Is Bitcoin Real

“Bitcoin isn’t real!”  I’ve seen this objection in variants with up to three exclamation points, so it really must be self-evident.  Perhaps it’s only the crypto-zealots and those poor people who they momentarily beguile with mathematical proofs who are so lumpen as to not understand.
Maybe if one just repeats “it’s not real” three times while clicking the heels of their loafers, they will be transported away from the phantasmagorical world where Bloomberg talks about blockchain and back to the rational sanity of Collateralized Debt Obligations.  Maybe that’s too much, but certainly “it’s not real” is the slogan for those who believe the future holds some Emperor’s New Clothes moment for this silly computer money and in a few years we’ll all laugh about the people who paid $6,000 for some 1s and 0s.  I’m not going to weigh in on whether it’s currently over or under-valued here, but Bitcoin is as real as the United States Dollar.

First, we do need to get a little metaphysical and define what “reality” is in this particular context (beyond that, you’re on your own).  I’ll break this into two aspects, tangibility and intrinsic value. Tangibility means that the realness of currency is manifested by the fact that it could be in the sole physical possession of the owner, secured from corruption to the best of the owner’s abilities. Additionally, a currency (technically, at that point it’s more properly referred to as “money”) is real if it represents a unique claim on something that has value beyond fad or convention.  If this seems a bit abstract, that’s the nature of modern fiat currencies rather than an attempt to move the goalposts for crypto.   In short, it’s real if you can throw it in a safe and estimate what it’s worth without mark-to-market data relative to another currency.  Sound fair?

From here on, I’ll be casual about “currency” versus “money” because it’s not important, and if you’re well-versed on those semantics, you probably already own crypto.  It is definitely worth reminding yourself about the components of the money supply (M0, M1, M2, M3) to follow along.  Finally, I will typically refer to Bitcoin, but all cryptocurrencies have the network effect and physical wallet features, so the argument is generic.

Cryptocurrency is not required to be in physical existence.  That’s kind of the whole point.  We know, of course, that the money in our checking accounts isn’t tangible either so a precise statement of why this bugs people might sound something like “I could convert to cash and take possession of the money in my bank account, and that gives me some peace of mind about the whole wacky scheme.” Perhaps surprisingly, not only could you take possession of and physically transact your crypto-currency if you wanted, you could do it more easily and in a more robust way.

If you are not familiar with the concept of a paper wallet, the idea is that crypto users can create and print or load the all the information (address and private key) required to control some amount of Bitcoin on paper or a thumb drive.  As a practical example of why you might do this, let’s say that you have some Bitcoin and you suspect the security of your exchange or computer or maybe you want to show some serious class and give your grandkids Bitcoin for the holidays, but – as we all know – giving someone something without actually physically giving someone something just isn’t the same.  No problem, you create one uniquely-addressed paper wallet or drive for each “crypto-bill,” in whatever denominations you want; 1BTC, 3.1415BTC, 0.00002BTC, whatever.  The two operations that we apply to bills and coins – authenticate and transact – work just as well with the crypto-bills, albeit differently.  Someone can verify the amount in the wallet using only its address, analogous to looking at the denomination of the currency and checking that it’s not counterfeit.  You can transfer the amount to them by handing over the private key (the recipient should transfer it to a different wallet they’ve always controlled ASAP of course).

Aside from the aesthetic plus of being able to make your own crypto-bills of arbitrary denomination, two things distinguish this physical or M0-like cryptocurrency as superior to bills and coins. First, consider the mother of all bank runs.  The danger in a bank run is that there is more value in the other components of the money supply than there is in cash, so the promise of cash convertibility cannot always be honored.  The typical nation’s fiat money supply can be 90% unphysical, so the worst case scenario bank run is a game of musical chairs with one chair and ten people.  A good exercise would be to imagine asking the people in lines around banks and ATMs which have broken out in Venezuela, Greece, or India how real their money is.  Conversely, if everyone suddenly decides to physically instantiate all 16.5 million Bitcoin as paper wallet crypto-bills in the manner described above, perhaps a few office supply stores would see a bump in printer ink sales.

Secondly, since the address and private key constitute the complete set of information required to control a paper wallet, you can (and should) make a copy of that information to guard against destruction.  Conversely, if the family dog eats a $100 bill you left on the table, having a photocopy of the lost bill won’t do you any good.  Chalk up another plus for the paper wallet crypto-bill.

Certainly, nobody is suggesting that this is how crypto should be used and a profound advantage of cash is that even paper wallets require access to the blockchain to verify and safely transact.  One will not completely supplant the other.  The issue here is more historical than anything else; in the components of money supply M0, M1, M2… we see the phylogeny of money itself where the physical evolves into the electronic, each more awkward and derivative than the last. (n.b. The Fed itself stopped tracking M3 or “broad money” with precision in 2006, presumably because it’s too “real” to quantify, I guess.)  Since cryptocurrencies are designed to be fast and electronic, the awkwardness occurs when you go the other way and impose the atavism of replicating M0.  But, again, if you want a coffee can of Bitcoin hidden in the attic, you can do that.

