BITCOIN - IT IS A FRAUD.

Bitcoin – it is a fraud.

By

Koti Ravi Kiran Chalasani.

Email:ravi_kiran13@yahoo.com

Bitcoin is  promoted as a digital currency.  It is promoted as a major financial innovation of recent times.  For the free spirited enthusiasts, it is an unshackling of their hard earned money from the whims and fancies (read control) of the central government.  It provides an escape from the financial controls, imposed by a central bank, controls which might be ethical or unethical, and which controls might be abhorrent to a free market enthusiast. 

Bitcoin can be earned by contributing effort and time at the computer.  The effort and time contributed might not be useful to anybody.  This is akin to mining gold.  The miner gets gold, and she expending effort and time in mining is not useful to anybody.

 

The programme that releases bitcoin does so based on a mathematical formula, to take care of supply constraints and basically with no other social agenda including transfer of wealth.  So, the programme replaces an ideal central bank. 

As people start trading in bitcoin for real goods and services, it has attained a status of currency.  Depending on the demand and supply, its value in fiat (central bank mandated) currencies is determined.

    

Before one concludes bitcoin is a fraud, it is essential to state a few concepts about money, wealth, nation, and central banks.

A nation is a creation of the people constituting it, out of free will and participation or by fiat.  Except for guarantees spelled out in its constitution, a nation abrogates for itself all wealth within its influence.

Every nation mandates a central bank, which is a repository of all monetised wealth of the nation. 

All a central bank does is a trusteeship function.  Through credit formation, the central bank issues currency which is released into the nation to facilitate trade and commerce. 

Currency issued by a central bank is backed by all the monetised wealth of the nation.  A currency is an IOU on the nation. 

When gold standard was in place, the amount of gold held with the central bank is a check on the value of the currency and it acted as a moderator on the profligacy of the legislature.   After the gold standard is done away with, the market determined rate of the currency against other currencies, (assuming that it is an open free market with no monopolistic and other unethical practices in the market), indicates the credit worthiness of that currency and that acts as a check on the profligacy of the legislature.

A well monitored open free market is often shunned by many central banks as inducing volatility in the currency to the detriment of the nation.  But as long as disgorgement offices for unethical trading are in place and efficient, volatility induced by unethical trading practice is minimized or becomes non-existent,  and  then volatility has a direct relation with the actions of the legislature only and it would act as a check on the profligacy of the legislature.

However, many central banks, citing their inability to establish disgorgement mechanisms, favour controlled market to free market for their currency trading.  The opaqueness of a controlled market, increases the risk premium of the currency, and it becomes an unnecessary cost to that nation, which cost is never quantified or accounted for when central banks favour controlled markets. 

Controlled markets are advantageous to unethical legislatures which do not recognize the equality of citizen but believe in their right to mandate legislation, which ultimately benefits individuals at the cost of the society.    

Controlled markets also engender a sense of disenfranchisement of the citizen as at the time of nation formation, all the citizens, especially in a participative formation, have deposited their wealth with the central bank to hold in trust, figuratively speaking.  The controls are mandated legislation, after the nation formation.   

This is akin to a person going on journey having opted to place her wealth for safe keeping with a trusted person and on return find controls placed on her access to her wealth.

It is on this sense of disenfranchisement that phenomena like bitcoin try to cloak itself with legitimacy and provide an alternative to the central bank controls mainly controls on capital flight.

Coming to another aspect of bitcoin phenomena:

A central bank is sort of a credit wholesaler and the financial institutions are the credit retailers and the citizens are its customers. 

Inflation is when the units of currency printed, exceeds the units of wealth created.

From central bank to the ultimate consumer, the citizen, the credit flows through a number of linkages.  Due to information asymmetry, at each linkage as the credit flows, certain risk is assumed and translates into inflation.  It is practically impossible to have perfect information about the fiscal discipline and productivity of the link down in the chain to the consumer that certain risk has to be assumed.  This assumption of risk creates inflation and this inflation is unavoidable.  

