15 March 2018 – Cryptocurrency fans point to the vast “paper” fortunes that have been amassed by some bitcoin speculators, and sometimes predict that cryptocurrencies will eventually displace currencies issued and regulated by national governments. Conversely, banking-system regulators in several nations, most notably China and Russia, have outright bans on using cryptocurrency (specifically bitcoin) as a medium of exchange.

At the same time, it appears that fintech (financial technology) pundits pretty universally agree that blockchain technology, which is the enabling technology behind all cryptocurrency efforts, is the greatest thing since sliced bread, or, more to the point, the invention of ink on papyrus (IoP). Before IoP, financial records relied on clanky technologies like bundles of knotted cords, ceramic Easter eggs with little tokens baked inside, and that poster child for early written records, the clay tablet.

IoP immediately made possible tally sheets, journal and record books, double-entry ledgers, and spreadsheets. Without thin sheets of flat stock you could bind together into virtually unlimited bundles and then make indelible marks on, the concept of “bookkeeping” would be unthinkable. How could you keep books without having books to keep?

Blockchain is basically taking the concept of double-entry ledger accounting to the next (digital) level. I don’t pretend to fully understand how blockchain works. It ain’t my bailiwick. I’m a physicist, not a computer scientist.

To me, computers are tools. I think of them the same way I think of hacksaws, screw drivers, and CNC machines. I’m happy to have ’em and anxious to know how to use ’em. How they actually work and, especially, how to design them are details I generally find of marginal interest.

If it sounds like I’m backing away from any attempt to explain blockchains, that’s because I am. There are lots of people out there who are willing and able to explain blockchains far better than I could ever hope to.

Money, on the other hand, is infinitely easier to make sense of, and it’s something I studied extensively in MBA school. And, that’s really what cryptocurrencies are all about. It’s also the part cryptocurrency that its fans seem to have missed.

Once upon a time, folks tried to imbue their money (currency) with some intrinsic value. That’s why they used to make coins out of gold and silver. When Marco Polo introduced the Chinese concept of promissory notes to Renaissance Europe, it became clear that paper currency was possible provided there were two characteristics that went with it:

• Artifact is some kind of thing (and I can’t identify it any more precisely than with the word “thing” because just about anything and everything has been tried and found to work) that people can pass between them to form a transaction; and
• Underlying Value is some form of wealth that stands behind the artifact and gives an agreed-on value to the transaction.

For cryptocurrencies, the artifact consists of entries in a computer memory. The transactions are simply changes in the entries in computer memories. More specifically, blockchains amount to electronic ledger entries in a common database that forever leave an indelible record of transactions. (Sound familiar?)

Originally, the underlying value of traditional currencies was imagined to be the wealth represented by the metal in a coin, or the intrinsic value of a jewel, and so forth. More recently folks have begun imagining that the underlying value of government issued currency (dollars, pounds sterling, yuan) was fictitious. They began to believe the value of a dollar was whatever people believed it was.

According to this idea, anybody could issue currency as long as they got a bunch of people together to agree that it had some value. Put that concept together with the blockchain method of common recordkeeping, and you get cryptocurrency.

I’m oversymplifying all this in an effort to keep this posting within rational limits and to make a point, so bear with me. The point I’m trying to make is that the difference between any cryptocurrency and U.S. dollars is that these cryptocurrencies have no underlying value.

I’ve heard the argument that there’s no underlying value behind U.S. dollars, either. That just ain’t so! Having dollars issued by the U.S. government and tied to the U.S. tax base connects dollars to the U.S. economy. In other words, the underlying value backing up the artifacts of U.S. dollars is the entire U.S. economy. The total U.S. economic output in 2016, as measured by gross domestic product (GDP) was just under 20 trillion dollars. That ain’t nothing!