Bitcoins

I guess I'm reacting to our friends at /. obsessing over Bitcoins again, but I'm finding it hard to take the idea seriously. At the same time, readers should be aware that I'm not exactly a great predictor of stuff:

- I thought the iPhone wouldn't happen, and when it did I couldn't see how a $600 locked down EDGE-only device could possibly be successful.
- I still don't understand why people want iPads.
- I thought, early on, that Windows 8 would be a hit, although I did couch that a little by saying that I assumed the UI would be worked on and made more desktop friendly before launch.

And then there was my backing HD DVD over Blu-ray. True, I never predicted it would actually succeed, and my subsequent prediction that Blu-ray would be a flop anyway despite the failure of HD DVD turned out to be mostly true. But in all honesty, the only technology I think I successfully predicted would be an outright success in the last decade or so was the original Wii console.

So the fact I'm thinking "Bitcoins? Load of crap" shouldn't mean a whole lot to you. But I can at least write down my reasons here, and then revisit them in five years when the Fed announces that the dollar will be backed by Bitcoins to help with "consumer confidence" or something or other...

So, anyway, here's what I think.

I think Bitcoins are fundamentally a result of the massive confusion and distrust of basic economics that the techie community has, which in turn is why they'll probably fail in the long term.

Here are my major reasons.

First and foremost, Bitcoins are based upon the concept that a "legitimate" currency must be based upon something tangible and rare, and that "fiat" currencies like the dollar are problematic because they're not.

I completely disagree. Fundamentally, currencies like "gold coins" did well at one point in time because people were willing to accept them in exchange for goods, services, or other debts, and no other reason. The fact they were made of gold, a rare and usefulish metal, did little but kickstart the process of making the currency a medium of exchange.

With fiat currencies, the currency is, by definition, something an entity is willing to accept in exchange for goods, services, or other debts. That is, the government is saying "Even if nobody else does, we'll accept it."

From that point of view, a fiat currency is more valuable than a currency based upon tangible goods, because you're aware that there is always a customer, who always will accept the currency at the stated price. True, you can distrust that customer, believe they'll mismanage the currency or whatever, but the degree to which this matters determines how long you'll hold on to the currency rather than whether you'll take it to begin with.

Second, there's the belief Bitcoins are based upon something tangible, like gold.

They're not. Bitcoins cost precious resources to make, but they don't represent those resources once made. If I own a Bitcoin, I don't have access, in any form, to the amount of energy needed to make one. I can't heat my home from a collection of unused Bitcoins. So even if you take the position that "gold coins" beats "dollars" any day of the week, you miss the point of why those gold coins were valuable to begin with.

What are Bitcoins? At best, information, but the information can be shared freely once extracted, so they're not even that.

Thirdly, there's the belief that their uncontrolled rarity makes them useful as a universal currency

If there's one thing the last 100 years of economics has taught us, it's that currencies must grow with the economies they support. A lack of money in circulation leads to stagnation or even to economic depressions. Bitcoins contain no inbuilt mechanism to rapidly expand the amount of cash in circulation if such a need arises. At best, Bitcoins' proponents claim that existing non-BC systems like Fractional Reserve Banking could be used, but FRB is distrusted by people who support Bitcoins because it's exactly the kind of "Wealth being represented by money in a way they don't understand" they're trying to get away from, it's not clear such a system is even viable in Bitcoin world.

Economies that attempt to restrict the amount of cash in circulation end up suffering extreme "Business cycles", booms and busts caused by massive expenditures followed by the amount of cash being available being significantly lower than that needed to represent the new, expanded, economy. I don't know about you, but I don't actually want to live in that kind of world.

My thoughts

Ultimately I think the assumptions behind Bitcoins are wrong. I don't think the promoters understand actual economics, and I don't think Bitcoins even fit the economy they think they're implementing. They've gone all-in for rarity, without recognizing the need for value according to their own models.

Will Bitcoins succeed anyway? Well, maybe. But never as a replacement for actual currency, more as a convoluted and absurd way to pay for things, while simultaneously acting as a conduit for paranoid investments, and possibly even some forms of money laundering.

What will kill it as a way for any substantial legitimate group to consider using it as their primary currency is that the lack of real value in Bitcoins means that the currency will continue to oscillate in value between massive extremes and do so too rapidly to be worth considering as a transactional currency. Ironically, for a currency promoted by people who are obsessed with the dollar being subject to hyperinflation or hyperdeflation at any moment, they've managed to build a currency that's had more bouts of both in the last decade than other major Western currencies have had, all put together, in the last Century.