ECB Says Bitcoin’s Origin is from the Austrian School

The information age has really began to affect even the state of money.

Digital money outside the ambit of government through the Bitcoin system has been on the rise.

chart from the Economist

The proliferation of Bitcoin has even gotten the attention of the European Central Bank (ECB)

Bitcoin represents a decentralized web based Peer to Peer (P2P) currency system or as defined by Wikipedia.org 

decentralized digital currency created by the pseudonymous entity Satoshi Nakamoto. It is subdivided into 100-million smaller units called satoshis.

It is the most widely used alternative currency, with the total money supply valued at over 100 million US dollars.

Bitcoin has no central issuer; instead, the peer-to-peer network regulates Bitcoins' balances, transactions and issuance according to consensus in network software. Bitcoins are issued to various nodes that verify transactions through computing power; it is established that there will be a limited and scheduled release of no more than 21 million coins, which will be fully issued by the year 2140.

Internationally, Bitcoins can be exchanged and managed through various websites and software along with physical banknotes and coins.

A short video explaining the bitcoin system below:

While skeptics allude to “anonymity” which comes with the innuendo of “illegal” transactions, as attraction to Bitcoins, the ECB in the following paper counters that the genesis of Bitcoins has been from the framework of the Austrian school of economics

Two influences on the Bitcoin says the ECB (See Virtual Currency Schemes October 2012).

First the Austrian Business Cycle.

The theoretical roots of Bitcoin can be found in the Austrian school of economics and its criticism of the current fiat money system and interventions undertaken by governments and other agencies, which, in their view, result in exacerbated business cycles and massive inflation.

One of the topics upon which the Austrian School of economics, led by Eugen von Böhm-Bawerk, Ludwig von Mises and Friedrich A. Hayek, has focused is business cycles.

In short, according to the Austrian theory, business cycles are the inevitable consequence of monetary interventions in the market, whereby an excessive expansion of bank credit causes an increase in the supply of money through the money creation process in a fractional-reserve banking system, which in turn leads to artificially low interest rates.

In this situation, the entrepreneurs, guided by distorted interest rate signals, embark on overly ambitious investment projects that do not match consumers’ preferences at that time relating to intertemporal consumption (i.e. their decisions regarding near-term and future consumption). Sooner or later, this widespread imbalance can no longer be sustained and leads to a recession, during which firms need to liquidate any failed investment projects and readapt (restructure) their production structures in line with consumers’ intertemporal preferences. As a result, many Austrian School economists call for this process to be  abandoned by abolishing the fractional-reserve banking system and returning to money based on the gold standard, which cannot be easily manipulated by any authority.

Second is the Austrian concept of depoliticization of money through competitive free markets

Another related area in which Austrian economists have been very active is monetary theory.  One of the foremost names in this field is Friedrich A. Hayek. He wrote some very influential publications, such as Denationalisation of Money (1976), in which he posits that governments should not have a monopoly over the issuance of money. He instead suggests that private banks should be allowed to issue non-interest-bearing certificates based on their own registered trademarks. These certificates (i.e. currencies) should be open to competition and would be traded at variable exchange rates. Any currencies able to guarantee a stable purchasing power would eliminate other less stable currencies from the market.

The result of this process of competition and profit maximisation would be a highly efficient monetary system where only stable currencies would coexist.

The following ideas are generally shared by Bitcoin and its supporters:

– They see Bitcoin as a good starting point to end the monopoly central banks have in the issuance of money.

– They strongly criticise the current fractional-reserve banking system whereby banks can extend their credit supply above their actual reserves and, simultaneously, depositors can withdraw their funds in their current accounts at any time.

– The scheme is inspired by the former gold standard.

But Austrians have objected to a complete connection for other theoretical reasons.

