Is Bitcoin the Future of Money?
What’s being touted in some circles as the future of money looks hardly more peaceful than its past. Bitcoin, a formerly obscure cyber-currency, is now all over the headlines with reports of bankruptcies, thefts and FBI lockdowns. If our fate is to buy and sell in bitcoins, this instability is troubling. But despite the headlines, the triumph of Bitcoin and related cyber-currencies is a lot less likely than recent commentary would suggest. One cause of all this hype? The number of people who understand what Bitcoin is seems almost immeasurably small—and that probably includes some of its users.
Money, it should be conceded, is not a simple topic. Most people understand how gold, which is something of a primal money, is mined, refined and shaped into coins. It is rare, pure, easily divisible and has been cherished over the centuries. Paper money is more complex. From 1900 through 1971 (with the exception of during World War I), the US dollar was backed by gold, meaning its value was legally defined by a certain weight of the metal. That ended in 1971, when Richard Nixon shocked the world by breaking the link to gold and allowing the dollar’s value to be determined by trading in the foreign exchange markets. The dollar is valuable not because it’s as good as gold, but because you can buy goods and services produced in the United States with it—and, crucially, it’s the only form the US government will accept for tax payments. Among the Federal Reserve’s many functions is allowing the issuance of just the right quantity of dollars—enough to keep the wheels of commerce well greased without slipping into a hyperinflationary crisis.
But Bitcoin (capitalized as a concept, lowercased when referring to units of the currency, according to American Banker) is another animal entirely. It is the first and most famous of a large and growing family of so-called “cryptocurrencies.” Others include Litecoin, Feathercoin, Songcoin (“designed for The Music Industry”), Auroracoin (Iceland only) and Dogecoin (“the fun cryptocurrency”)—but Bitcoin is by far the largest. Its origin is traced to a 2008 paper written by the pseudonymous Satoshi Nakamoto. Newsweek recently claimed to have located the real one, but he promptly denied all, so the whole thing remains quite mysterious.
According to its semi-official definition, a crypto-currency is “a peer-to-peer, decentralized, digital currency whose implementation relies on the principles of cryptography to validate the transactions and generation of the currency itself.” (While that is one dense slab of prose, to be fair to the cryptoids, it wouldn’t be easy to define the dollar succinctly either.) What this means is that Bitcoin and the rest are electronic currencies created and transferred by networked computers with no one in charge. The role of cryptography is not merely to guarantee the security of the transaction, but also to generate new units of the currency, which are “mined” by having computers solve complicated mathematical problems. Once solved, new coins are created and their birth—with digital signatures guaranteeing authenticity and uniqueness—announced to the rest of the system. The creator earns the value of the new coins when they enter the system.
Trading is done via exchanges, which communicate with other exchanges, but there is no central authority. Some trading is done online, but you can also buy bitcoins for cash in person.
The mining requires enormous amounts of computing power, though specialized processors have been developed to reduce power consumption, which in turn produce many tons of carbon. Even the most ephemeral coin has material roots.
That’s the technology of bitcoin; but is it money? The classic economist’s definition holds that money is a store of value, a unit of account and a medium of exchange. You go to the store and find that a can of tomatoes is priced at $3—a unit of account, which the store will book as revenue once it’s sold. You take $3 out of your pocket or via your debit card—you draw down the store of value (cash on hand or in the bank) and use it as a medium of exchange. The value of the US dollar is that everyone in the United States, and beyond, recognizes the currency as fulfilling these tests of money. The dollar is valorized by the goods and services that it can buy.
Bitcoin has serious problems in all three respects. From the beginning of 2013 through early February 2014, the price of a bitcoin has varied from $13.40 to $1,203.42—a ratio of 90 to 1. Its average one-day change (ignoring whether it was up or down) was 4.3 percent. In just one day last April, Bitcoin lost 48 percent of its value relative to the US dollar—and that came the day after it lost 33 percent. But by November 2013, Bitcoin had shaken off this case of nerves and risen 1,405 percent off that crash low. By contrast, the ratio of high to low in the Federal Reserve’s broad index of the US dollar’s international value was just 1.07 to 1. Its biggest one-day move was under 2 percent; its average one-day change was 0.3 percent. (The dollar’s biggest daily change was less than half of Bitcoin’s average daily change.) Yes, inflation has steadily eaten away at the dollar’s value, but in relatively steady and predictable ways over the decades. It does not gyrate by almost 50 percent in a day. So much for a store of value.
Almost no one accepts payment in Bitcoin, nor do any businesses of note keep their books in Bitcoin; it fails both as a unit of account and a medium of exchange. And its short history—the first bitcoins were minted in 2009—has been turbulent. The US government seized funds from Mt. Gox, then the largest Bitcoin exchange, in May 2013, and just this past February, Mt. Gox collapsed from an undetermined mix of theft, fraud and mismanagement, leaving hundreds of millions of dollars in losses in its wake. There have been many other reports of thefts, frauds and hackings, which Bitcoin partisans dismiss as mere growing pains. But with no regulator, no deposit insurance and no central bank, this sort of thing is inevitable—it’s just tough luck. Introduce regulators and insurance schemes, though, and Bitcoin will lose all its anarcho-charm.
Keynes once called gold “part of the apparatus of conservatism” for its appeal to rentiers who loved austerity because it preserved the value of their assets. Bitcoin serves a similarly totemic purpose for today’s cyber-libertarians, who love not only the statelessness of it as money, but also its power to subject the institutional banking system to “disruption” (one of the favorite words of that set). And like gold, Bitcoin is deflationary. There’s a limit on how many bitcoins can be produced, and it gets more difficult to produce them over time until that limit is reached. Of course, new cryptocurrencies could arise. But the existence of the limit reflects the deflationary sympathies of the libertarian mind—in a Bitcoin economy, creating money to ease an economic depression would be impossible. Which is not to say that only libertarians love Bitcoin.
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