The emperors new coins

A parable about money

In a land not far from here a shoe maker received a gram of gold in payment for a shoe makeover for one of his esteemed clients. Happy as he was he decided to go to town to look for a good bank to exchange his gold for one of the more customary forms of money in his town. First he came across a good old fashioned, and trustworthy looking, bank called ‘Gold Bank’. The shoemaker went in and asked the kind old gentleman how much money he could get for his gram of gold. The banker explained that in exchange for one gram of gold he would give the shoemaker a banknote with the text “Pay 1 gram of gold to bearer. Fully backed by the Gold Bank”. ‘I will put your gram of gold in my safe’, said the banker, ‘and any time you or anybody else presents this banknote to me, I will exchange it again for a gram of gold’. ‘That’s very nice’, said the shoemaker. ‘I will consider your offer.’

And the shoemaker went on his way until he saw a modern and shiny bank called ‘Nothing Bank’. The shoemaker went in and asked the kind young lady how much money he could get for his gram of gold. The bank lady explained that  in exchange for one gram of gold she would give him two banknotes, each with the text “Pay 1 nothing to bearer. Guaranteed by the Nothing Bank”. ‘That doesn’t sound like a good trade’, complained the shoemaker. ‘On the contrary’, said the bankster. ‘Our banknotes are accepted by all merchants in town. And one of our notes buys just as much as the value of 1 gram of gold. So by exchanging your gold for our money you double your purchasing power.’ ‘How do you accomplish such a remarkable feat?’ asked the puzzled shoemaker. ‘Simple’, said the bankster. ‘Since we do not back up our notes with gold, we have no need to keep the gold we collect in our safe. So each gram of gold we collect, we sell to the goldsmith next door, and he pays us one nothing-banknote for it. So for each gram of gold we receive, we write out one new banknote and collect one already existing banknote by selling the gold. That’s how we can afford to pay you two banknotes for every gram of gold you give us.’ ‘Amazing’, said the shoemaker. ‘I will consider your offer.’

The shoemaker walked on until he came accross the third and last bank in town, called ‘Throwaway Bank’. It looked more like a small little shop than a bank, as they had various gardening tools, such as shovels, for sale which seemed unrelated to the banking business. Nevertheless, the shoemaker went in and asked the young nervous looking glass wearing man how much money he could get for his gram of gold. ‘We don’t exchange gold for money directly’, said the young banker. ‘But what you can do is pay our gardener one gram of gold. In exchange for that he will dig a large hole in your garden, and then fill in up again. But he does a very good job, you won’t notice it at all and your garden will look exactly the same as before.’ ‘What on earth is the point of that?’ asked the shoemaker. ‘I don’t know anything about money, but why on earth have all that work done for no purpose?’ ‘Oh but it does serve a very useful purpose’, exclaimed the youngster. ‘Although digging and filling the hole may not have inherent value, it has great value in making a very efficient and useful money system possible. You see, if you have your neighbors witness the work done and have them sign a piece of paper saying so, that piece of paper is accepted by us as “Proof of work.” And in exchange for that we will pay you one throwaway-banknote, which has about the same purchasing power as 1 gram of gold. Oh one little thing, it is hardly any disadvantage at all, but I mention it just in case. It does take about an hour before any payment made in throwaway-banknotes is verified. So, say you want to buy a loaf of bread at the bakery, then there is an hour waiting time after paying before you can pick up your bread. ‘Interesting’, said the shoemaker. ‘I will consider your offer.’

Comment

I told this story at my first presentation of Dcash on the 13th of April 2013 at the Gold, Savings and Money Conference in Nieuwegein.  At the end I asked my audience: ‘Now the question for all of you is as follows. Suppose you had one gram of gold and you had to pick one of the three banks mentioned in this story, the Gold Bank, the Nothing Bank or the Throwaway Bank. Who would choose the last bank, the Throwaway Bank? Please raise your hands if you would pick the Throwaway Bank. Out of about 100 people one person raised his hands.

The parable, of course, is meant as a critique of Bitcoin. And as an aside it sheds some light on the contrast between gold backed money and fiat money. One of the problems with Bitcoin is how wasteful it is. For every bit of $1 purchasing power, up to $1 of computer resources may be wasted to create the digital coin representing that value. It’s as if when converting dollars to euros you have to pay a commission of 50%. The irony of Bitcoin is that while its success marks the beginning of the end of central bank control over our money, the very thing making Bitcoin the first successful digital coin is the reason for its inevitable downfall. And that is the fact that it is not backed by anything with real value. Because of that there is no need for any non anonymous trusted money issuers. By allowing money creation based on ‘proof of work,’ an easy non centralized non stoppable growth was made possible. But that very cause of its success, the fact that it is not backed by real value, also makes it a bubble waiting to explode. I repeat the prediction I made in my speech: I predict that within one year the value of a bitcoin will drop to below $1.