Bitcoins, coal exports, and the New Switzerland: a puzzle

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Here is a puzzle for you: what is the theoretical link between bitcoins, Australian coal exports to China, and the US becoming a New Switzerland? It’s a bit of a convoluted link, so see at what stage in the story below you spot the answer.

Bitcoins are all the rage at the moment. With 11 million of them on the internet, each worth a 1000$ today (maybe more tomorrow!), it is a market of 11 billion dollars. This is peanuts in terms of world trade or even Internet trade, which measures volumes in the trillions of dollars rather than paltry billions, but still worth a chat.

Bitcoins have unusual properties as a currency: they are essentially a long string of numbers and characters that uniquely identify a ‘bitcoin wallet’. If you like, your possession of bitcoins stands and falls with a complicated password. Bitcoins can be sent to your wallet by anyone from their own wallets, but only the holder of your password can send from your wallet. So your password, your wallet and your bitcoins are one. For most purposes, there is a finite amount of bitcoins, but at the margin one can create a few more by doing lots of calculations that require a lot of electricity. (I hope you begin to see where coal might come in! )

Now, as a future internet currency, bitcoins are doomed. There are three reasons for that: their limited supply, the ‘greater fool’ principle, and governments.

The finite supply of them (there are 11 million of them now, and there will never be more than 21 million of them as they have been designed to get harder and harder to create) means that, if they are truly used as currency on a large scale in the presence of continuous growth in trade, that their value will continuously grow. This in turn would be its undoing because people would then hold onto them rather than spend them, anticipating that future value increase, meaning they are no longer used as means of exchange and their market collapses. It is a classic hoarding collapse of currencies seen before in money history.

The ‘greater fool principle’ will also kill off bitcoins: the fact that bitcoins really are no more than passwords means their value is entirely dictated by what the next person is willing to pay for them. This is true of all pyramid schemes, where one person buys into the scheme hoping future entrants will make it worthwhile. Often when a population is new to finance you see such pyramid schemes come in – they for instance caused havoc throughout Eastern Europe when the Eastern Europeans started to discover the joys of Western banking after the collapse of communism in the 1990s – and bitcoins is a pyramid scheme tailor-made to rip off a young and inexperienced internet generation. The early adopters in pyramid schemes make fortunes out of the scheme. The next entrants hope that there are even greater fools out there who are going to pay even more than they did, right up until the market runs out of greater fools.

But governments might well pull the plug before the internet has run out of greater fools or the inevitable hoarding kills it off. This is because of the potential for money laundering offered by bitcoins, which is where China comes in.

Consider how one can money-launder with bitcoins. There are really two ways. Like having anonymous bank accounts in Switzerland, buying bitcoins can be done simply by buying them off a previous owner without any identity swap necessary. All that needs to be swapped is real money. Hence a criminal, or merely a corrupt official, can launder his ill-begotten money by buying the bitcoins in his vicinity with cash. He can then smuggle them out of the country by simply going abroad with the password or sending the password to an associate abroad in some way, after which the bitcoins can be transferred into goods or dollars again. The ease with which one can dodge banking fees and capital export restrictions with bitcoins is such that they are ideal for criminal networks looking to launder. Which is of course why they were used by criminals and corrupt officials in the silkroad networks closed down recently. You should thus not be surprised to know that China is now second in the number of bitcoin dowloads in the world, with Russia also appearing in the top 5.

There is another way to launder money though and it involves electricity. Once one has bought up all the local bitcoins with cash, one cannot easily launder money by buying foreign bitcoins via sending money electronically in some other way to foreign bitcoin holders, simply because those online transactions risk being observed by the authorities. But one can create new bitcoins by ‘mining’, which is essentially a direct function of computations requiring sheer computing power, ie, electricity.

So the want-to-be money launderers in China, of which there will be many given the fairly embryonic state of its financial sector, its huge capital export restrictions, and the broad penetration of computer infrastructure and skills in China, might well start mining bitcoins once they have exhausted all the existing bitcoins locally. And this in turn will require vast amounts of energy generated by …… coal-fired powered stations. And where does a lot of that coal come from? You guessed it, Australia.

Consider how this might go: money launderers would convert, say, 200 billion dollars of surplus (merely 10% of China’s accumulated trade surplus of the last few years) into 200 billion dollars of bitcoins via spending 200 billion dollars on computations, ie Australian coal. They then take the passwords abroad and spend it on something else, hoping of course that the bitcoin market hasn’t collapsed whilst in transit!

So the trillions of dollars of surplus run by the Chinese over the years might possibly end up being laundered by means of bitcoins and Australian coal! Causing lots of additional greenhouse gas emissions, one might add.

The story should make it clear to you why governments cannot allow this to happen and the steps they might take to prevent this from happening, via banning bitcoin mining or closing the market down or coming up with an alternative regulated internet currency.

The international politics of this are interesting though, and that is where the New Switzerland comes in: since it might well be the Chinese and Russians doing a lot of the laundering by buying up the existing bitcoin reserves where they are now (mainly the US), one can imagine the US not being all too keen to shut its bitcoin markets down quite yet. The US too wants to enjoy the benefits of undermining the financial controls in other countries, like Switserland has done for ages!

On this point, I wonder if the price of diamonds and Swiss bank fees are reducing with the new competition for money laundering provided by bitcoin?

