Peter Schiff and Bitcoin

Recently, Peter Schiff has been in the Bitcoin news for a series of videos and talks involving him on the topic of Bitcoin. The ones I am familiar with are:

Bitcoin vs. Gold - http://www.youtube.com/watch?v=0L7SOPDOvvI

Ed & Ethan 86 Bountiful Baskets of Bitcoin Banter, Blather, and Bluster. - http://www.youtube.com/watch?v=IaBREg5rzlI

Bitcoin vs. Gold: The Future of Money - Peter Schiff Debates Stefan Molyneux - http://www.youtube.com/watch?v=mFcTJAQ7zc4

I would like to address a few points made through those videos and hopefully nip a few misconceptions in the bud.

Difference between gold and bitcoins

The "Bitcoin vs. Gold" video sums up Peter's view on the difference between gold and bitcoins rather neatly. In his view, gold is better since it has intrinsic value. In the second video, Erik Voorhees counters that argument stating that there is no such thing as an intrinsic value (since value in itself is an abstract concept), but we should be rather talking about the value of how useful an object is. I also heard an argument about having to distinguish "intrinsic value" of gold from its "historical value". Lets debate those points.

Intrinsic value

Intrinsic theory of value article on Wikipedia states talks about a value of an object contained in the item itself. We also get "Most such theories look to the process of producing an item, and the costs involved in that process, as a measure of the item's intrinsic value.". In this view, gold's intrinsic value is the cost to mine it, and with Bitcoin - also the cost to mine it. The value of gold being useful to various people will be debated below, as I wouldn't call it "intrinsic" into gold - it's subjective to a given person and not a property of the material itself like density or conductivity would be.

So the process of mining is similar between both Bitcoin and gold. Early people mining gold had it easier - they could come across big veins of the metal and mine it much easier than people nowadays have to. All the easy gold was mined out early, and the process is getting harder and harder. With Bitcoin, the early coins were easier to create, but with increased interest everyone has taken their digital shovels and started to compete against one another. There are differences between those processes - there isn't much chance gold mining would get easier any time soon (until asteroid mining becomes a thing), while it could get easier to mine bitcoins if the network would lose a lot of miners, but that is unlikely to happen.

So clearly, both Bitcoin and gold have intrinsic value as defined by the cost of creating them. Lets look at the historical value and the usefulness value.

Historical Value

Gold has been viewed as money and a desirable commodity for thousands of years. Bitcoin has been around for almost 5 years now. This obviously gives gold the status of a safer store of value over a long period of time, provided the trend holds. Similarly, Bitcoin has the same historical value advantage over other cryptocurrencies - it has been the first to be created, the most widely adopted and has a story behind it - mysterious crypto wizard driven by the ineptitude of banks creates a new currency to end the banks. All other things being equal, Bitcoin is superior to other cryptocurrencies in this way.

Usefulness value

Food has value since we need it to survive. Land has value since it is used to grow food. Steel has value since it can be used to make durable tools and so forth.

Gold is useful in electronics (good conductor), chemistry (doesn't easily react with a lot of things), jewellery (looks pretty). All of those properties add to its value. At the same time, the high value of gold detracts from its usefulness - as lovely as it would be to make full electronic circuits out of gold, it's not as cost-effective at the current price.

Bitcoin is useful in electronic transactions. It is cheap, fast and can't be taken down without taking down the Internet. Unlike gold, Bitcoin's usefulness does not diminish with it's value, but increases. If Bitcoin is worth less, then the maximum amount of money one can transfer is smaller, but if they are worth more, one can always divide them up even further (8 decimal places of precision). Barring the currently high default fees in the program (0.0001BTC per 1kB of transaction), Bitcoin is getting more useful all the time.

However, Bitcoin's usefulness relies on it having value. It is by definition a way of transferring value, so without it bitcoins would be useless. Bitcoin's value is kept strong by a few factors - it's scarcity, cost to create them (the "intrinsic value"), its wide adoption and so forth, but one can recognize that "if everyone wanted to cash out", bitcoins would become worthless, barring someone giving Bitcoin a "floor".

The story isn't much brighter for gold however. If "everyone decided to cash out", it's value might drop down to something comparable to perhaps copper - $7 per kg. That's not much compared to the current price of gold. One can say, that the usefulness value is what gives gold floor value, not current value. Those are quite different.

Fundamental property of money

In the second video as far as I remember, Peter was discussing the fundamental properties of money in the context of Bitcoin lacking one of them - not being backed by anything, nor having a value onto itself.

