There has been a lot of talk about Bitcoin these days. Its recent astonishing rise and fall seems like a classic bubble running on fast forward.
Some people are comparing it to the Tulip Mania and others see this as a minor woe in a new currency that liberates them from the grasp of central banks and tyrant governments.
From the Bitcoin website: Bitcoin is a digital currency, a protocol, and a software that enables Instant peer to peer transactions
First of all the current volatility has probably led to some significant redistribution in wealth which for the unfortunate people on the wrong end of the trade is surely very painful. Nevertheless I generally think there is value of pushing the boundary of the possible in terms of monetary transactions and also of monetary theory. Regardless of how the future of Bitcoin looks like, this is an interesting experiment and should hopefully one day give us more insight about what makes a currency viable and how cross border payments can be done cheaper. With the ascent of Ripple there already seems to be a new contender entering the spotlight.
On the other hand the possible use in criminal activities and its other weaknesses are probably a threat to the long term success of Bitcoin.
Having said that, a lot of aspects of Bitcoin seem more akin to commodities. Even most opponents of Keynesian central bank policy would argue that the money supply should grow in line with the growth of real GDP for price stability and not follow some unrelated mining activities of a set of computers. Also it does not earn interest and the ease of use to buy real goods is not (yet) at a level for the main street customer. (Arguably the absence of interest rates these days is not a big disadvantage). Most of all though the massive swings in value make it more of a high risk speculative instrument than a metric and store of value. Who would want receive their salary in a fixed amount of Bitcoins as long as the price of daily goods are still linked to traditional currencies while the value is dropping like it did in the past days? Vice versa who would want to pay a fixed salary in a Bitcoin bull market?
The fear of expropriation from governments through haircuts like in Cyprus or hyperinflation seems to be one of the drivers of the previous rise in Bitcoin’s price. For people afraid of holding ‘Fiat’ currencies it seems to look like an alternative to Gold and Silver (and perhaps guns, ammo and canned goods).
Maybe the hybrid nature of the precious metals gold and silver (and possibly platinum) between commodity and currency is the closest match to explain the economic aspects of Bitcoin. They share some similar features:
The properties mentioned above and long history as a means of payment of precious metals are very conducive to creating that necessary trust, but there is no obvious level what the value should be. The long history aspect is also the biggest difference to the new digital currencies, it will take almost inconceivable events for the trust in gold to vanish completely, but Bitcoin relatively speaking only just showed up and has no track record to speak of.
That leads us to the question what properties an ideal currency would have. The following seem like a good start:
The last point is sometimes a matter of debate, but that is a long story in itself.
As long as the currency remains a small niche player that’s where the requirements ends. But if Bitcoin or one of its successors ever become really big, then certain aspects of monetary policy become more relevant. Arguably applying monetary policy will be difficult to impossible by design as one of the key aspects of Bitcoin is to exclude central bank intervention.
Krugman’s article “Baby-Sitting the Economy” comes to mind. Also the above mentioned growth of money supply in line with the growth of real GDP will almost certainly be violated. Especially once the built in growth of Bitcoins becomes so low that it’s virtually zero. This would potentially lead to a highly deflationary scenario with all its adverse effects. A hoarder with very deep pockets could theoretically reduce the Bitcoin money supply but there is no way to expand the supply beyond a certain point.
Also for large scale success users will need assurance of the robustness of the currency against DDOS attacks on exchanges and protection from theft from their computers through malware. Given the current vulnerability of the PCs of lots of non tech savvy users this will likely remain an issue for some time to come. Even if governments remain agnostic about the concept of a digital currency outside the control of central banks, they may feel urged to take a stand against rampant money laundering, shady silk road dealings and large scale theft of assets of voters.
While the current turmoil may make for good speculative opportunities I don’t think that at this stage we know enough about Bitcoin or its peers to see it as a reasonable alternative to traditional currencies. Putting all your savings in it out of fear of losing them in a central bank induced hyperinflation may just make you lose a fortune because you bought at too high a price. We simply don’t have enough data points to get even the slightest sense of where a medium or long term equilibrium may be.
Given the nature of the currencies it’s also not not sure whether there will ever be one, except maybe at 0. Also if digital currencies are ever going to take off, their current experimental stage could well mean that we need several more iterations (and hence failures) before someone gets it right.
One of the main problems of the new digital currencies may be the fact that they tend to start small and in the absence of a central bank or anyone else with similar powers there is little room to adjust the money supply to external events. Once there is a notable bull market happening it can easily trigger vast amounts of speculative money to enter the currency and trigger a bubble like the one observed in Bitcoin. Once the bubble pops the speculative money may well exit and never come back but the new currency will have suffered a severe blow to its usefulness and credibility.
I assume that designing a digital currency that can deal with such events and satisfy the wide spread resistance against 'Fiat' money will be a challenge for some time to come.
We just sent you an email. Please click the link in the email to confirm your subscription!
OKSubscriptions powered by Strikingly