I continue to be asked about the role of Bitcoin and other crypto-currencies in the economy. It remains an interesting question, primarily because it offers such a good opportunity to explain what money is and is not.
Faithful readers will recall I wrote on this issue in the summer of 2013. I was uncomplimentary of Bitcoin, noting that its primary use was in facilitating illegal transactions over the internet. I called it a ‘schadenfreude-generating machine fueled by libertarian tears and child pornography.’ Judging from the flood of hate mail I received, that struck a nerve.
Fast forward four years, and Bitcoin remains an intriguing presence on the fringe of commerce. The first Bitcoin billionaires were recently announced — the Winklevoss twins of Facebook infamy, putting an ironic twist on their story. Over the past four years, Bitcoin has grown out $41 billion in total value. To put that into context, it is 0.0000000049 percent of all the world’s money.
Three criteria determine whether something can rightfully be considered money. It must store value, serve as a medium of exchange and serve as a measure of value. Bitcoin is surely a measure of value, and its exchange rate in other currencies is easily known. Notably, it is most often compared to the U.S. dollar.
As a medium of exchange, Bitcoin is quite limited. Given its early history as an enabler of criminal exchange, almost no government support anywhere outside of North Korea exists for its use. If you wish to buy something outside the Bitcoin network, you have to exchange it into local currency. This is true of any exchange, but Bitcoin exchanges are harder to access. This would seem to relegate Bitcoin to a special purpose currency — but there are challenges to Bitcoin even as a store of value.
Bitcoin recently had a data loss that caused the loss of about 10 percent of all its currency. Now, most money exists only on computers, which is a huge improvement over the ledgers of fractional reserve banking. Risk to computing platforms isn’t really the problem. The challenge to Bitcoin is that there is no government guaranteeing against this loss or insuring deposits. This challenges Bitcoin as a store of value. A scary example might help.
Suppose something as farfetched as a nuclear electro-magnetic pulse damaged or destroyed the nation’s power grid and most of our computers. This terrible event would be most destructive, and it would leave our banking system in tatters. However, most of the financial system could be restored, because the presence of a federal government can insure the existence of the currency.
Bitcoin would evaporate without hope of restorative action. There is simply no reason for government to take interest in its preservation, outside maybe North Korea, which now sees it as an embargo-proof financial instrument.
Given that folks who organize and operate the world’s money and fiscal environment are not infallible, an external monetary source is attractive. Bitcoin offers freedom from government interference, inflation and meddling. But what is its greatest attractiveness is also its greatest danger. Safeguarding money supply has been an interest of governments for as long as kings minted coinage with their likenesses on it. That won’t likely change, and as long as Bitcoin offers few benefits outside those who transact in it, its use as a store of value is highly suspect. And that will keep it a marginal player in the world’s economy.
Michael Hicks is the director of the Center for Business and Economic Research and an associate professor of economics in the Miller College of Business at Ball State University. Send comments to [email protected].
