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?