Bitcoin and the money supply

Bitcoin’s future as an alternative currency is generating heated debate and in-depth analysis of its potential effect on the money supply. Just in the past week, the Bank for International Settlements (owned by the world’s central banks) and a senior official from the Central Bank of Canada have both issued public statements on the potential impact. Just over a month ago, the Bank of England did the same. The attention that this is getting is good for headlines, perhaps, and no doubt makes for interesting intellectual debate. The debate may be intellectual, but it is also hypothetical, beside the point, and not particularly helpful, for three main reasons.

by Levi Morsy for Unsplash
by Levi Morsy for Unsplash

First, we lost control of the money supply years ago, when we left the gold standard. Central banks can in theory expand and contract national money supply by printing money, buying securities, tweaking banking regulations, etc. More money means lower interest rates, less money means that interest rates go up, and that is how central banks hope to influence economic growth. Yet they have much less control over the result than we generally believe. The actual amount of money in circulation is actually up to the banks, individual users, foreign investors and a long list of players each of whom has a different agenda.

Since so much of the money that we spend and save doesn’t even have physical form any more, it’s even harder to count, let alone control. Even the Federal Reserve itself admits that “over recent decades… the relationships between various measures of the money supply and variables such as GDP growth and inflation in the United States have been quite unstable. As a result, the importance of the money supply as a guide for the conduct of monetary policy in the United States has diminished over time.” And that’s just the US figures. Trying to get a feeling for the global money supply is a challenge, to say the least.

So, if we don’t know what the money supply is, how are earth are we going to know to what extent Bitcoin affects the final amount? And if the “official” money supply figures are not important anyway, as the Fed itself admits, what does it matter?

Second, a further layer to the irrelevance of this debate is that, while Bitcoin in many ways is a superior currency to the current fiat options, it won’t replace the dollar, the Euro, the Yuan or any other well-established local currency. Bitcoin is an ideal complement to local currencies, and is much better at trans-border payments and transfers. But the physical, practical, psychological and even emotional hurdles that need to be overcome before a culture relinquishes the comfort of the familiar and the convenience of the physical, outweigh the advantages of insisting on a blanket, society-wide adoption.

As Bitcoin takes over the international payments space, which is where its advantages really shine, it may end up surpassing major local currencies in terms of transaction volume, especially as trade becomes ever more international. But realistically, that won’t happen for many years yet. And even if (= when) it does, it won’t imply the elimination of other forms of payment. We will not end up with a bitcoin-dominated world.

Although it’s virtually impossible to have a reasonable idea of the global money supply, one figure that I saw earlier this year put the total at $43 trillion. The market capitalization of Bitcoin currently stands at under $5 billion. About 0.01%. Even when all the latent bitcoins have been mined and the supply stands at its potential maximum of 21 million, at current prices the Bitcoin market capitalization will only be $7.6 billion. Still not nearly enough to make a difference. Even if the price shot up (or gradually increased, if you prefer) to $1,000, and the world money supply stayed more or less the same, the total Bitcoin supply would still be less than 0.05% of the world money supply. In the year 2140. I don’t really see why central banks would tremble at that.

And third, this type of headline, while interesting, does little other than stoke the fear of this unknown financial concept that is going to bring about more change than we are comfortable with. I’m sure that if you asked a room full of anyone, even bankers who are supposed to understand the nuances, if they would like to see central banks lose control of the money supply, most would say no (even though, as I pointed out earlier, they don’t really have control of it anyway). No, we don’t want central banks to lose control of the economy. No, we don’t want Bitcoin to make our economy even more unstable.

And the headlines are actually misleading. In all three examples cited in the first paragraph (and there are many more), the word “unlikely” was prominently used. What the Senior Deputy Governor of the Central Bank of Canada actually said was: “In the unlikely situation in which cryptocurrencies were used broadly, a significant proportion of economic transactions would not be denominated in Canadian dollars.” We need to give more emphasis to the word unlikely. And we need to think about what level of “significant” is needed to wrest influence from the Central Bank. And with that we will realise that the Central Bank of Canada, the US, Europe and many other economic powers will most probably encounter greater dangers to their hegemony than Bitcoin. Which does not mean, of course, that Bitcoin won’t end up being powerful.

