Bitcoin next to Beachcoin

Imagine two wealthy, autonomous island nations in the middle of the Pacific Ocean. One day, more due to boredom than Bernanke, both decide to stop pegging their currencies against the US dollar in favor of a more modern currency board policy that better suits their respective economies. Both islands have continued to have a very high savings rate, due to cultural values on thrift and risk unlikely to change anytime soon, and years of zero-interest rate policies by the far off US Fed have removed long-expected monetary dividends from these savings, while fuelling volatile and unwanted speculative bubbles like those seen in Hong Kong with its USD peg. A gold standard seems too outdated to these islanders for several reasons: it would be expensive and wasteful to physically ship the gold to and store them on the islands, gold is a poor tracker of the value of good and services these islands actually trade, gold does not grow or pay dividends, and perhaps most extremely: many key decision makers on this island have a real fear that some major gold discovery or nuclear production method may be right around the corner ready to send gold prices plummeting. A diversified, trade-related basket currency board like that of the Singapore dollar, SDR or even Chinese Renminbi seemed like a possible next best choice, but being imaginary, these islands were ready to try something radically different than what any major fiat currency was doing.

Let’s call one of the islands “Teknesia”, reflecting the more computing and high-tech nature of its economy and general population. Teknesia’s technology has made it largely self-sufficient in producing and extracting its own commodities, and has maintained a very small trade surplus with the rest of the world in a variety of services it can offer online through its high-speed connections. For this reason, Teknesia was an early adopter and user of bitcoin, litecoin, and other cryptocurrencies, and has already been taking advantage of the ease of cross-border payments using them. Domestically, bitcoin has largely replaced PayPal as the way of sending quick electronic payments when, for whatever reason, the locals don’t use cash or free bank transfer services. For several reasons, ranging from the quality of the software and global network support, ease of transition and international exchange, and limits to supply that can’t be debased by any central bank, the Monetary Authority of Teknesia (MAT) decides to adopt a currency board policy pegging the Teknesian rupee (TNR) to bitcoin.

The other island, only about 30 nautical miles east of Teknesia, let’s call it “Geonesia” is in many ways very similar to Teknesia, but is less familiar with and less economically built on technology than Teknesia and instead is far more weighted in its natural resources and real estate development. Geonesia’s most internationally valued gem is its gorgeous 10km long beachfront on the south shore of the island, far from the shipping port in the north, but with a road and light rail making the nearby business district easily accessible. The Geonesian government owns this beach and all land at least 100 meters inland from it, and so decides to try the following set-up:

• This 100 hectares of beachfront land is transferred to a trust administed by Geonesian Central Bank (GCB).
• The GCB then issues 10 billion units of its new currency, called the Geonesian Beachcoin (GNB), each representing an equitized interest in the equivalent of one square centimeter of the land. This initial issue is mostly done as an exchange against its old currency (which was backed by US dollars), but the GCB also welcomes direct exchanges against qualified foreign currencies.
• The GCB trust then collects lease payments on this land from the owners of buildings and other properties developed on it, similar to property taxes or the “government rent” Hong Kong collects on leasehold land. These lease payments are negotiated, contracted and collected by the GCB trust in qualified foreign currencies and paid out to holders of the currency as a dividend, net of a fee/tax withheld by the GCB.

This is certainly not the first idea of how island land could be used to back a currency – another article suggested the idea for Greece and New Zealand.

The bitcoin-backed TNR and the beach-backed GNB each have their respective advantages and disadvantages. The main reason not many economists have viewed bitcoin as a ready alternative to even a gold standard, let alone the current currency order, is that BTC/USD is just way, way too volatile – with the recent BTC/USD trading range of 100 – 150 being close to its greatest level of stability so far.  BTC/USD volatility, as the first chart shows, is often double or higher that of Facebook shares’ volatility.

This comparison highlights one of the main tail risks of bitcoin: what happens if bitcoin turns out to be like Friendster and litecoin is the new Facebook, meaning all the MAT’s bitcoins quickly become worthless and even the tech-saavy Teknesians are somehow end up missing the great litecoin boom?  The next chart shows, not surprisingly, that the spike in Bitcoin prices over US$200 earlier this year coincided with a spike in interest in Google searches for BTC, and the lower price now corresponds to that moderately lower level of attention.  The big risk for holders of bitcoin, as for anyone who spent too much time or money on their Friendster profile, is that not enough of the world economy cares for it.  To diversify against this risk, the MAT is likely to allocate a portion of the currency board to litecoin and other cryptocurrencies in proportion to their relative use, and Teknesian banks can easily update their software to handle transactions in this portfolio.

Beachcoin by its very nature avoided the risk of online popularity contests by instead choosing a more ancient and eastern approach (at least east of the Eastern European countries that somehow rank second only to the US as the source of google searches on BTC): value backed by a hard asset, preferably income-producing property.  Beachcoin does not face the same macro risk of a systematic dislike of bitcoin, but in the same way lacks being part of a global monetary pool.  Beachcoin is and will always be limited to pointing to that small 100-hectare plot of beach land on that small island in the middle of the pacific ocean, which may arguably have far more stable value than a bunch of software bits, but at the expense of being more local.

I would be especially keen to hear or read the thoughts of other property investors and monetary policy followers on this thought experiment and the pros and cons of the two currencies, especially a property-backed one like Beachcoin.