievable, I view that as a feature not a
bug because it is the prevailing trait of a digital bearer instrument.
Two bitcoin digital attributes that make it superior to physical gold
are its ability to create backups and its difficulty of confiscation.
Furthermore, the number of spaces to the right of the decimal point
(currently eight) is immaterial to bitcoin’s suitability as a monetary

Now for the big and final one. Denninger asserts that monetary
sovereign issuers possess not only the privilege, but the obligation, of
seigniorage, which Denninger refers to as bi-directional since
sovereigns have the responsibility of maintaining a stable price level
during times of both economic expansion and economic contraction. As a
product of Hayekian free choice in currency,
market-based bitcoin is decentralized by nature and poses a false
comparison to the century-old practice of central bank monetary
manipulation. Fear not deflation.

Governments have appropriated
the monetary unit for their own benefit by declaring it the only
preferred monetary unit for payment of taxes to the State. Believing
that governments have sincere and good intentions in administering the
monetary system is akin to believing in fairy tales. Control of the
monetary system serves one and only one interest — the unlimited
expansion of the sovereign’s spending activity to the detriment of the
unfortunate users of that monetary unit. Decentralized Bitcoin
obliterates this sad state of affairs.

Denninger’s biased and establishment preference for a monetary
sovereign serves only to harm his analysis because it undeniably closes
him off from alternative, and usually superior, free-market monetary
arrangements. More damaging, however, is the fact that it places him
outside of the mainstream in free banking circles and squanders his
remaining quasi-libertarian credibility as a champion of markets.


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