Banks and Bitcoin getting closer through forensics

Apart from investing heavily in blockchain research, banks have been wary of dealing with bitcoin-related companies. The anonymity and potential illegality of some of the transactions, as well as the generally unregulated nature of bitcoin as a “currency”, have led banks to close down accounts that they suspect of dealing in bitcoin, and to deny accounts to new bitcoin startups. Although the banks themselves would not be holding bitcoins for their clients, the (generally unfounded) fear of being caught without verifiable transaction records in the event of an audit has been stronger than the desire to capture new business.

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This may be about to change.

Technically, Bitcoin is not anonymous, it is pseudonymous, and transactions are often traceable. It can be anonymous with extra effort, re-routings and mixing solutions, but for most Bitcoin businesses, that’s not an issue. Often it’s not even a feature that they offer their clients. It’s the possibility of untraceable transactions that spooks the official institutions, although they are reluctant to publicly admit this. The Bitcoin sector, and regulators, are starting to openly protest. Just last week Australia’s Competition and Consumer Commission launched an official investigation into banks’ policies regarding digital currency clients. Their findings will most likely be totally confusing.

Enter the Bitcoin forensics. Chainalysis offers the service of Bitcoin transaction tracking. Their website declares that “We built Chainalysis to spot connections between digital identities”, which means that they use transaction data to link addresses and to thus decipher the originators of certain bitcoin transactions.

chainalysis

Chainalysis is, as far as I know, the first to publicly offer this service, attracting considerable controversy. Its tracking methods have been accused of distorting network latency, and its de-anonymization purpose is rubbing freedom decentralists the wrong way. But, it is a service that will end up being necessary if official banks are to start opening their doors and their credibility to Bitcoin startups.

Just over a week ago Chainalysis signed a collaboration agreement with British bank Barclays, to add a layer of compliance onto digital currency transactions. This could pave the way to Barclays becoming the first large commercial bank to officially accept Bitcoin clients. This would not only be very good news for the startup sector, but it would also enforce Barclays’ reputation as being quite “with it” when it comes to Bitcoin. In June it signed a collaboration deal with bitcoin exchange Safello to try out various bitcoin-related services. And earlier this month it signed a contract with blockchain trade finance facilitator Wave.

This does not mean that Barclays will necessarily be holding bitcoins for its clients. But back in September they did say that they were looking into the possibility of helping their charity clients to collect and disburse bitcoin donations. Until bitcoin is officially declared a “bankable” currency, it is unlikely that we’ll be able to open a bitcoin-denominated account at our local branch. But regulators do seem to be heading towards declaring bitcoin official tender. Just a few days ago the European Court of Justice ruled that, for tax purposes at least, Bitcoin should be considered as money.

Hopefully, with Barclays scooping up the potentially lucrative market of Bitcoin businesses eager for respectability, other banks will take a similarly progressive stance and realize that Bitcoin is not about illegal activity, any more than cash is. And from what I gather, banks have never had any problem accepting and storing cash.

Bitcoins and banks and patents

Banks’ growing interest in Bitcoin is not news. Yesterday I came across a new twist: banks filing bitcoin-related patents. This development makes sense, given the increased activity in Bitcoin research. It looks like the banks, far from being terrified of the potential disruption, are jumping on board and seriously thinking about how this new method of value transmission can improve their operations and their service. By starting to file patents, they seem to be moving – however slowly – from research to actual implementation.

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image via Death to the Stock Photo

Just last week the US patent office published a filing by Bank of America for a patent called “System and Method for Wire Transfers Using Cryptocurrency”. The idea is a simple exchange: client 1 exchanges dollars (for example) into bitcoins (for example), which are then transferred to client 2, who changes them back into its local currency. This way client 1 avoids hefty currency transfer fees, and client 2 receives the funds sooner (10 minutes or less, depending on the cryptocurrency, versus several days). In addition, client 1’s information is kept more secure, and stays with the originator (Bank of America), who obviously has complied with the Know-Your-Client/Anti-Money-Laundering laws.

The twist here is that Bank of America’s algorithm will decide whether a cryptocurrency is appropriate (there are cases in which it will be simpler to use traditional channels), and if so, which one.