Although    the    theoretical    roots    of    the    scheme can   be    found    in    the    Austrian    School of   economics,    Bitcoin    has raised serious   concerns among    some    of    today’s    Austrian    economists.  Their    criticism    covers   two     general     aspects:

a)    Bitcoins     have     no    intrinsic     value    like gold;    they     are   mere     bits    stored    in    a computer; and  

b)    the    system    fails    to   satisfy the    “Misean  Regression   Theorem”,    which explains    that    money    becomes    accepted    not because    of    a   government    decree    or    social convention,  but because    it    has    its    roots    in a    commodity    expressing    a certain    purchasing    power.

The world does not exist in a vacuum.

The information age will provide alternatives not only to capital markets (e.g. P2P Lending and Crowd Funding) but to money as well.

Bitcoin or not, the incumbent political system’s sustained policies of debasement will only accelerate and intensify the search for currency alternatives premised on the burgeoning forces of “decentralization”.

Many Americans Opt Out of the Banking System

Perhaps mostly as a result of bad credit ratings from lingering economic woes, many Americans have turned into alternative means to access credit financing.

The following report from the Washington Post,

In the aftermath of one of the worst recessions in history, more Americans have limited or no interaction with banks, instead relying on check cashers and payday lenders to manage their finances, according to a new federal report.

Not only are these Americans more vulnerable to high fees and interest rates, but they are also cut off from credit to buy a car or a home or pay for college, the report from the Federal Deposit Insurance Corp. said.

Released Wednesday, the study found that 821,000 households opted out of the banking system from 2009 to 2011 and that the so-called unbanked population grew to 8.2 percent of U.S. households.

That means that roughly 17 million adults are without a checking or savings account. Another 51 million adults have a bank account, but use pawnshops, payday lenders or rent-to-own services, the FDIC said. This underbanked population has grown from 18.2 percent to 20.1 percent of households nationwide.

The study also found that one in four households, or 28.3 percent, either had one or no bank account. A third of these households said they do not have enough money to open and fund an account. Minorities, the unemployed, young people and lower-income households are least likely to have accounts.

This serves as proof that despite the lack of access through the conventional banking system, substitutes will arise to replace them. Demand for credit has always been there. Such dynamic resonates with the post bubble bust era known as the Japan’s lost decade.

I may add that people opting out of the banking system may not at all be about bad credit ratings, they could also represent manifestations of an expanding informal economy in the US. Chart below from Bloomberg-Businessweek includes undocumented immigrant labor, home businesses, and freelancing that escape the attention of tax authorities.

Over the past decade, the informal economy has been gradually ascendant even for developed nations. Advancement in technology may have partly contributed to this.

Although the recession of 2001 (dot.com bust) and the attendant growth in regulations, welfare and ballooning bureaucracies may have been the other principal factors.

My guess is that the post-Lehman era, which highlights governments desperate to shore up their unsustainable fiscal conditions, may only intensify the expansion of the informal economies even in the developed world.

Add to this the growing concerns over the economic viability of the banking system and continued innovation in technology (e.g. P2P Lending, Crowd Sourcing and etc…), the traditional banking system will be faced with competition from non-traditional sources.

Capital Markets in the Information Age: P2P Lending

The information age has been bring about changes in the capital markets, I earlier showed crowd funding, now comes a variant, P2P lending

Writes Alex Daley at the Casey Research

It's a new idea but is based on the familiar technologies of the Internet; it's known as peer-to-peer (P2P) lending. The premise is simple: cut the bankers out of the loan market and keep the difference for yourself by making loans directly to other consumers.

I know, that sounds rather risky. When I see my neighbor pull up in his driveway with a shiny new car that I can guarantee costs more than his annual salary, the idea of loaning money directly to other consumers seems a little crazy. However, that's where the real innovation lies. With peer-to-peer lending, an individual investor doesn't make a single $10,000 loan. Instead, he can buy 400 different loans, taking only $25 of risk per loan, for example. Services that offer this option pull together large numbers of investors, who each take a small slice of large numbers of loans, thereby distributing risk much like an index fund. The result is usually a steady and expected rate of return after fees and defaults.

