Sunday, July 13, 2014

Thoughts on bitcoin

Cutting edge blogger that I am, I'd like to share some thoughts I've been having on the hot new thing that everyone was talking about last December when the price peaked and then crashed: bitcoin.  There have been a lot of people talking about bitcoin taking over from regular currencies or simply failing horribly.  I do think that failure is a possibility, but it seems to me that if bitcoin or some other crypto-currency does end up succeeding it will be beside conventional state-backed currencies instead of replacing them.

Money is something we all use, and for several different purposes.  You can break out money's main functions as being a medium of exchange, being a unit of account, and being a store of value.  A medium of exchange is something that passes value from person to person, whatever you use to pay someone for something or settle a debt.  A unit of account is what we use to measure prices.  You can imagine a world where everyone expressed prices in dollars but people only carried quarters around.  The store sign says that the book is $2, so you hand the clerk 8 quarters to buy it.  In this case the dollar is the medium of account but the quarter is the medium of exchange.  I think a "store of value" is pretty self explanatory, so I'll just point out that while we mostly only use currency as a unit of account, and only use currency or currency-like thing such as credit cards as mediums of exchange we tend to use a lot of different things as stores of value.

So how does bitcoin shake up in all of this?  Well, it does pretty well as a medium of exchange as far as I can tell.  Digital like a credit card number, but anonymous, unrevocable, and decentralized like cash.  In terms of it's use as a store of value, well, it's generally made money for people who've invested in it but there's an awful lot of risk there.  And as a unit of account it's absolutely horrible.

Bitcoin is designed to be deflationary, and deflation is bad stuff.  People are notoriously loss averse, and sellers become reluctant when the goods that they could sell for BTC 6 yesterday are only moving at BTC 5 today.  And people especially don't like to see their paychecks shrink.

So if bitcoin is ever successful, I expect it to be used as a means of facilitating transactions denominated in currencies without these problems.  People will have a wallet with only as many bitcoins as they need at the moment and use them in transactions denominated in dollars or better yet Australian dollars.

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