Other financial services companies have tried the patents game: Western Union was granted a patent in 2014 for an alternative currency exchange. While it didn’t explicitly mention cryptocurrencies, it did refer to tokens and virtual “coins” in use at the time of filing in 2009. In 2014 Mastercard filed a patent for a “global shopping cart” that supports a variety of payment methods, including bitcoin. And Amazon, which seems to be on its way to becoming a financial services company, has been awarded a bitcoin-related patent for cloud computing payments.

Bank of America is the first “bank” to file a patent that would allow it to offer more flexible and lower-cost services to its clients. It certainly won’t be the last, and in the typical game of catch-up, we’ll probably see more activity in bitcoin-related patents filed by established institutions over the coming months. Barclays, UBS, Citi, Santander, ING and many other big banks have all acknowledged bitcoin “labs” dedicated to exploring and improving on the blockchain technology. Citi has so far said that the results of its experiments with Citicoin (a bitcoin-like in-house virtual currency) will be open source, which means that they have no intention of patenting, so that other brains can build on its work. But patents are a logical extension of private research, and an understandable way of getting some sort of return on the lab investment, as well as of stopping others from patenting “obvious” and/or proprietary technology.

A flurry of patent filings, which we’re likely to see over the coming months, is a good sign that case uses are being polished. Let’s hope that the patent office is sensible in which ones to grant. And let’s hope that patent filings are rapidly followed by implementation.

Bitcoin for charities

A few days ago we talked about Barclays’ confirmation that they were working with some of their charity clients to look at how Bitcoin* could help them collect and disburse funds. But we didn’t really go into how Bitcoin can help. If you’re familiar with Bitcoin, the advantages are obvious. But if you (like most people) are not, then talking about these advantages will give you a good idea of how Bitcoin can make payments and money transfers easier, faster and cheaper. Which, when it comes to the use of charity funds, we can all agree is a good thing.

by Neslihan Gunaydin for Unsplash
by Neslihan Gunaydin for Unsplash

Bitcoin is a digital currency that cannot be counterfeited or duplicated. It is not controlled by a bank or an organisation, so no one has control over how many there should be, nor what value it should have. No one can decide tomorrow that it doesn’t exist anymore, or that we’re suddenly going to issue lots more and dilute the market. While the original idea was thought up and initially programmed by a pseudonymous person or group called Satoshi Nakamoto, bitcoins are not created by anyone. They create themselves, according to a pre-programmed steady-release algorithm. A certain number of bitcoins are created as a reward every time a node (a powerful computer or group of computers) verifies a transaction, specifically that I have the bitcoin that I want to send to you, and that I haven’t already sent it to someone else. The process of verification is complicated, very mathematical and requires significant computing power, but is what gives Bitcoin its innovative qualities of being unhackable. Bitcoins have been “hacked” before, but only through incorrect application of the program, or through the theft of account keys.

The beauty of Bitcoin is that it can be sent anywhere in the world with almost no delay (10 minutes) and almost no cost (minimal transaction fees). It would be a huge advantage for most global charities to be able to receive funds from anywhere, and be sure that the funds are actually reaching you without the subtraction of hefty transfer fees, commissions, etc. If someone wants to donate $100, say, it would be nice to know that you’re getting $99 instead of $79. Those figures are approximate, of course: bitcoin transaction fees are not fixed, and at the moment are very low or even non-existent. The nodes that maintain the system get their reward for verification through additional bitcoin, but the amount awarded is programmed to decline over time to 0. Transaction fees will become more important, but they will remain much lower than with traditional methods (lower overheads, fewer people involved, and if they don’t, bitcoin users will switch to another system that is).

The low transaction fees broaden the potential pool of donors to those who can only spare a few dollars. Up until now, transfer fees would have made it uneconomic to donate small amounts. With Bitcoin, the collective weight of micro-donations could well equal or even surpass that of more substantial amounts.

Another huge advantage for charities, especially those working in parts of the world with unstable or corrupt governments, is that the funds go directly to you. They do not pass through any middleman. No-one can take an arbitrary cut. The charities have much more control over the donations. They will probably need to use an exchange to convert the bitcoin into the local currency, and these will take their commission, but the dent in the funds received is more transparent and more reasonable.