Some people claim money has 7 characteristics, others that it has 6. Lets look at them. They both agree that money should be:

• durable - it can't change properties over time. This is why we don't use food and other perishables
• divisible - one needs to be able to make smaller fractions of it. This is why we don't use art
• portable / convenient to use - one needs to be able to carry it around and use it conveniently. This is why we don't use granite as money
• fungible - different pieces of money should be worth the same, they should be interchangeable - one coin shouldn't be worth different amount than another coin of the same denomination. This is why we don't use real estate
• limited in supply - money can only retain worth if there is a limited amount of it. If everyone can print money, it's not money
• acceptability - everyone needs to accept it, otherwise trade is harder

The extra characteristic that is named by some is:

• intrinsic value - money needs to have value unto itself

With the last one usually being used by people that maintain that only gold and silver is money since it possesses that characteristic.

Gold is durable, divisible, fungible, limited in supply and has intrinsic value. I am not sure how many people accept would accept it - probably some store clerks couldn't take it. Gold is portable in the real world, but fails in the digital world of today. If a company was to issue gold currency online, they would need to hold onto it for people to redeem it, not issue money without backing and hope not to get shut down by a government. Electronic version of gold would have the portability for online transactions, but its durability would suffer should the company be in a threat of being shut down.

Bitcoin is durable, divisible, portable, fungible, limited in supply and is gaining more and more acceptance by the day. Peter has asked for a list of merchants that accept Bitcoin, so here is a modest list of them, and a map of physical places that accept Bitcoin. I would certainly like to see one for gold (where one can spend gold, not buy it or sell it). As discussed before, bitcoins have intrinsic value of cost associated with creating them. They are not backed by a physical commodity like gold certificates would be if one is going by that definition of intrinsic value.

Bitcoin has at least 5 of the 6 characteristics of money, and is gaining the 6th, acceptance, by the day. If one is going by the 7 characteristics, it also depends on the definition of intrinsic value - it might or might not have it.

Gold by some standards can have 5-7 characteristics, depending whether one is dealing with transactions online or offline and the definition of acceptance.

Exchange fees

In the third video, Stefan brought up a few examples of large value transactions being transferred over Bitcoin for next to nothing. Peter countered that statement saying that it's not next to nothing - one would need to pay exchange fees to get bitcoins, and another exchange fee to get fiat back, and the buying and selling itself would move the price due to the big volume.

One can agree to the last part when it comes to transactions of more than a few million dollars worth. Currently looking at the market depth of one of the exchanges, a sale of $3M would drive the price down from the current drive up to 973 USD/BTC to 900 USD/BTC. A similar buy would drive the price up to 1013 USD/BTC. The daily volume of bitcoins traded on MtGox today is about $500M, on BitStamp - $480M, on BTC China it is about one and a half of that worth of CNY. One can say that bitcoin doesn't have the volume to handle such multi-million dollar purchases and sells, but at the same time the daily volume is big enough to handle that.

As for the exchange fees, while they certainly might not be zero (on BitStamp they are between 0.5% and 0.2%), they are still over an order of magnitude smaller than what Peter himself is charging (from the end of his video on CombiBar - 6.95%-7.85% over spot price). PayPal falls somewhere between that - 2-3%+$0.3. Bitcoin is still cheaper than the alternatives.

Bitcoin is a Ponzi Pyramid Scheme

Peter's biggest blunder came up during his talk with Ed and Ethan in the second video. First, he was very adamant about Bitcoin being a Ponzi Scheme. When faced with a clear definition of what it actually is and why Bitcoin is not a Ponzi Scheme, he quickly switched his statement to "Bitcoin is a Pyramid Scheme then".

Clearly, someone hasn't done their research into the subject and is just parroting whatever they heard. Peter, if you are proven wrong, don't jump from one accusation to another, be humble enough to at least say that you are not sure and you might look into that. Being uncertain about something is not a bad thing - we all learn and make mistakes, but claiming something for certain without proof or thought behind it shows that there is no use trying to have a debate with someone.

To put an end to such accusations - European Central Bank has looked into Bitcoin and whether it is a Ponzi or Pyramid Scheme in 2012. Their conclusion is "Moreover, the scheme does not promise high returns to anybody. Although some Bitcoin users may try to profit from exchange rate fluctuations, Bitcoins are not intended to be an investment vehicle, just  a medium of  exchange.". Later it also states that "[...] the current knowledge base does not make it easy to assess whether or not the Bitcoin system actually works like a pyramid or Ponzi scheme [...]". So the facts are that the ECB has looked into it, did not find indications that it is a Pyramid or Ponzi Scheme, but they are not completely certain since it is not easy to know for sure. Unless one has something new facts to bring to the table, there is no proof that Bitcoin is either of the two.

Cashing out

Around the same time Peter made the above accusations, he also brought up a point about the system collapsing when early adopters decide to cash out. A similar notion was stated by ECB - "[...] it can justifiably be stated that Bitcoin is a high-risk system for its users from a financial perspective, and that it could collapse if people try to get out of the system and are not able to do so because of its illiquidity.". Nobody is claiming otherwise. But think about the kind of people that are the early adopters of Bitcoin that can have a big amount of bitcoins.

