Bitcoin investors should learn a lesson from Awesome, a dictator who lost his life introducing the one of the world’s first fiat currencies. A fiat currency is a form of money to exchange goods and services that has no intrinsic value. For example, a gold coin is not a fiat currency, because it is made of gold, something that has value in, and of, itself. Paper currency, like the US Dollar, is a fiat currency because the note has no intrinsic value.
Bitcoin has a lot in common with early fiat currencies, so let’s take a second to review fiat currency and take a quick history lesson from one of its early adopters.
First off, how does fiat currency get its value? Fiat currency has value when:
1. It has limited supply
2. People believe it has value
3. It can be easily transferred to facilitate economic transactions
Right now, Bitcoin meets all three of these standards. There is limited supply due to its unique block-chain encryption standards, people believe it has value from the increasing rate of exchange to the dollar, and it can be transferred easily to facilitate economic transactions using online Bitcoin wallets. So how did fiat currencies get started and what can we learn from these early currencies about the future of Bitcoin?
In 1294 Gaykhatu (literally, “Awesome” in Mongolian) was the leader of one Hoard of Mongols ruling over what is now Iran, Iraq and Southwest Asia. Taking his name a little too literally, Awesome decided that he needed fiat currency like that introduced by his distant cousin Kublai in China.
Awesome was in the middle of a crippling drought in his territory, and after several years of expending all of the royal treasury building a seriously sweet palace (still unfinished, of course), he was broke. When he heard that Kublai was just printing his own money, he saw his path to riches and summoned the Ambassador from Kublai’s court, demanding to see the new paper currency.
So smitten with this idea, Awesome copied the idea and printed his own money. He liked the notes printed by Kublai so much, he even copied the Chinese characters on them. He demanded that everyone accept these new notes as currency. However; Awesome had competing currencies. He didn’t think about confiscating all the gold and silver currency in circulation and soon discovered that no one wanted his paper money (Kublai at was smart enough to make some of his Chao out of copper to help with the perception of value).
Awesome also launched his new currency during the worst cattle plague his realm had ever encountered, and printing new money at such a tumultuous economic event was just poor form. Needless to say, no one thought Awesome was awesome. Riots and violence broke out around his kingdom.
Topping it off, Awesome himself emptied out his treasury of the notes he printed for himself, buying lavish materials for his palace from merchants foolish enough to accept his worthless piles of paper. Awesome was bankrupt, his markets frozen from the lack of a credible medium of exchange.
In the end, he was pelted with all manner of foul, medieval produce without refrigeration, and openly mocked over the irony of his increasingly worthless name. His cousin was so angry, he didn’t stop there, he killed Awesome by strangulation with a bowstring and took over his kingdom. Yeah, that ended badly.
So, what does this have to do with Bitcoin? Bitcoin has value only from the drug dealers, money launderers, illegitimate governments, and black market moguls who see Bitcoin as a valuable exchange to conceal their dirty doings. Like Awesome, these neer-do-wells created a virtual currency that can’t be traced to support their palace building.
And like Awesome, this party will crash back down to earth. There are two primary structural problems to Bitcoin that will undermine its ability to satisfy all three standards for a fiat currency.
First, quantum computing stands to make any encryption 100% worthless in the next ten years. We are rapidly approaching a future where there will be no secrets stored on computers, because no computer can encrypt itself sufficiently to prevent a quantum computer from hacking any and all methods designed to protect it, end of story. This means that the encryption protecting Bitcoin itself, Bitcoin wallets, and any and all servers that are used to process and secure its ownership rights, will all be broken and worthless. This destroys the fundamental premise of value, to say the least. Goodbye limited supply!
Second, governments can block people from using Bitcoin as a measure of exchange. Why would they do this? Because Iran, North Korea, drug cartels, tax evaders, and money launderers are using Bitcoin to evade sanctions, bank laws, taxes, and pretty much violate every lawful economic law on the books. They are already starting to do so, in China and South Korea, and the impact of this on Bitcoin value is just beginning.
At the end of Bitcoin, no governments will allow an asset class that has a primary purpose to undermine the faith of their regulated, lawful financial system and allow untraceable and untaxable exchanges of value between two parties. In short, all these ICOs are a threat to the established global financial system, so the governments who created this system will not permit Bitcoin to stand. You can’t fight city hall, let alone every major world government.
When these governments begin to go to war against crypto-currencies in earnest, belief that Bitcoin has value will plummet, the ability to use it to exchange goods and services will evaporate, and its demise will be the latest chapter in fiat currency collapse. When this happens, I hope the Winklevoss twins have good security. I’d hate to see them go the way of Awesome.
Joe Merrill is an Austin-Texas based venture capitalist at Sputnik ATX and Linden Ventures. Follow his blog at http://www.econtrepreneur.com or on Twitter @Austin_VC