May 03, 2024

Ferdinando Ametrano

Hayek, Bitcoin, and the digital Euro

Ten years after the initial request, on January 10th, the SEC has finally granted authorization for the Bitcoin ETF. This decision, under Gary Gensler’s leadership, marked a significant shift from the previous stance of hostility toward cryptocurrencies. By approving requests from major international asset managers like BlackRock and Fidelity, the SEC has now opened the opportunity for Bitcoin investment through ETFs to the broader market. The response has been swift: in less than three months, these ETFs have amassed over $12 billion in funds.

But what is Bitcoin? It is a digital artifact that is transferable but not duplicable, that is, it can be spent only once (in favor of Alice) but not twice (in favor of Bob). For the first time in the digital field, this feature is intrinsic to an IT protocol and is not guaranteed by an authority or issuer, as happens instead with the security of a current account balance. This scarcity attribute is pivotal in endowing Bitcoin with economic value, as recognized by market participants. And the market recognizes this precisely for the ability to transfer economic value in a safe, fast manner and with negligible costs. This stands in stark contrast to the sluggishness and constraints of conventional bank transfers, the complexities of international transactions involving various currencies, and the vulnerabilities associated with fraudulent credit card use. What Internet has been for the transmission of information, Bitcoin is for the transmission of value.

There’s a widespread expectation that digitization will revolutionize our banking and financial systems for the better. However, the reality today is far from this ideal. When we attempt to transfer even a small portion of our savings, such as through a bank transfer, we’re often constrained to specific weekdays and business hours. Moreover, these transactions can take two days or longer to finalize, restricted only to those who are identified and hold bank accounts, and often incurring fees paid to intermediaries.

This situation presents a paradox: in an age where technology has vastly advanced, our financial infrastructure remains outdated and restrictive. The pressing question isn’t whether we’ll achieve a global peer-to-peer network for instant and free payments, but rather who will bring this transformation and when it will happen.

Nobel Prize winner Milton Friedman had already observed in a 1999 interview that ”what is missing, but will be developed shortly, is reliable electronic cash, a method of transferring funds over the Internet from A to B, without A knowing B or B knows A, the same way I can take a $20 bill and give it [to a stranger].” Bitcoin appears to have realized this vision, and as a result, its value has skyrocketed thousands of times over in recent years.

The growing demand for digital cash is putting pressure on central banks to provide a modern payment solution that aligns with current needs. While digital cash initiatives have faced obstacles in the past, there’s a recognition of the benefits they offer to savers and consumers. However, central bankers have been cautious, fearing that widespread access to digital cash could result in a shift of savings away from the commercial banking system towards the central bank. Such a scenario could have detrimental effects on the transmission mechanisms of monetary policy, potentially leading to disruptions in the financial system.

Fabio Panetta, while serving on the board of the European Central Bank, proposed a limitation on digital Euro holdings, capping it at 3000 Euros per person. Beyond this threshold, negative interest rates would apply. This measure was seen as a relief for commercial banks, but it raised concerns about the potential impact on credit and debit card usage. It appears inevitable that the introduction of digital cash will damage some existing financial players.

Christine Lagarde has emphasized that the digital Euro project is not yet approved and, regardless, its implementation is still several years away. This extended timeline stands in stark contrast to the rapid pace of innovation in the digital sector.

In addition to Bitcoin, Facebook’s foray into the realm of private currency has also exerted significant pressure on central banks in recent years. However, Facebook’s efforts were met with strong opposition from both sides of the Atlantic. In the United States, concerns were raised about any initiative that could potentially challenge the dominance of the dollar as the international reserve currency—a position crucial for sustaining both US public and private debt. Meanwhile, in Europe, there was a staunch defense of monetary sovereignty, as if it was an indisputable principle. In addition to Bitcoin, Facebook’s foray into the realm of private currency has also exerted significant pressure on central banks in recent years. However, Facebook’s efforts were met with strong opposition from both sides of the Atlantic. In the United States, concerns were raised about any initiative that could potentially challenge the dominance of the dollar as the international reserve currency—a position crucial for sustaining both US public and private debt. Meanwhile, in Europe, there was a staunch defense of monetary sovereignty, as if it was an indisputable principle.

These incidents highlight a broader trend in the monetary sphere: our era has elevated the state, whether through liberal or Marxist frameworks, as the ultimate arbiter of rights and authority. This sobering reality echoes the sentiments expressed by Nobel Prize-winning poet Czesław Miłosz, who lamented the subjugation of individuals to the whims of the state authorities. As Miłosz poignantly observed “this state of affairs has led many to focus on mundane pursuits, like enjoying coffee or chasing butterflies, while those who truly cherish the res publica—the common good—risk facing severe consequences”.

Hayek, the Nobel Prize winner in economics, might aptly remark that we’ve succeeded in convincing people that the economy is at the mercy of the state authorities, and those who advocate for sound money principles risk facing legal consequences. Indeed, even a cursory reading of his work “Denationalization of Money”, reveals the irrationality and folly of such attitudes.

