Wednesday, November 20, 2013

Economy: Why Bitcoin Is A Toy And Not A Currency

(Drivebycuriosity) - There is a lot ado around Bitcoin. This is a "digital currency that functions without the intermediation of any central authority", says Wikipedia (wikipedia): "Through various exchanges, Bitcoins are bought and sold at a variable price against the value of other currency".

This morning the price of Bitcoin crashed to $460 (.businessinsider). Two nights ago it was over $900. Less than a week ago Bitcoins were traded at less than $400 (techcrunch) and in the begining of the year a Bitcoin cost just $13.55 (cnbc).

The wild fluctuations show that Bitcoin is not a currency:

1. Paying with Bitcoin is a game of chance because of the wild fluctuations. Tomorrow`s value of any payment could be much higher or lower than expected. Neither seller or buyer could calculate the transaction.

If a company would mark their prices in Bitcoin they would lose their customers when a sharp Bitcoin rally makes their goods & services too expensive or they would suffer high losses when a Bitcom crash makes them too cheap.

If someone borrows Bitcom he could go bust because his debt could explode when the Bitcoin price jumps, lenders fear the risk of a sudden Bitcoin crash.

The extreme fluctuations would make accounting and business plans senseless.

2. Bitcoin is popular because its supply is limited like paintings from Picasso. According to Wikipedia new Bitcoins are created at an ever-decreasing rate (wikipedia). The total number of Bitcoins is capped at 21 million.

But this restriction also an obstacle on the way to the use as a currency. In the 1940's, Milton Friedman recommended  a fixed money supply, the idea that the money volume should be kept at a certain volume. Later he abandoned this proposal. He realized that a growing economy, say with a rate of 2% annually, needs a growing money supply. The money volume has to grow at least with the same rate as the economy to finance the growth. Otherwise prices - including wages - would have to fall, in this example around 2% annually. Friedman acknowledged that generally falling prices could lead to a severe depression. Therefore the limited supply of Bitcoins would not satisfy economic growth.

Because of these problems it is highly unlikely that many people use Bitcoin as a currency, say for payments, calculating prices of goods & services, and denominating loans. Today there is already a strong competition between alternative currencies like US Dollar, Euro, Chinese Yuan, British Pound (Pound Sterling), Swiss Franc and more. Each of these currencies represents an economy and it is much more reliable for economic calculations & transactions than Bitcoin.

Conclusion: Bitcoin is cool because it is a very geeky Internet gadget. The wild price fluctuations invite gamblers to play with it. But it is not a currency and will never be.

1 comment:

  1. It's going to be a great short opportunity at the perfect time
    I agree, many "bitcoins" have come and gone before, this is not any different