12 Responses to "Bitcoins, coal exports, and the New Switzerland: a puzzle"
  1. He can then smuggle them out of the country by simply going abroad with the password or sending the password to an associate abroad in some way, after which the bitcoins can be transferred into goods or dollars again.

    That’s not money laundering though – if our criminal does this, he then has to explain where he got the goods or dollars he’s importing from. “I sold bitcoins to buy them doesn’t wash, because the next question becomes how he acquired those bitcoins. The same applies to using electricity.

    Money laundering means making a portion of a dirty income appear as if it’s a clean income – to do it properly, you have to create a reasonable story as to where this income came from. Classic money laundering involves operating a business like a bar, with a high margin product that is pruchased anonymously with cash in large quantities. In the example of a bar, you buy extra bottles of whiskey and simply tip them down the drain, but claim you sold them in individual shot glasses to anonymous drinkers at a high margin. You have the reciepts to prove you bought the product from your suppliers, and you have an actual bar with drinkers who could plausibly have bought it from you. Other good businesses for money laundering are tattoo parlours and hairdressers.

    • sure, the money is not (yet) squeaky clean in that it can be used for anything. I see money laundering as a matter of degrees where money ranges from impossible to buy anything with to fully legit. In that context, the trick above converts dollars in one country to dollars in another, moving it out of the sight and restrictions of one country, without paying taxation or bank fees.

      • Money launderers are typically happy to pay tax – that’s really the whole trick, to get illicit income back into the licit income stream (and being part of the licit income stream implies paying taxes). In the bar example they would pay GST on the drinks that were never really sold and income tax or company tax on the laundered “profits”.

      • (I should point out that I’m not trying to be pedantic here – it’s that I don’t think that Bitcoin in its current form is at all suitable for money laundering. It’s essentially a public ledger system, where all transactions are traceable given sufficient resources.)

        It does seem more useful as a method of bypassing capital controls, but even then there would seem to be limits. If you want to ship a bunch of wealth out of Argentina, say, you’d need to find someone willing to change your pesos for Bitcoins, which ultimately will be limited by the quantity of bitcoins which can be produced in Argentina with electricity paid for in the local currency. It doesn’t help that you can ship unlimited quantities of Bitcoin into the country over the internet, because in order to buy those foreign Bitcoins you would need foreign exchange, and if you could do that then you wouldn’t need Bitcoins as an intermediary.

        • Agreed that transferring across countries is a clear bitcoin attraction.

          Laundering within a country is also possible though: there is a random element to mining, as well as to the bitcoin clearing house rules, that make it suitable for laundering, much like one can launder at a casino: set up a 100 miners with a million to burn in electricity, then only claim the one miner who makes 90 million in bitcoins and let the other 99 fade without divulging you bankrolled them. (essentially by guessing part of the answer, mining can be like gambling). I think the authorities might have missed that trick when they publicly say bitcoin is not useful for laundering.

  2. “And where does a lot of that coal come from? You guessed it, Australia.”

    This is not correct. Australian thermal coal exports to China in 2012-13 were 38Mt (BREE) while Chinese thermal consumption in 2012 was roughly 2700Mt (BP Review).

    Most of China’s thermal consumption is produced domestically (perhaps 2450 to 2500Mt in 2012) while the majority of their imports come from Indonesia.

      • “…one can of course interpret that as saying that additional electricity would at the margin have to be generated from imported coal.”

        One can, but one would be wrong to do so. China has excess capacity; the present surplus in global markets makes it cheaper for Chinese consumers to import than to buy domestically. Additional demand from China would clear the surplus relatively quickly (it is around 10-20Mtpa), increasing prices and shifting marginal buyers back into the domestic market.

        Your hypothesis relies on the claim that additional coal consumption implies greater imports – this claim is not correct, and therefore your hypothesis is wrong.

        (FYI That graph is an energy-adjusted figure which severely discounts the actual volume of imports from Indo and is not particularly relevant.)

        • You are really not getting the spirit of the post. I call it a theoretical link and say it won’t happen because authorities wouldn’t let it happen, so am clearly talking about a hypothetical under which the additional energy would come largely from one of the current mayor coal exporters to China, ie Oz.
          Btw, Jonathon who? Anonymous nitpicking is cowardly.

          • So to clarify, the post is a discussion about policy advice for a impossible, hypothetical situation with implausible assumptions? It’s amazing there are some in the community who still think academics live in ivory towers and spend their times on abstract, pointless matters.

            If you view the email address I use when commenting, you can see my full name and institution. I apologise if you find my comments nitpicking; I felt it was worthwhile to point out that an assumption was deeply flawed and your argument untenable.

  3. Lets put it bluntly. Bitcoins are not “real” money. Anybody who gets invoved with them will ultimately lose their shirt.

  4. “… if they are truly used as currency on a large scale in the presence of continuous growth in trade, that their value will continuously grow. This in turn would be its undoing because people would then hold onto them rather than spend them, anticipating that future value increase, meaning they are no longer used as means of exchange and their market collapses. It is a classic hoarding collapse of currencies seen before in money history.”

    A currency continuously increases in value, leading to hoarding and making it unsuitable for use as a currency. Does it still have value when it has collapsed as a currency? If not, how do you get from “continuously increasing value” to “zero value”? And what historical episodes do you have in mind?

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