And there are plenty of defaults. Consumer credit is a risky space, after all. With peer-to-peer lending one can choose among unsecured loans only. However, despite what you may have gathered from your last attempts to find a parking space at Home Depot on a Saturday, the majority of people are good. And those good people have a tendency to pay back their loans. As an investor, these P2P services allow you to pick loans by risk category. Credit scores, debt-to-income ratios, income verification, and all the familiar tools of the professional lender are there, allowing you to make decisions about what kind of loans to buy and which to avoid.

This allows individual investors to tailor a portfolio to their own risk tolerance. Whether selecting all the individual loans by hand, or using the bulk investing tools each of the suppliers provide, a portfolio can be built in a variety of ways: from only investing in "A" grade loans with single-digit interest rates and predictably low defaults, to debt-consolidation loans for consumers with much lower credit scores, paying much higher interest but coming with significantly higher defaults as well, and everything in between.

Read more here

The above represents changes in the investment sphere (perhaps some of these companies will be publicly listed someday), as well as, changes in the social dimensions which should impact the political economy: The growth of P2P lending and Crowd Funding will eventually reach a tipping point where it will be seen or becomes a threat to the establishment. And that threat will be met with a feedback mechanism: response-counter response feedback by political authorities and the markets.

Nonetheless the internet has been providing the platform to expedite dramatic and rapid innovation based transformations.

Capital Markets in the Information Age: The Advent of Crowd Funding

I believe that the information age will also introduce material changes in the capital markets. And part of such changes may have emerged through crowd funding, which according to the Wikipedia.org,

signifies as the collective cooperation, attention and trust by people who network and pool their money and other resources together, usually via the Internet, to support efforts initiated by other people or organizations.

And social media networks are likely to serve as major platforms for crowd funding with Facebook leading the way.

From the Wall Street Journal,

Facebook Inc., with an eye toward future business relationships, wants to be friends with more social-media start-ups.

So it is going after those start-ups' investors.

Facebook's new fbStart program is open to early-stage business investment groups, also known as "seed funds" and business "accelerators," that have social-media developers in their portfolios. Developers at companies supported by the fbStart partner firms will get an advanced look at new tools and features Facebook is creating for its site. In return, Facebook hopes that some of those start-ups could eventually build a business around its platform.

So far partners in the fbStart program include Seedcamp, sFund, 500 Startups, TechStars, and Y Combinator, among others, a Facebook spokesman said.

In documents filed for its initial public offering last week, part of Facebook's pitch to potential shareholders is that it can serve as a platform for other companies, and ultimately take a percentage of those companies' revenue. Since Facebook first opened up to developers in 2007, a growing number of start-ups, such as social-gaming firm Zynga Inc., have built almost their entire business around the social network. Other examples include BranchOut Inc., a professional network, and Color Labs Inc., which provides live phone-based broadcasts to Facebook friends.

"We've been asking Facebook for ways to get better access and advance information for our companies, and this is their way of doing that," said David Cohen, founder and chief executive of TechStars, a Boulder, Colo., start-up accelerator that has helped nearly 100 new businesses raise more than $125 million since 2007.

About half of TechStars' portfolio of more than 80 active companies are expected to make use of the program, he said, ranging from ventures that develop entire platforms on Facebook, to others that incorporate social-media tools and features from the site.

Most of the 70 start-ups in 500 Startups, a $30 million seed fund and business accelerator in Mountain View, Calif., use the Facebook platform in one way or another, said Christine Tsai, a 500 Startups partner. With fbStart, "they're putting a lot more manpower behind working with us in a more formal way," she added.

As internet based crowd-funding grows, we should expect incumbent financial institutions to integrate them or if not social media networks will likely get a larger slice of the capital markets.

The internet has been validating the great F. A. Hayek’s knowledge revolution through the forces of decentralization.