Sterling or bitcoin? I know which one I trust more

“I have to be honest, it is hard to see that bitcoin has what we tend to call intrinsic value.” That was Bank of England governor Andrew Bailey, speaking this week. He’s clearly not a bitcoin fan. Previously, he has warned bitcoin investors to "be prepared to lose all your money".

Today, we put the opposing view. We outline some of the recent actions the Bank of England has taken and we propose that, in fact, it’s hard to see how sterling has what we tend to call intrinsic value. And we warn sterling investors that, while they might not lose their money, they should be prepared for their money to lose all its purchasing power.

Bitcoin’s value derives from the hard work required to create it

One of the common criticisms of bitcoin is the vast amounts of electricity that the network consumes in so-called mining. There is a good reason for this consumption, however: mining is the process by which the bitcoin network is maintained and new coins are created. The more computer power that goes into this, and thus the more electricity that gets consumed, the stronger the network becomes.

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Gold has value because it is scarce; it is hard to find and expensive to produce. Bitcoin creator Satoshi Nakamoto’s aim was to digitally replicate the gold mining process. If gold were common, it would have no value. It is its very cost of production that gives it value (among other factors).

“But I don’t understand how bitcoins are created,” runs the common complaint. Well, you connect your high-powered computer to the bitcoin network and it processes bitcoin transactions in competition with other computers around the world. In processing transactions, it helps run the bitcoin network.

A plethora of supercomputers are now at work around the world, especially in areas where electricity is cheap (for example, in Iceland or near nuclear generators). The computer that best processes these transactions is rewarded with new bitcoins. This is how bitcoins are created. You can’t just conjure up bitcoins. You have to do some hard computer work first and thereby make your contribution to the network. And even if you do this, there is no guarantee you’ll get bitcoins at the end of it. There is risk.

It is both the scarcity of bitcoin and the resilience of the network – the incredible computer power behind it and the vast amounts of power it consumes – that make bitcoin desirable. Its value is determined by market forces alone. If nobody bought bitcoin the price would plummet. But people do buy the coins – for precisely the reasons outlined above. It is sound money. Its purchasing power increases over time – quite dramatically. There is a finite supply.

It’s much easier to create sterling than bitcoin

So to the Bank of England. On Monday afternoon, the UK’s central bank created £1.473bn – very little computer power required – and bought UK gilts with the money. The government will then go and use that money for whatever it spends it on. Coronavirus ads, that kind of thing. It’s all part of the quantitative easing (QE) programme.

This £1.473bn was added to the national debt, which now stands at over £2trn. How big is a trillion? I could spend a million pounds every day since the year of Our Lord zero, and I still would not have spent a trillion pounds. Our national debt is twice that.

Since March 2009, £745bn has been created via QE. There was no cost of production to this money. People get their knickers in a twist over how bitcoins are created – take a look at central banking! The money is then used to buy government debt – lent to the government, in other words, to fund its spending.

The understanding has always been that these gilts will be eventually sold back into private hands. However, as the Mail on Sunday reports this week, “about £100bn of these gilts have already run to maturity without being sold back to investors. That means the Treasury had to pay the Bank the face value of the bonds.

“Any normal bondholder would have kept the money. But the Bank – a nationalised entity – has promptly returned it to the Treasury. The Bank has also returned £57bn of its coupon payments – the interest it received – on the gilts.” And people say bitcoin is complicated!

“The result”, continues the Mail, “is that more than £150bn of national debt has effectively been paid off – at no cost – using money created by, and passed between, the UK's two main financial authorities”.

This is just a sleight of hand away from simply printing money to fund public spending. Direct financing of public debt is the sort of activity Weimar Germany and Zimbabwe got up to. The UK Treasury has borrowed around £175bn this year so far – three times the amount it borrowed last year – to cover the cost of its coronavirus policies.

Meanwhile, the Bank of England is priming us for negative interest rates (for more on that, read Merryn’s take here). Thanks very much. But I’ll stick with the bitcoin.

Check out Dominic’s new audiobook, The Shadowpunk Revolution, on Audible and iTunes. It’s a sci-fi rock drama about invisibility with a full rock soundtrack. And it’s very much a metaphor for bitcoin. Out now on Audible and iTunes.