Bitcoin is back in the news, and with each time in the news, it gets more notoriety. For the most part, this post is going to assume you know a little about it. If you want more info, you can start with this post at Wonkblog. But more or less, Bitcoin is a digital and anonymous currency with a predictable supply. In this post, I am going to analyze its short term situation and long term prospects, because I think they are very different issues.
Short Term. I am pretty convinced, along with almost everyone else, that Bitcoin is suffering from a bubble right now. It's value has been skyrocketing. This would be great if Bitcoin were an investment vehicle. But it is intended to be a currency. As long as its value increases like this, it can't function as a currency because most people are hoarding it knowing that its value is increasing faster than the cost of goods.
If it isn't a bubble and the value keeps rising, it won't be much use as a currency. If the bubble pops, that doesn't doom the currency though. If there is still value in using it as a currency, it's value may not completely go to zero with the bursting of the bubble. In other words, the bubble might pop, the investors will flee, and those that want the currency as a currency will remain. This is probably what the Bitcoin supporters really want.
Long Term. So let's say that happens - the bubble bursts and the value of the Bitcoin comes back to something more reasonable. The question then is whether it is a useful currency. The answer depends on what it would be used for.
Bitcoin has a number of unique features: the supply is predictable; it is cost-free (or friction-less); it is anonymous. Let's look at each one.
First, let's look at its cost free nature. I do think this is important, to some degree and might help it or a successor catch on. Most other ways of using money online costs money. There are banking fees and credit card fees and other transaction fees. There are no fees with Bitcoin. I think a lot of users like this.
Second - Bitcoin is anonymous. This appeals to the crypto-anarchists of the interweb, as well as anyone else looking to break the law for a price. I don't doubt that this is attractive. It is a way to buy drugs, for example. But it is the anarchism aspect that I don't understand. There are rules for society in the real world, and so there should be on the internet. So here, my problem is the philosophy, though I understand that my disagreements won't stop this from being an attractive part of the currency.
Last is the predictable supply. This aspect goes along with the gold-bug leanings (ie people that want the dollar and other currencies on the gold standard) of some on the internet. Generally, I agree with all of modern economics that the gold standard is bad policy for any country's currency. To have the most stable economy, a nation needs a national bank to regulate and change the money supply. And just look at our history - the economy was far more stable and with fewer and less severe recessions since coming off the gold standard. Even Milton Friedman agreed; in fact his thesis was that the Great Depression should be blamed on poor management of the money supply and not a lack of stimulus spending.
Having said that, if Bitcoin is not a national currency, I don't know what harm having a predictable supply will cause - at least to the economy generally. There might be more ups and downs with the value of the currency. There might be times when it is not an effective currency because of hoarding. But as long as that only affects those who choose to use it and not any national economy - ie as long as it isn't widely used enough to crash an economy - I don't really care.
That also means though that the success or failure of Bitcoin doesn't really say much about the success of currencies with limited supplies that are not controlled by a national bank. Or rather, I can see Bitcoin succeeding without it being a positive lesson for the gold standard. But I can also see it failing because of its limited supply. It can also fail for other reasons. If it fails, we'll just have to analyze why.
There is one final issue, which is related to the supply issue, and that is trust. Some people don't trust national banks or private banks. Instead, they trust this software, which is open source. I am not one of those people. I trust our national bank and I trust our private banks (mostly). We have deposit insurance, and I know that our national bank's mission is to ensure a stable economy. I also don't trust the software, mostly because like most people I don't fully understand it. But there are some who are the opposite, who understand the software but don't trust (and maybe don't understand) our banks. In which case, Bitcoin is great for them. But I think they are wrong. So long as both options are available, everyone is happy.
