BITCOIN: Will it be the money of the future?
Bitcoins are interesting as a social phenomenon as well as an economic one, but we are not likely to know exactly what changes, if any, this innovation will play in people's lives until much more time has passed. The idea of a new, private, electronic currency fascinates many, especially the technologically savvy and libertarians who distrust government involvement in the market. There is considerable overlap between those two groups. But the very limitations that its designers put on producing more Bitcoins means that this particular new currency long will remain a curiosity for the average person. Bitcoins are touted as a new form of "money." So to understand them it is good to review the basic economics of money. There is no commonly used exact definition of money, but all economics students learn that money has three functions: It is a "store of value," a "medium of exchange" and a "standard of value." It serves as a durable asset to preserve buying power from one time period to another, as a way to buy things or make other payments and as a common denominator of the value of things. "Money" is anything that is generally accepted or used to carry out these functions. Historically, money came in the form of standardized units of some scarce metal. Today it commonly is paper bills and base metal coins, or deposits held within regulated financial institutions. But it can also be in electronic form, held on primitive devices like stored-value cards or more sophisticated ones like Bitcoins. Regardless of its form, certain conditions must hold for money to have value and fill the functions above. The most important is scarcity. If the quantity of money produced is not limited relative to the size of the economy in which it is used, the money will lose value. The next most important factor is general acceptability. Large numbers of people must use the money in making payments or as a store of value. There must be a broad consensus that the money has value for it to serve in exchange and so that it will remain valuable. Bitcoin's strongest claim is that its scarcity is supposedly inherent in the mathematical algorithm designed to create it. There is no Bitcoin central bank that has the discretion to engage in quantitative easing that would rapidly reduce its scarcity and hence its value. The new money similarly is supposedly counterfeit-proof through the monitoring of Bitcoin transaction ledgers by "miners," the tech-savvy people who bring the currency into circulation. If true, that licks a historic problem with paper and coins. Bitcoin began with the promise of ensuring anonymous electronic transactions, something credit cards and banks can't guarantee, and took off precisely because of public fears that actions by the Fed and other central banks would reduce the buying power of the U.S. dollar and other major currencies. Buy the new inflation-proof Bitcoin, the reasoning went, and you are protected regardless of what anyone else does. As a way to avoid the dollar, Bitcoins are safer and easier for transactions than using physical commodities or even gold as a hedge against commodities. Even if only a fraction of merchants accept them in payment for goods, small quantities can be exchanged for dollars for immediate expenditures, while the bulk of one's wealth remains in inflation-proof Bitcoins. At least that is the theory.
That remains an article of faith for Bitcoin devotees. But others, including me, are skeptical. The guaranteed scarcity and proof against counterfeiting depend on what is now foolproof encryption technology remaining uncrackable forever. But the cat-and-mouse history of codes and ciphers teaches us that what is considered unbreakable at one point in time may not be so a few years later. The ability to make a lot of money by finding some way to "mine" Bitcoins faster and easier than its designers intended is a powerful incentive to innovation in both...
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