Personally, I think that one of the biggest impacts will come from ease of use. Sending bitcoin can be as easy as three taps on your smartphone. Or you can donate directly in the comments section of any webpage or via email using ChangeTip. Bitcoin is not limited by physical or political boundaries. It is true that it can be difficult to convert Bitcoin into local currency in certain places. But exchanges will become more efficient, and work-arounds will help overcome regulatory obstacles. The end result will be a more efficient funding for good causes. And if something is easier to do, more people tend to do it.

*You’ll notice how sometimes Bitcoin is written with a capital B and sometimes lower case. The convention is that when you’re talking about the system of Bitcoin, the protocol and the concept, you capitalize it, because it’s a name. But if you’re referring to the currency, as in “I’m sending you two bitcoin”, then it is lower case because it’s a thing. In another post we’ll go into the craziness of this naming system. Because, as you will see, even I get confused sometimes often.

The new stockmarket: Issuing shares on the blockchain

With stockmarket crashes, Black Mondays and popped bubbles in the headlines recently, this news passed by pretty much unnoticed: last week Digital Asset Holdings successfully issued stock in a private company on a totally different sort of exchange.

Why is that even news, you ask? Because it’s the start of something potentially huge, that could increase investment overall, help the circulation of money, improve funding efficiency and give liquidity to previously illiquid markets.

stock-trading

Some background: Digital Asset Holdings (DAH) is a blockchain startup that aims to use the technology behind Bitcoin to improve trading settlement. Focussing mainly on digital assets, DAH has developed an efficient and secure exchange system for digitized shares, cryptocurrencies and more, and plans to offer the services of this platform to financial institutions. Technically it’s not Bitcoin, as instead of one decentralized, public ledger with a token of value (currency) attached, DAH offers many, centralized private ledgers with no currency attached. But the transmission method is based on the same principles. By encoding securities’ information onto something similar to a blockchain, the company can improve transparency of ownership, and speed of transaction, both of which will make regulators, investors and traders happy. And if regulators, investors and traders are happy, then financial institutions will be happy.

Last week DAH created shares in Pivit, an online betting platform that uses the power of crowds to predict outcomes of elections, games, or any other public event, and sold them to private investors. This is the first time that the blockchain principle has been used to issue and distribute shares in a company. Not a lot of details are available, as in how exactly it works, or even exact figures, but we will find out more over the coming weeks. What I find most exciting is the potential to make investments in private companies more liquid. With the “decentralized ledger technology”, ownership should be much more easily transmittable, without so many contracts, verification procedures and time-consuming steps.

A limitation is that this is still not open to “ordinary people”, as the stock market is. The investors in this latest crypto-round are all qualified investors. That is fair, as the risk in investing in private companies is even higher than investing in the stock market – less information, less liquidity. But it is a step towards improving the efficiency of the financing of private companies, and to potentially broadening the field of startup funding. Will this lead to a more creative business ecosystem? Let’s hope so.

Bitcoin and banks: a perplexing relationship

One of the most difficult aspects of setting up a Bitcoin-related company is finding a bank that will work with you. Simple things like collecting revenues and investment, and paying suppliers and employees, become insurmountable barriers. Because setting up a tech startup isn’t hard enough, right? And it’s not like the Bitcoin technology is easy or anything…

So it was with delight that I read earlier this week that Barclays would start accepting bitcoins into bank accounts. This was potentially huge, because actually accepting bitcoins is a huge leap forward compared to other banks, who won’t even accept dollars that have just been converted from bitcoins. I could almost hear the ripples of excitement going through the rapidly growing Bitcoin startup sector.

photo by Davide Ragusa for Unsplash
photo by Davide Ragusa for Unsplash

But the excitement was premature. CryptoCoinsNews and others announced soon after that Barclays has denied this. If this denial is true (and it most likely is), it is a huge blow to many who were expecting startup operations to get easier. And it is confusing to those of us following banks’ interest in Bitcoin, because Barclays is one of the leaders in the banking sector in Bitcoin investigation and experimentation.

How can an institution invest in a technology, yet at the same time turn away business because it feels that the technology is too risky?