(Crypto mining farm. from: https://pool.bitcoin.com/index_en.html)

(Printing $50 bills. from: https://www.moneyfactory.gov/hmimlepe.html)

The second aspect of the realness objection is the claim that cryptocurrencies aren’t anchored to any asset or institution to which we can assign value.  This is an era of fiat currencies for certain, but a national monetary supply at least has the possibility, if not outright insinuation, that it could be collateralized by national assets (public lands, goods, precious metal stores, threat of force) as an ultimate backstop.  In the past, failing national currencies have been repaired or replaced by such collateralization.  Famously, the damage from Louis XIV and Weimar Germany’s monetary excesses were halted with land-bank currencies.  It’s hardly a gold standard, but isn’t that more than crypto?  After all, what are 1’s and 0’s worth?  First, the nitpick objections: there is no reason why a cryptocurrency can’t explicitly hold reserves of something with more widely accepted value.  In fact, one coin (Tether: www.tether.to) maintains a reservoir USD at parity, one USD to one Tether coin. (n.b. we are not endorsing Tether …at all. )

Even without an explicit Fort Knox, all cryptocurrencies are tied to an intrinsically-valuable service; namely inexpensive, swift, and secure transactions.  I will appeal to Adam Smith’s view on value and say that fundamental worth of something is in its productive capacity.  Saying a Bitcoin wallet is worthless because it’s a ghost on a hard drive analogous to calculating a valuation of Hong Kong real estate based on the mineral wealth of the land (none) and arability of the soil (nope).   Serious quantitative work on how to value networks of transactions through ideas like Metcalfe’s law is fairly young, but minimally all networks working to use and verify blockchain have the value that their services provide.  I’m not expecting anyone to be totally blown away by arcana about network scaling laws, but the basic fact is that the ability to have secure nearly-instant transactions from a user in Oslo to someone in Ghana does have value and Bitcoin will only “go to zero” when absolutely nobody is willing to incentivize others to perform such services.  This can happen, but it will be when the protocol in question (Bitcoin, for example) is completely supplanted by better networks that do a better job.  Specifically, this will require a long blockchain, tested protocols, lots of independent nodes and that will take time.

Other cryptocurrencies provide or represent additional specific services that hold intrinsic value as well.  Currently, the most important of these, from both a market cap and interest point of view, is the Ethereum network.  An ETH token is convertible to an amount of computing power which allows users to have code executed on the blockchain.  It’s just about as complicated as it sounds, but the point is that Ether tokens represent an amount of computing power that the network is obliged to execute.  There are also applications tied to cryptocurrencies that represent the right to use some amount of distributed file storage (Storj, Siacoin) and as with Ethereum, one could calculate the market rate for these services to assign a sort of “book value” for the cryptocurrency.  The point, again, is that there is a very non-speculative intrinsic value which is generally secured by the mathematical legislation of computer code instead of trust that political exigencies would force nation states to intercede to “restore faith in the currency.”

Just to put some crude real-life comparison to this, the world is currently valuing the Ethereum network of transactions, smart contract framework and computing power as roughly equal to the “faith and credit” inferred to exist in Ecuador’s non-physical money supply.  Which would you rather have a 1% claim on?  Regardless of your decision, if you had to think about it, you’ve admitted that we’re dealing with more than digital tulips.  A full list of the institutions that are supporting or collaborating with the Ethereum project can be found here (insert link).  In full disclosure, I picked Ecuador because of the size of their money supply compared to ETH’s market cap at the time of writing this, but I would be remiss not to  point out that the faith and credit in their currency collapsed in 2000 forcing Ecuador to abandon their currency and use the USD as legal tender.  You may change your answer to the above question, nobody will judge you.

Do an image search on “Bitcoin” and you’ll see the psychological crux of the “it’s not real” objection.  Almost invariably The Bitcoin is depicted as a circular medallion cast from some precious metal.  Even people in the crypto space themselves, those supposedly not benighted by the dogmas of tradition, seemingly can’t help but make an idol for Bitcoin.   In a sense, the realness objection is more of an alien-ness objection; because we haven’t been immersed in these ideas for our entire lives, we need to distill and carefully verify that each of the aspects that make sovereign currencies useful and trusted and “real” have an analog in the cryptocurrency space.  Can the QR code and private key replace the role of the watermark?  Can the robust computational network replace the role of nation state’s backing as legal tender?  They can, we just need to develop and use the correct tools to evaluate their health.