Yes, yet another post about Bitcoin. I promise no mentions of bubbles though. This one is not to sing its praises, nor is it to bash its shortcomings. This is merely one to raise a fundamental question concerning the utopia of a bitcoin-based global economy: what of loans?
The answer I usually get is amazingly amusing. The answer is usually the same as the question; “what of loans?”. Maybe the answer is too obvious but bear with me.
Loans are at the core of the global economy today. They are the central engine for investment, growth and entrepreneurship. Yes venture capital is indeed growing but loans are still central to no-hype businesses, a.k.a. the vast majority. Ok, so far so good, but how is that related to bitcoin? Well, since you asked, imagine we are starting a little business and we take a loan in bitcoins (we are visionaries), say 100 Bitcoins.
Ok, let’s get down to business. Let’s invest: a machine here, a building there, a few cool online services, ok done. It only took 3 months, we are very efficient. Now let’s start making some money to pay back the loan and live happily ever after. 100 bitcoins, that shouldn’t be hard. Before taking the loan, we did the math; it would only take 60 months to pay it back. Let’s start selling. Oh, wait! What? My product is worth 10 times less in bitcoins? Why? The Bitcoin appreciated! 100 bitcoins today are worth a lot more than they were 3 months ago. How much more? 10 times more. So our product is worth 10 times less? Yes. But then we would not be able to pay the loan back. Exactly!
As the value of bitcoin is appreciating very fast, taking out loans in bitcoins is ludicrous. Unless the business is growing as fast or faster than Bitcoin, it would be impossible to pay back the loan (using money generated by the business). And even if a business is growing at that rate, which is a few businesses every decade, the loan would eat up all of the growth.
That might seem like a momentary price deflation problem that would disappear as the value of Bitcoin stabilizes but it is not. Even when it does stabilize, which is so far into the future, and considering the limited supply of bitcoins, its value would continue to rise. Maybe not at the same pace as these early days but it would still continue to rise. In other words, whatever loan one makes today, they would have to pay a lot more tomorrow when paying it back and that’s not even taking into consideration interest. Take interest out of the equation and you have no incentive for savers to lend their money to entrepreneurs and the growth engine stops.
Price deflation… It sounds oddly familiar, where did that happen? Oh! Oooh! Yikes! Hmmm. There was a time when people were taking loans to buy houses in a certain currency and all of a sudden those houses were worth a lot less in that same currency. Even if they were not means of production (in most cases), people stopped paying back because they felt they were paying a lot more than what they got. Now let’s not call out names here but wherever that was it did lead to a disaster. Extend that decrease in housing prices to wages, profits, interests and rents combined with an increase in the value of loans and behold the perfect economic bust. A masterpiece.
It’s so grim of an outlook. Yeah, let’s look somewhere else. I always had a preference for venture capital over interest bearing loans. Could venture capital be the answer? Let’s see. A savvy investor would require a higher return from their investments than they would get from keeping their money idle. Right? If they invest 100 bitcoins in a company that spends it on different means of production and 3 months later those means of production are only worth 10 bitcoins, the investor just lost 90% of their investment in bitcoin terms. Now unless you are competing with Eike Batista, I would imagine you would rather keep the 100 bitcoins. That is an extreme case, no doubt, but even with a more stable Bitcoin, there would still be a loss of value. Some companies could certainly grow faster than that loss, thus giving the investor a higher return than 0, but the loss still weighs heavily on their growth and would send more new businesses to the grave, unnecessarily. Unfortunately, venture capital can’t solve this one either.
So, my question is: “what of loans?” and while at it “what of investments?”