I attribute my early interest in bitcoin to my six years as a correspondent in Argentina.
The lesson I took from that country’s repeated financial meltdowns is that any fiat monetary system requires a bedrock of trust in the nation’s governing institutions. When people don’t trust their government, the system is always prone to collapse.
It wasn’t until I discovered bitcoin, four years after my 2009 departure from Buenos Aires, that I understood this clearly. I’d been well aware of Argentines’ lack of trust in government – the local commentariat endlessly talked of their leaders’ corruption. But only after learning of how bitcoin’s decentralized cryptographic protocol allowed users to transact having to trust centralized intermediaries did I see the connection between that trust deficit and Argentina’s financial dysfunction.
Argentina is by no means alone in this problem. But as its government finalizes yet another bond restructuring deal with investors, this time to write down $65 billion in foreign debt, and with its perpetually volatile economy facing its worst contraction ever, it’s worth exploring this more deeply.
Now, more than ever, Argentina’s failures offer a cautionary tale, especially for the U.S. And with speculation growing over changes to the global financial system, cryptocurrency and blockchain models could help us design systems more resilient to this kind of failure.
Note, this is a “bitcoin fixes this” essay. Believing that bitcoin alone will save all Argentines – or Turks, Venezuelans or Filipinos – is, as Coinshares Chief Strategy Officer Meltem Demirors noted this week, naive and offensive. This hard-to-use technology is no silver bullet for the root causes of economic destitution.
Nonetheless, bitcoin’s decentralized blockchain-based system for exchange and record-keeping is a valuable frame of reference for assessing existing monetary governance and for thinking about alternatives. To paraphrase Marc Hochstein, CoinDesk’s executive editor (and last week’s replacement author of this newsletter), “blockchain doesn’t have all the answers, but it asks the right questions.”
The untrustworthy sovereign
To understand how Argentina’s financial system failed and the potential of a decentralized alternative, we must first review the history of money itself, the power structures it fosters, and the friction it creates.
For the past 5,000 years, money has been closely associated with the idea of “the sovereign,” by which we essentially mean “the ruler.” Different communities have used different currencies – from wampum in the early American colonies to cigarettes in prisons – but it’s the ones issued by monarchs and state governments that dominate. That’s because of the sovereign’s unique power to mandate which currencies are legal tender and accepted in payment of taxes.
In the 20th century, as the nation-state became entrenched as the core realm of political power, national governments cemented their quasi-monopolies as issuers of legal tender currencies. This was done in coordination with banks, to which they granted exclusive access to central bank reserves, treating them as agents for generating, distributing and circulating money.
But while governments and their agent bankers could guarantee their currency’s dominance, they couldn’t control its value among users, who always found ways to sell an unwanted national currency for something of more lasting value: gold, or foreign currencies, or goods they’d stockpile before inflation eroded their purchasing power. They would seek fiat alternatives when governments exploited their unique currency-issuing powers to pursue their own self interests.
Rigidly fixed currency regimes, such as the gold standard or Argentina’s 1990s dollar-pegged currency board, offer some protection against that risk. They’re intended as a policy straitjacket to prevent a government from abusing its citizens’ trust.
Yet, the state’s power ultimately supersedes this straitjacket, as President Richard Nixon demonstrated by abandoning the dollar’s gold peg in 1971 and as Argentine President Eduardo Duhalde did by ending the Argentine peso’s dollar peg in 2001. Sovereign power is absolute.
At the end of the day, a currency’s viability hinges on the degree of trust people hold in their government. One could argue the United States’ relatively solid economic performance since 1971 and Argentina’s disastrous experiences over the same period reflect the comparative degree of institutional trust in each country’s system of government. (One could also argue the distinction between the two countries has narrowed dramatically in recent times.)
In Argentina, the trust breakdown manifests as financial and economic volatility, much like anywhere else that’s prone to such boom-bust cycles.
Such countries’ financial systems serve the interests of speculators, not their people. Short-sellers swarm in to sell stocks and bonds during a downturn, prompting governments to take drastic measures to stem the outflow of funds – such as the many times Argentina has limited bank withdrawals and transfers in failed bids to protect the peso, only to paralyze its payments system. Eventually, the country’s assets reach oversold levels – when a deal is done with bondholders, for example – which is when speculators return as “vulture funds” buying “distressed debt” to ride the inevitable rebound. It’s a dirty game, but they’re not the root of the problem. This system stems from an original sin: the government’s breach of its people’s trust.