Centuries ago, we moved away from the principle of cuius regio eius religio where the ruler dictates the religion and subsequently separated the Church from the State. Today, we stand at the brink of a similarly momentous political and cultural transition, where the technical feasibility exists for a separation between money and state. While this may not entail a complete divorce between the two, it could pave the way for Hayek’s vision of private currencies competing with state-backed ones.

China has embarked on an ambitious endeavor to elevate the Yuan as an international reserve currency by introducing it in digital form. This move has stirred apprehensions, particularly regarding the potential for China to tacitly support international criminal activities, leveraging the anonymity of digital transactions as a competitive edge against the US dollar. Although China’s central bank has refuted such allegations, concerns persist, especially in the United States.

In Europe, there’s a sense of unease stemming from decades of reliance on the US dollar as the ultimate safe haven currency. The prospect of intensified competition between the Dollar and the Yuan raises fears of the Euro being overshadowed or marginalized in the global financial landscape.

Amidst the rise of Bitcoin as a digital store of value and the emergence of private currencies championed by tech giants, central banks find themselves navigating the realm of monetary engineering amidst geopolitical tensions. In Basel, the Bank for International Settlements endeavors to foster coordination and reconciliation among various central banks regarding the development of digital cash initiatives. Despite the recognition of systemic risks inherent in these developments, it’s encouraging to witness market competition sparking evolutionary trajectories in the history of money. Furthermore, the competition between states now manifests in financial and commercial arenas rather than on battlegrounds or through the deployment of weapons of mass destruction.

Bitcoin continues its upward trajectory unabated, notwithstanding the criticisms from detractors who often seem more bothered by the phenomenon than genuinely interested in understanding it. The ECB blog hosts highly critical articles, echoing sentiments expressed by notable figures such as Nobel Prize winners Paul Krugman and Joseph Stiglitz. Krugman famously remarked that ”the impact of the internet on the economy will not be greater than that of the fax,” highlighting the fallibility of predictions in the face of technological advancements. Similarly, Stiglitz underestimated the risk of failure for American agencies Fannie Mae and Freddie Mac, whose collapse precipitated the 2007 financial crisis. These examples serve as a reminder that even intelligent individuals, including Nobel laureates, are susceptible to errors in judgment.

Bitcoin epitomizes permissionless innovation—a concept that doesn’t seek approval or permission from centralized authorities. It operates without centralized security mechanisms, entry barriers, or editorial control. This approach isn’t anarchic or unrealistic; rather, permissionless innovation has demonstrated its benevolence and effectiveness in various spheres. For instance, e-mail wasn’t crafted by a consortium of post offices, and the Internet was not planned by telecommunications companies.

It’s highly improbable that a new currency and its transactional network would be conceived and developed by a consortium of banks and governments. Bitcoin’s decentralized nature embodies the spirit of permissionless innovation, offering a glimpse into a future where innovation thrives without the need for centralized control or approval.

Hayek wrote “I don’t believe we shall ever have a good money again before we take the thing out of the hands of government, that is, we can’t take them violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can’t stop”. Bitcoin operates as this sly roundabout. While it may not qualify as exemplary currency in its own right, Bitcoin aspires to be the digital counterpart of gold. Anyone who bought two pizzas in 2010 by paying 10 thousand bitcoins, i.e. 700 million dollars at the current exchange rate, did not get a good deal. But Bitcoin aims to emulate the role of gold as a store of value, and with the added benefits of a swift, secure, and uncensorable transactional network.

Reflecting on the historical significance of gold in shaping civilizations, money, and finance, we can grasp the disruptive potential of its digital equivalent in our contemporary digital era and the future of monetary and financial systems. Just as gold has held a central role in human history, Bitcoin’s emergence signals a significant shift in how we perceive and interact with value in the digital age.

The future may witness the emergence of private currencies backed by reserves denominated in Bitcoin—a concept akin to a Bitcoin standard. This could potentially rejuvenate the gold standard in a digital form, possibly incorporating insights from Irving Fisher’s Compensated Dollar. These new currencies might represent the realization of Friedrich Hayek’s vision of a competitive landscape where freely-issued currencies vie to ensure the stability of purchasing power relative to a reference basket.

In this scenario, private currencies backed by Bitcoin reserves could offer an innovative approach to monetary stability and value preservation, drawing upon the principles of free market competition and decentralized currency issuance. This could mark a significant evolution in the realm of monetary systems, shaping the future landscape of finance and economics.

The remarkable growth in the price of Bitcoin should come as no surprise, as it likely hasn’t reached its full potential yet. Similarly, the intrinsic volatility in its price dynamics—the market’s attempt to ascertain its value—shouldn’t be alarming. In this digital gold rush, the presence of unsavory characters—outlaws, charlatans, and scammers—can muddy the waters and reinforce negative perceptions. However, just as San Francisco emerged from the chaos of the Wild West, we can be optimistic that the market and the Rule of Law will ultimately prevail. Bitcoin’s provision of freedom to all of us will likely contribute to a more robust and fair financial system in the long run.

May 03, 2024

Ferdinando Ametrano

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