Why Banks are Declaring War on Bitcoin

What if we lived in a world where all transactions were person to person and cost almost nothing.

What if we lived in a world where the money you save gradually becomes worth more, not through interest, but simply because as time passes you can buy more stuff with the same amount of money.

What if debt becomes a very bad idea because, if you owe 10 units of currency today and the currency is slowly becoming worth more, then you would gradually owe more money. So no one would want to go into debt.

What if debt becomes a very bad idea because saving becomes a very good idea, because whatever money you have becomes worth more as time passes. It becomes worth more, not because it’s being exploited by a bank, but because more people want the same amount of money.

This is the world we’re headed into because that is how Bitcoin works. It’s a parallel universe for banks and one that leaves them at a massive disadvantage.

Bitcoin is not a central bank currency where money supply can be regulated by policy, policy that can be lobbied and manipulated by the captains of industry. Bitcoin’s money supply is governed by an algorithm, and that algorithm ensures that Bitcoin will always suffer from deflation. That means the rate at which Bitcoin money is created will slow down and eventually stop. So as long as economic activity (which dictates money demand) is slowly increasing, the currency will slowly become worth more.

Traditionally, deflation, where money becomes worth more and prices of goods and services fall, has been the economists worst nightmare. That is because when you have deflation, wages fall. Most consumers carry some sort of debt. If you owe $100,000 on your house and your salary drops from $50,000 per year to $30,000 per year, you’re in deep trouble. You start spending less, economic activity decreases and this fuels further deflation. An economy can end up in a deflationary spiral this way.

In the Bitcoin economy, deflation is built into the currency. That means it’s a very bad idea to borrow money denominated in Bitcoin because you’ll end up owing more and more as time passes and never be able to pay it back. But on the plus side, if you don’t go into debt and you decide to save, any money that you hold will gradually become worth more.

This is a nightmare for banks because they want you to borrow money so that you’ll pay interest on your borrowings and they’ll keep the spread between the interest that you’re paying and the interest that they paid to borrow the money they lent to you.

It’s a further nightmare because banks want you to open a savings account and deposit money with them so that you can earn interest on your money so that you can keep pace with inflation. If you don’t deposit money with a bank in an inflationary environment, your money will become worth less. But if you do deposit money with a bank, they will invest it on your behalf, they will earn interest, and they’ll give you a lower interest rate and keep the spread. So if you’re not putting money in a savings account because your money becomes worth more automatically through deflation, banks lose.

So to summarize, you’re not borrowing and you’re not putting your money in a savings account or investment account to keep pace with inflation, so banks have lost revenue from lending and from deposits which let them borrow short and lend long – one of their staple business models.

So where does that leave banks? Well, they could just spend their time facilitating transactions like Visa, Mastercard, The SWIFT network, Western Union Money Transfer and so on. But we’ve already said that with Bitcoin transactions are person to person and cost very little. Banks don’t even get that revenue.

And that is why banks are working very very hard behind the scenes to try and kill Bitcoin before it kills them. Here are some examples:

The banks that are most afraid are  banks in developing countries like South Africa, where transaction fees are far higher than first world countries. Fees are higher because depositors tend to be less wealthy and keep much lower balances, so to make up for the fact that there’s less money for banks to invest, they gouge their customers with high transaction fees. Developing countries also tend to have large migrant populations who send money home with services like “Instant Money” which allows for SMS’ing a code to someone who can go to a local supermarket and receive money associated with that code. The transaction fees for services like that are high and if Bitcoin becomes a more cost efficient replacement for both money storage and money transmission, banks in developing countries will lose out on a very lucrative business.

The war on Bitcoin has barely begun. The amount of ammunition that traditional banks have to fight this war is vast, because the ammunition is your money.

The early Internet was more free than the Internet today. Crypto currencies may be the most free they will ever be right now.

Bitcoin transaction reversal and arbitration is built in. How it works.

Eli Dourado has a well written and easy to understand article about how Bitcoin transaction reversal and arbitration works. The feature built into Bitcoin is known as m-of-n or “multisignature” transactions. Here’s a brief extract:

The simplest variant is a 2-of-3 transaction. Let’s say that I want to buy goods online from an anonymous counterparty. I transfer money to an address jointly controlled by me, the counterparty, and a third-party arbitrator (maybe even Amex). If I get the goods, they are acceptable, and I am honest, I sign the money away to the seller. The seller also signs, and since 2 out of 3 of us have signed, he receives his money. If there is a problem with the goods or if I am dishonest, I sign the bitcoins back to myself and appeal to the arbitrator. The arbitrator, like a credit card company, will do an investigation, make a ruling, and either agree to transfer the funds back to me or to the merchant; again, 2 of 3 parties must agree to transfer the funds. This is not an escrow service; at no point can the arbitrator abscond with the funds.

The full article is on Eli’s blog.

Another feature of the currency that adds intrinsic value, along with no intermediaries, very fast transaction time and negative inflation which makes it a great value store.

And so the next Bitcoin Crash Begins…

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UPDATE on Dec 7th, 2013: Looks like the crash started Dec 5th, so I was off by a few days. The lowest I’ve seen has been $666, so it’s still a little off my prediction of $600. There’s still some major selling activity out there and we may still see $600. Bitcoin crashes historically have taken between a few days to 6 months (max) to recover. If you’re speculating on this currency I hope you’re only betting (because it is gambling) money that you can lose and are taking a 18 month view. I’m also morally oblidged to suggest that you actually spend some of your bitcoin on buying stuff to help get the currency off the ground as an actual currency and not just a vehicle for speculation.

Original post from Dec 1st:

Volume has just spiked and the price is about to break below $1000 for Bitcoin on Mt Gox. This is going to be a big crash down to around $600 bucks and it’s going to be fast. It’s already down to $750 on BTC-e but that is generally much cheaper than MtGox due to higher risk (based in Bulgaria & anonymous owner). If you’ve been watching BTC price for a while you’ll recognize this as just another profit taking crash after a big runup. They’ve happened over and over since Bitcoin broke through one buck per coin.

Then, as has happened before, it will climb back up to $1200 and beyond, probably up to somewhere between $4K and $10K before the next big crash. If you do want to speculate on crypto currencies, wait a day or three and you’re about to get a great deal on Bitcoin. 

If you’re new to Bitcoin, you’re going to need a strong stomach to ride this one out. Enjoy!

PS: I will add one Caveat. There is a fundamental issue that may be causing some paranoia and that’s the block size approaching 1 MB and miner software incompatibility with block sizes over 1 meg. But it’s something we’ve seen before.