Trying to eliminate this unavoidable inflation or theoretical inflation would result in credit freeze and probably collapse of the financial system.    

However when inflation is used as a policy tool, then the central bank is abdicating its trusteeship responsibility.  Inflation is a tax on the society in general, and devalues the wealth of the nation placed with the central bank at nation formation.  This devaluation is beneficial to all who still hold real wealth.  For a vast majority of nations, the government not only holds the largest chunk of the real wealth of the society but usually is also the largest debtor from the central bank.  So, when legislature enters the domain of the central bank, and using inflation as a policy tool, legislates and mandates inflation, the citizen, the original wealth depositor with the central bank, would again feel cheated and disenfranchised.

The traditional hedge against such inflationary policies is to shift the currency to a store of wealth.

For anything to function as a currency, it has to satisfy the property of iid.  In statistics it translates to identical and independently distributed.    Here in this context, it translates to identical and infinitesimally divisible.  Not only should it have the property of iid, it should be in limited supply and be acquired by human effort.  It should also not decay or change over time and withstand rigors of handling and travel. 

If it is freely available, then it would not have any value, and everybody would be currency rich and it would be an absurd situation.  Only by being acquired by human effort, does it make wealth participative.  By having a property of iid, it facilitates trade in any unit desired and by its identical nature would be freely combined, divided and exchanged anywhere.  Noble metals, especially gold fits the bill.  It is not freely available and it is acquired by human effort (mining), and as it is available in pure form, the effort can be expended by anybody to acquire gold.   To acquire gold one has to mine, but have no specific skill or knowledge, to extract it.  A micro gram of gold is identical to another microgram of gold from a kilo gold bar and it is also identical with pure gold across the world.  It does not decay or disintegrate and can very well withstand the rigors of handling and travel.  

 For its value it is compact and weighs a lot less.  It is easy to carry one kilo of gold rather than its value in grain.

So, gold is the traditional and ultimate currency.  It is also a store of wealth.  A store of wealth can, be a piece of art, diamond, any rare object, even secure real estate, and gold is also one store of wealth.

As gold is not only a store of wealth but ultimate currency, the preference to shift currency to gold is predominant at times of inflationary policies.

Bitcoin phenomena tries to imitate gold (can be obtained by human effort, has the property of iid programmed into it, can be carried and handled easily (online accounts), it does not decay or disintegrate with time), and tries to convince that it is also a candidate for the status of ultimate currency. 

But bitcoin differs from gold in one fundamental aspect, gold is controlled by nature (no alchemist ever had success), but a bitcoin is controlled by human.  Man is always fallible.

So, a bitcoin is not supported by the anything, and it is controlled by human.  It takes advantage of the sense of disenfranchisement with the central bank and the inflationary policies of the legislature and cloaking itself with a sense of legitimacy and innovation, while underneath being hollow, is nothing but a fraud.

The central banks role and function is trusteeship.  Its mandate can only be preservation of the wealth deposited with it at the time of nation creation.  It should do this, through having efficient fraud prevention and disgorgement mechanisms, and maintaining inflation at the unavoidable level.  There is no other mandate for a central bank.   

Controls on capital, unless imposed by the legislature with a social justification not related to the mandate of the central bank, are a sign of central banks inefficiency and credibility.  Legislature, by encroaching into the central bank space, to induce inflationary policies or to tamper with the wealth of the nation, or so called, enlargement of the mandate of the central bank, causes frustration in the vast majority of the citizens, and with the sense of disenfranchisement, would seek salvation from frauds like bitcoin.

Bitcoin phenomena is a product of the imbalances in the system created by central bank not sticking to its one and only one true mandate, and legislature entering into the space of the central bank and playing havoc with its policies.

Legislation banning bitcoin is only going to give a very temporary reprieve.  If the imbalances in the system are gone, there would not be any space for frauds like bitcoin.