First people that found out about Bitcoin were tech-savvy programmers that knew a lot abour cryptography. We have people like Hal Finney, Gavin Andresen or Dan Kaminsky. Being a programmer myself, I can try relating to how they are feeling about Bitcoin - an elegant solution using strong cryptography to solve a problem in a novel way. To gold bugs the Bitcoin system would be like a whole country issuing gold-backed currency. Sure, some people would want to cash in their gold stashes and live rich, but a big number of them would want to see it grow. A few early adopters might cash their bitcoins in, get rich quick while the price of Bitcoin would go down and possibly kill people's confidence in the system, but that would be destroying what Bitcoin can become.

I personally have faith in the early adopters of Bitcoin not to do that, but I understand people that have concerns. Then again, Bitcoin has survived two big bubbles and is stronger than ever. It might not be possible at this point to damage it permanently even with the price dropping a lot. But this is getting to the realms of psychology and speculation, so lets move on.

Gold-backed cryptocurrency would be superior

Another one of Peter's arguments is that a gold-backed cryptocurrency would be superior to Bitcoin. Well, there are ways to start issuing a currency like that even today, so if you're interested in running something like that Peter, let me know ;). At any rate, there is one big problem with a cryptocurrency like that.

It has to be centralized by definition.

Again, we have the example of Liberty Dollar. One company holds the precious metals and issues currency backed by it. That company has to have a physical location and is thus an easy target for a government seizure, theft and the like. Gold was made illegal in the US once already, it can happen again, ruining the value of such a currency overnight.

Sure, you can have many locations that would be issuing such currency, but that would essentially be multiple centralized currencies, each prone to default and corruption.

With a system like Bitcoin, nobody can seize your coins. Heck, I can hold millions of dollars in my head. Bitcoin can be made illegal in a country, but that won't make it impossible to spend the bitcoins somewhere else, or use them despite that.

Peter made an argument that a government could stop Bitcoin by spying on people. Not really. It is possible to operate Bitcoin over TOR or use node-to-node encryption, making the Bitcoin traffic unreadable. While people could try breaking into your computer and spying on you that way, that is a problem of privacy onto itself and should be addressed before you address the issue of using Bitcoin.

Other cryptocurrencies

Last argument of Peter's that I want to discuss is him stating that anyone can make another cryptocurrency like Bitcoin, and thus they aren't really scarce. Well, we already have more alt-coins than I care to count, and most of them get no traction. But lets discuss the issue anyway.

Bitcoins are scarce by definition. If your client enforces the protocol, there will never be more than 21M BTC. If someone changes that, you don't have to follow them, and most people will likely stick to the 21M limit present from the inception of Bitcoin. Gold can be mined from asteroids in the future, and currently it is possible to synthesize it if you have huge amounts of energy, so in theory Bitcoins are more strictly scarce than gold.

Bitcoin's protocol is changeable. It can be adjusted to address any issues one would have in the future. If the cryptography behind it gets weakened, it can be switched. If quantum computers become a reality, the algorithms can be switched. Until then, Bitconi's cryptography is secure "until computers are built from something other than matter and occupy something other than space.".

As such any Bitcoin copy does not have much advantage in the long run. There are notable technologies build on top of Bitcoin (Namecoin's distributed domain name service for example), but as for currencies themselves, Bitcoin has similar advantage as gold has to other metals - historical value, as described above. Bitcoin was the first, is more adopted and has been worth a lot more over the time than any other currency. The notion that Bitcoin can be easily replaced by another cryptocurrency like it is similar to gold being replaced by another metal. Sure, people with deep pockets could say that Ruthenium or XenCoin are the new "it", but it is unlikely to happen. Bitcoin is more prone to such change due to smaller market cap than gold, but as time goes on, there will be less doubts as to whether or not Bitcoin is here to stay.

Summary

To sum all up, Peter Schiff has all the right to be sceptic about Bitcoin and some of his arguments make sense, but at the same time others are false.

• Both Bitcoin and gold have intrinsic value as defined by the cost to mine them
• Gold has bigger historical value (thousands of years), but similarly Bitcoin has the strongest historical value of all cryptocurrencies
• Both Gold and Bitcoin have usefulness value
• Usefulness value only gives gold a floor value, not current value
• Gold's usefulness value diminishes with price, Bitcoin's increases with price
• Bitcoin with more and more adoption will be closer and closer to having all characteristics of money, gold is losing those characteristics with online transactions
• Fees are lower in Bitcoin, but the market volatility and depth are not useful for really big transactions
• Bitcoin is not a Pyramid or Ponzi Scheme
• People cashing out can ruin the value of Bitcoin
• Gold-based cryptocurrencies are centralized by nature and vulnerable to government seizure
• Bitcoin is very likely to remain the top cryptocurrency due to its historical value, just like gold is likely to be the metal of choice for storing wealth