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There is a very simple problem with BitCoin that means it is doomed.  The problem is that there is a limit on the quantity of bitcoin that can be created. According to the IEEE Spectrum article on BitCoin, the estimated limit is 21 million BitCoins.

Simply put, a limit on the number of BitCoins that can be created makes the idea of BitCoin as a currency laughable. It exposes a foundation assumption about money and economics on par with the flat earth society or evolution denial.  The designers of BitCoin should have been suspicious because the world left the gold standard. But the designers of BitCoin embraced uneducated naivete and presumed that leaving the standard of a limited amount of money (gold) was an error. ‘Money should retain value!’ they thought. So obviously, a hard limit on it is necessary.

And yet, these very same designers of BitCoin are part of the segment of society that creates new utility value. Engineers dream up things that never existed before and bring them into the world. There are reasons why the money supply needs to be something that can enlarge. Creation of new value, new products, new capabilities that never existed before is one of them.  When new value appears it must be accounted for somehow. If you cannot enlarge the money supply to account for new value then when ever something new appears, the price of everything must go down to account for it. That’s deflation, which is the hobgoblin of economic depression.

Similarly, the same designers of BitCoin whose high-tech milieu is entirely dependent on banks giving out credit (loans) failed to bother themselves with understanding how banking works. They apparently don’t understand that banks create money through the reserve system. Or if they do, they didn’t connect the dots. Instead, they seem to have bought the “funny money” idea that increasing the money supply devalues currency. It’s true that it can, but things are way more complex than that.

First, let’s review how banking creates money by clicking here.  Now think about what it means to make loans when the amount of money is limited and you can’t create new money.

Let’s create a game to understand this better. In my game there are 100 QuantCoins and I am the angel investor who holds them all. There are ten players. I loan out 10 QuantCoins to each player and charge 10% interest, and I take a 50% equity position in each player. All players must either pay off their loans, with interest, after 20 rounds of the game or go bankrupt and I collect whatever money they have left. Only if they pay off their loan do they get to keep half of what they made.

Tell me where the players that pay off their interest get the money from. Obviously, everyone can’t pay their interest for the simple reason that the game has been designed to demand 110 total QuantCoins out of a system containing only 100 coins.

As the investor in the game, how much money do I make back at the end? Remember, I said that everyone either goes bust and gives me their remainder or pays me off with interest, and I retain a 50% share of each investment I made.

The answer is that the best scenario I can have is that I wind up with 100 QuantCoins at the end, just like I put in because there aren’t any more coins to go around. But, I could do far worse than that. In the worst scenario, one of the 10 players that I loaned money pays me back 11 QuantCoins and collects all the rest of the money in the game. If that happens, 9 of the players pay me nothing, I am left with 11 QuantCoins of interest + half of the 89 QuantCoins of my big winner. In other words, in the worst scenario, I have 55.5 QuantCoins for my 100 QuantCoin investment.

Note that this is what happens if one of my investments does remarkably well. In fact, if you do the math, the better my investments do, the less money I make. In other words, in a money system with a fixed quantity of money, if there is the best possible outcome in the Silicon Valley business model, the investor community is creamed. If I do that again with my 55.5 QuantCoins I can compound my losses.

Obviously, there is no way that a sane investment community would do that.  In pre-banking societies we see exactly that phenomenon. Before banking, societies were pretty static. A few societies dealt with this problem by collecting tithes to a temple, having the temple do most of the lending and declaring a jubilee regularly to keep things going.

Banking is the innovation that made it possible for loans in aggregate to be paid off as long as the aggregate of borrowers in the society were on balance creating real value. As long as that is the case, loans mostly get paid back. If loans mostly get paid back and there is 10 or 20 times as much money outstanding in loans as the bankers invested in the seed capital of their bank, interest rates stay relatively low and the economy hums along.

Until BitCoin figures out how to support a robust banking system that doesn’t have any fundamental limit on the money supply, BitCoin is doomed.

Think about it. Any monetary system we engineer today has to be able to deal with expansion of the human population to at least 100 billion people across our entire solar system. BitCoin’s money creation scheme will barely get us out of living in caves as it stands. It can only be a passing fad, a storm tossed mote of insignificance in the world economy.

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