Bitcoin's Nature and Its Future.

• Author: McGinnis, John O.

When I became a member of the small band that the Federalist Society was thirty-seven years ago, it would have been impossible to imagine discussing the subject of cryptocurrency as part of its proceedings, let alone before such a substantial crowd. (1) But ultimately, the Society and the Constitution that it celebrates are concerned with the relation of liberty and the state. And there's no issue of modern technology more appropriate for us to consider, with cryptocurrency on the cutting edge of the divide between liberty and the state--between a centralized, coercive order, and a decentralized, voluntary one. And that divide, here, comes in that most important matter of money.

Modern fiat currency, like the dollars in your pocket and bank account, is quintessentially a creature of the state. Early in the twentieth century, Georg Frederick Knapp, the father of modern monetary theory, wrote, "The soul of currency is not in the material of the pieces, but in the legal ordinances which regulate their use." (2) Knapp argued that currency must be constituted by law, since only government could confer the requisite legitimacy to gain acceptance and public trust. (3) Thus, the underlying value of a currency is intrinsically tied to a public's trust in that legal system.

Of course, some citizens have little trust in their legal system, particularly when it comes to currency. Nation states can manipulate their currency, printing more money to fund projects for their favorite supporters. Savings then lose their value, as prices are driven up by inflation. (4) Citizens become less certain of money as a store of value and economic growth suffers. (5) Government control over money thus can be a form of oppression no less than the denial of civil liberties. Because, for instance, of its hyperinflation today, Venezuela is about the most extreme example of what I would call a monetarily oppressive regime. (6)

The recent advent of cryptocurrencies, Bitcoin chief among them, poses both a practical challenge to such monetarily oppressive regimes, and a theoretical challenge to the view that the public law of currency is the necessary foundation of money. Thus, while the creation of Bitcoin and other cryptocurrencies is impressive as a technological innovation, their central innovation is in trust, the essential characteristic of any currency that will have long-term success. (7) Bitcoin does not require faith in any public institution, such as the Federal Reserve, a monarch, or any other central authority, but rather, trust in the computer logic and the effectiveness of a decentralized order that maintains it. (8)

Thus, Bitcoin is nothing less than a fundamental assault on the idea that a public law of currency is a necessary prerequisite of the modern monetary order. In fact, Bitcoin has the potential to outperform the currencies produced by legal regimes as a store of value, precisely because it requires no trust in political process, but rather trust in a transparent set of rules and transactions that follow those rules. The basic problem for public or fiat currencies is that a legal system cannot generally make the precommitments necessary to completely isolate the governance of its money supply from all political pressure. (9) Bluntly, no one can insulate the stability claimed by public law from the hurly burly of politics.

To be sure, the U.S. dollar is the world's most trusted currency. (10) Despite its many critics, the dollar has formed the basis for 90 percent of international trade over the last thirty years. (11) Companies, consumers, and central banks around the world trust in the relative stability of the Federal Reserve and the U.S. government. (12) Yet, the dollar has been subject to periods of severe and unexpected inflation. In fact, since the creation of the Federal Reserve, the purchasing power of the dollar has fallen by 97 percent. (13) And that's not a surprise. Since the Progressive Era, the Federal Reserve has had, by law, other political objectives than maintaining the value of the currency, such as getting to full employment. (14) But individuals only have one desire for a currency: that it maintain its value. (15) The basic divergence...