The sovereign self
Unlike many hard-money bitcoiners, I don’t think the answer to these problems is to impose a hard limit on money supply.
I’m not saying bitcoin isn’t valuable; on the contrary, its strict issuance regime gives it “digital gold” qualities that offer a powerful hedge against breaches of governmental trust. It’s just that deflationary currencies, as Argentina’s 1990s currency board showed, often serve solely the interests of savers. In times of economic contraction, economies need money that consumers and investors will put to work rather than HODL. (I see Crypto Twitter’s rage tweets coming at me already.)
What solution, then, do bitcoin and other blockchain solutions offer to the “Argentine problem?” It lies, I think, in their radical new model of governance, one that turns the trust problem over to an open-source algorithm whose rules are defined by a permissionless network, a system whose rules Nixon could never have overridden. It’s not, per se, that bitcoin’s rules project a fixed 21-million coin supply 100 years from now, but that the rules themselves – whatever the community agrees to – cannot be changed by a centralized power.
What we’re talking about is a different concept of “the sovereign.” This is about not having to trust Richard Nixon, Eduardo Duhalde, the Federal Reserve’s Jerome Powell or Jamie Dimon of JPMorgan. It’s about empowering us to choose what currency or system we want for our wellbeing or to exchange value with others.
Whether we choose bitcoin, the dollar, gold, a stablecoin, or some other blockchain model, what most matters is the very freedom to choose. We need a system of choice that leaves those in power beholden to the choices of the individuals they deign to rule.
Amid so much discussion about the future of the financial system, with even Goldman Sachs questioning the future of the dollar’s hegemony, let’s learn from Argentina’s tragedy to design a universal system that crowns the “sovereign self.”
Privacy-positive performance
The world got a demonstration of bitcoin’s transparency recently, when a hacker took over the Twitter accounts of powerful individuals and companies, and used them to solicit bitcoin with a scam charity appeal. Crypto forensics experts and analysts, CoinDesk included, watched the hacker’s funds, analyzing their sources and where they were transferred.
So-called privacy coins aim to shield crypto transactions from that kind of scrutiny. Three of them – dash, monero and zcash – feature in the CoinDesk 20, a list of assets that show consistent market impact via consecutive quarters of verifiable trading volume.
Bitcoin is the highest-volume asset in the CoinDesk 20 and the next-most heavily traded assets often exceed it in returns. This past week’s run-up is no exception. The privacy coins are standouts, in that their volumes are often in the bottom half of the ranking, but two out of the three are in the top five by returns, year-to-date.
There’s little evidence the Twitter hack drove particular interest in privacy coins, but so far in 2020, the three coins with a privacy value proposition have punched above their weight. CoinDesk Research’s July Review has more on privacy coin volatility and correlations. We’ll continue tracking these projects over the summer.
The global town hall
GOLDEN MOMENT. The crypto world got excited this week by a resurgence in bitcoin and ether prices. As we went to print, BTC was testing $12,000 with a shot at its levels not seen since the great boom-bust of 2019-2019, and ETH, following a massive run-up from a bottom around $80 in early May, was toying with $400 and trading at its loftiest level since this time two years ago. But for the “normies,” surely this week’s historic market story belonged to gold. The price of the precious metal reached its highest level ever this week, surpassing $2,000 per ounce.
This is a big deal, people. I’m no gold bug. I believe bitcoin is a better substitute for scarcity in the digital age and I think a functional currency should have malleability in its supply function, which neither bitcoin or gold offers. But, please, have some respect for gold. Its cultural value has lasted longer than any language, religion or ideology. It’s the ore from which kings through the ages minted their coins, the shiny substance that permeates our children’s fables, the alluring mineral that fueled the conquest of the Americas. There’s no magical meaning to the $2,000 level but let’s recognize the wisdom of the crowd that drove this run-up. Amid the most extreme downturn in the global economy for 90 years, and as confidence in the political leadership is being tested, the soaring value of an ancient commodity that serves as a hedge against political and financial dysfunction must give pause for thought. Is something about to break?
INDEX ≠ ECONOMY. Last week, the S&P 500 returned to a level showing a positive return year-to-date and got within 40 points of its record high in late-February before COVID-19 sent markets into a tailspin mid-March. This happened as news broke that the U.S. economy contracted by an annualized rate of 32.9 percent in the second quarter.