The technology that Barclays is investing in is the blockchain behind Bitcoin. More and more banks, governments and exchanges are looking into how the blockchain can revolutionize payments, asset transfers, trade settlements, etc. Bitcoin works because transactions are grouped into transparent blocks that are then processed by a decentralized community of powerful computers. These blocks, once verified, get added on to an ever-increasing chain of previous blocks. The chain makes it impossible to alter previous blocks without altering every block that comes after, which would be prohibitively difficult. And the verification process makes it prohibitively difficult to duplicate coins or to spend coins more than once. I will talk about this more in future posts, but perhaps you can already see why banks are interested in the blockchain potential for faster asset transfer and settlement.

Investment aside, the business that Barclays (and other banks) are turning away is that of a volatile currency. Bitcoin went from $13 to almost $1,000 over the course of 2013, and is now trading at around $230. That’s volatile. Businesses that earn bitcoins are therefore categorized as “high risk”. Combine that with the public perception that Bitcoin is mainly used for criminal activity, and with banks fearful of public criticism and regulatory investigation, and the institutional reluctance to hold accounts for Bitcoin companies starts to become a bit more understandable. Banks are not known for their risk-taking intrepidity.

Yet, nor do they want to be innovated out of existence. Banks in general seem to be aware that blockchain technology has potential, and they have no doubt been following the headlines of valiant startups intent on shaking up the staid financial industry. So, cautious investment in the equivalent of “Research & Development” keeps them involved and gives them a reputation for being forward-thinking, without leaving their core business vulnerable to public or regulatory criticism.

So why the precipitate announcement? The press’ eagerness to announce good news for the sector probably led to the hasty interpretation of “we are looking into” as “we will” (my daughter does this all the time). Barclays has clarified that it is investigating a Proof of Concept (which means “let’s test it”) together with some of its charity clients, to see how Bitcoin could help them with fund raising and disbursement. It’s easy to interpret from that they will soon start allowing select clients to accept bitcoins for altruistic causes if, indeed, it does turn out to be an efficient transfer mechanism. But, Barclays has not committed either way.

Barclays has the advantage of being a UK-based bank. The UK government has repeatedly expressed an interest in Bitcoin, going as far to set up a £10m research initiative. So, if it’s regulatory approval that Barclays is waiting for, it probably won’t have to wait for much longer.

In the denial, Barclays stressed that “no Bitcoin is travelling through Barclay’s systems”. That emphasis is revealing, and underlines the understandable reluctance on the part of any publicly-traded bank to let the market think that it was holding such a volatile asset, either on behalf of clients or for its own book.

The reluctance is still perplexing. Most banks now have entire teams dedicated to Bitcoin research. In most cases they are looking into applications rather than the digital currency itself, but even so, they must be aware that Bitcoin is no more about criminal activity than cash is. Obviously, working with a Bitcoin-related business does not mean the bank account holds bitcoins – the bitcoin wallets can do that. These companies need currency accounts to accept payments with which to pay suppliers and employees, not to mention taxes. With KYC/AML (Know-Your-Client/Anti-Money-Laundering) regulations in force in most developed countries, the banks should feel relatively protected against illicit activity.

It will be interesting to see in what way Barclays lets its charity clients accept the digital currency. Will it act as a bitcoin wallet? Or merely a bitcoin exchange, transferring the bitcoins into pounds?

In June, Barclays announced that it has teamed up with Safello, a graduate from its fintech accelerator, to test blockchain applications for banking. Ironically, Safello, a Stockholm-based bitcoin exchange, had its account shut down by its UK bank (name withheld) earlier this year.

Perhaps Safello will play a role in Barclays’ careful Bitcoin acceptance, or perhaps the bank will end up incorporating other Bitcoin players into its stable. Either way, it looks like Barclays is in the lead when it comes to offering Bitcoin-related services to its clients.

Elsewhere, young Bitcoin startups are still struggling to get the basic level of service any business needs from its bank. Perhaps more startups will start to look at this as an opportunity. The lack of banking services for the Bitcoin community could lead to the development of a new subset of startups: the Bitcoin banks. Decentralized, hack-proof and unregulated. Appealing, or scary?