Bitcoin Is a Junk Currency, But It Lays the Foundation For Better Money
May 9, 2013
(This item originally appeared at Forbes.com on May 9, 2013.)
People sure love to talk about Bitcoin. But, among all the hubbub, I find little to no understanding of what a currency should be. What purpose does it serve? What are the principles of its creation and management?
This why I say that Bitcoin reflects “sub-kindergarten-level monetary understanding.”
Advocates might point to the fact that the market value of a bitcoin has risen quite a lot in recent months. It seems to be popular.
I say that the fact that it has risen so much is itself the problem with Bitcoin.
Let’s say I wanted to hire you for a job, and pay you in bitcoins. We decide on a price, for example ten bitcoins per hour, or 100 bitcoins when the job is completed.
What happens when the value of a bitcoin rises by ten times? Obviously, your employer either goes out of business due to exploding employee costs, or you have to renegotiate the contract.
How about if I buy a house, and get a mortgage denominated in bitcoins? If the value of a bitcoin goes up 10x, then the mortgage becomes unpayable and I default. This doesn’t make the banker particularly happy either, because now he has a foreclosure to deal with.
What if the value of a bitcoin drops by a factor of ten? My mortgage is now very easy to pay, but the lender is repaid in a currency whose value is only a tenth of what he originally loaned. You might think that screwing the banker is no big deal, but the banker is really just an intermediary — all debt-based “savings” denominated in bitcoins would fall in value by 10x.
You can’t borrow or lend in bitcoins. That’s why countries with poor-quality currencies typically have virtually no financial system. What borrowing and lending that does occur is typically done with dollars or euros.
What if I want to sell a car, and name a price in bitcoins? If the value of a bitcoin goes up by 3x, then nobody wants to buy the car. The car manufacturer goes out of business. If it goes down 3x, then I sell the car but get very little in return. The car manufacturer might go out of business again, as the selling price does not pay for the cost of manufacturing the car.
I suppose some people would argue that you could effectively set the price in U.S. dollars, and then just use bitcoin for transactions at whatever the market rate is at that time. This strategy is actually quite common. In Turkey, for example, it is common to set a price in euros, and then actually make transactions in Turkish lira at that market price. This is done because the lira has a terrible history of instability. It is something that appears wherever people have to deal with unstable junk currencies — like bitcoin.
In this case, you would just be using bitcoin as a payment device, while actually doing business on a dollar basis.
For thousands of years, people have always sought out stability in currency value. The world is full of junk currencies. What makes them a “junk currency”? Their value is unreliable.
People still seek stability today, but there is a bit of a twist. The U.S. dollar is not particularly reliable, compared to gold, which has a centuries-long history of maintaining stable monetary value. Changes in the dollar/gold ratio are mostly due to changes in the floating fiat dollar’s value, while gold is largely stable in value.
However, if a country or a person uses a gold-based currency today, the exchange rate between that gold-based currency and the U.S. dollar then becomes very unstable. This has great implications for trade and business, which is why most countries — such as China — have opted to focus on foreign exchange stability, while at the same time complaining that the Federal Reserve is making the dollar much too unstable.
Thus, there is a conflict today between “absolute stability,” expressed by gold, and stability of exchange with the rest of the dollar-based world, which you could call “relative stability.” However, in either case, the goal is some form of stability of value.
It was all a lot easier before 1971, when the U.S. dollar (and the British pound before 1913) was itself based on gold. There was no conflict between “absolute” and “relative” stability.
Today, you could peg the bitcoin to the dollar. Of course, this is rather pointless, as we could just use dollars instead.
Or, you could peg the bitcoin to gold. That would be rather more interesting, as it would provide a genuine high-quality alternative to the U.S. dollar.
Bitcoin — despite some of its innovative and effective computer science attributes — is fundamentally flawed. It has no mechanism to maintain any form of stability, but is simply whipped around by speculative fervor. This is amusing to gamblers perhaps, but you might as well just play roulette.