I feel like I should just end this item there. The juxtaposition is just so astounding. But we really should try to figure out how this could happen. Thankfully, Bloomberg contributor Barry Ritholtz has a column that lays out “Why Markets Don’t Seem to Care If the Economy Stinks.” His argument: market capitalization weightings within indexes such as the S&P are skewed toward a few key industries that are making an inordinate amount of money – especially technology – while those that reflect the COVID-devastated mainstream economy (e.g. retail and travel) occupy a tiny place within the indexes. He’s not arguing that things are great, but that we put too much meaning in indexes beyond the investment story they tell. Despite the habits of journalists over the decades, and despite the current U.S. president’s predilection for equating stock market rallies as a sign of economic strength, the experiences of Wall Street and Main Street are very divergent. That wouldn’t be a political issue per se, except that, in the current fiat system, the former absorbs far more benefit from monetary stimulus than the latter.
COVID COLLATERAL. Caitlin Long, founder of Avanti Bank and advocate for Wyoming as a blockchain jurisdiction, is everywhere these days. Here she is as the co-author of a recent paper published by the International Monetary Fund, along with Charles Kahn, Professor Emeritus at the University of Illinois at Urbana-Champaign and IMF senior economist Manmohan Singh. They focus on the payment system efficiencies that could arise from having capital that would otherwise be tied up in bank reserves and deposits used as collateral to back tradable crypto tokens. The bit that stands out: the idea that the trillions in dollars in reserves that central banks have created as a result of their COVID-19 stimulus efforts are now crying out for this kind of treatment.
Relevant reads
Goldman Sachs Eyes Token as Bank Appoints Head of Digital Assets.A couple of months ago, Goldman Sachs was out there pooh-poohing bitcoin, telling an investor call that bitcoin and cryptocurrencies are not an asset class. Three months later and the Wall Street bellwether is taking a very much more nuanced position. It’s keen on the technology underlying cryptocurrencies and has hired a head of digital assets to explore a Goldman-issued token. Paddy Baker reports.
TikTok and the Great Firewall of America. Missing the forest for the trees.That’s the impression one gets of the Trump Administration’s attack on Chinese-owned TikTok from this piece by Global Macro and Policy Editor Emily Parker. With the U.S. government now banning the social sharing app and Tencent’s WeChat service, Parker calls out hypocrisy. Concerns about data abuses by the Chinese government ignore the fact that U.S. companies are exploiting our data every day.
‘Crypto Instagram’ Is Becoming a Thing, Scams and All. If TikTok goes away in the U.S., expect many of that platform’s stars to migrate to Instagram. Be wary, though. As Leigh Cuen discovered, the Facebook-owned social media network is already a magnet for crypto scammers. It’s not just Twitter – fraudsters will thrive anywhere.
US Lawmakers Don’t Want Proof-of-Stake Networks to Get Overtaxed. With Ethereum 2.0 on the horizon, the business of token-staking is poised to get bigger. Inevitably, this hard-to-pigeonhole new means of earning crypto income will raise questions from lawyers on how it should be treated for tax purposes. As we’ve seen in past crypto developments, a lack of understanding in Congress runs the risk of prompting regulatory over-reaction. So it’s pleasing to see that, as Nikhilesh De reports, a group of crypto-savvy lawmakers are trying to get ahead of that and prevent the risk of overtaxing.
Social Engineering: A Plague on Crypto and Twitter, Unlikely to Stop. One silver lining to the massive Twitter hack last month is that it shed a light on how the real vulnerability in cybersecurity lies not with technology but with people. The crypto community is especially vulnerable, given the temptation that tokens represent to hackers. So, don’t miss this very useful explainer on these so-called social engineering attacks from Benjamin Powers and Nikhilesh De.
Fixing This Bitcoin-Killing Bug Will (Eventually) Require a Hard Fork. You might call it Bitcoin’s Y2K moment. Don’t worry, it won’t kick in until the year 2106, but this bug will kill the protocol if the community doesn’t agree to a hard fork in the code to fix it. But Alyssa Hertig’s great write-up of this particular problem is really valuable. It’s a great window into the challenges that open-source crypto communities face in coordinating hard forks and, specifically, into the issue of “protocol ossification” – the idea that the bigger the network becomes the harder it is to make code changes.
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