Having casually watched the Bitcoin buzz over the last several months with some fascination, I have to say that I am in the camp of the highly skeptical as to what if any public good is being served by unregulated virtual currency. But don’t interpret my skepticism as disapproval per se. I continue to be interested in the Bitcoin experiment relative to what it can potentially teach us about enhancing the efficiency of conventional currency systems.
First things first. What is currency?
My working definition refers to currency as a stable, secure, and fungible medium of exchange. The Economist notes that currencies need not be physical objects, but are stores of value subject to trading between nations in foreign exchange markets, which determine the relative values of the different currencies (The Economist, Guide to Financial Markets). By this definition, currency constitutes a symbolic vehicle by which value can be traded in the furtherance of some economic transaction – a vehicle that has evolved over three millennia to its present form.
At the dawn of human civilization, currency consisted of notes and other artifacts that implied ownership of some underlying good. Thus currency attested to some property holding and allowed this holding to be traded without the logistical burden of physically transferring the property between parties. Some time later, civilization gave rise to the innovation of coinage – devices representing a standard mediating value – which enabled economic transactions to be greatly simplified and contributed to the explosion of commerce. Then came paper, which introduced new efficiencies of scale, opened up opportunities for loans of gold and silver at interest, and ultimately led to the creation of modern financial markets.
Which brings us to today. The interesting question raised by Bitcoin and other forms of digital currency is whether moving money around electronically should be treated any differently from handling paper money. Peer-to-peer paper money transactions are free, secured by means of robust anti-counterfeiting features, and guaranteed by the full faith and credit of national economies. Should digital transactions be any different?
The economic rationale for moving from paper to digital currency is to lower the “friction” of currency-based transactions. To the extent that this is a compelling rationale, I for one am prepared to take for granted the digital-future of currency. But this still begs the question as to whether Bitcoin and other extra-governmental digital currencies have a role to play in this reimagined future. As a hip new alternative to PayPal, I can see some room in the marketplace for Bitcoin, but as an alternative to conventional currency systems, I am less than sanguine.
Bitcoin does have at least one very real advantage particularly with respect to online commerce, namely, lower consumer transaction costs. Then there’s its intrinsic appeal to the libertarian-minded, owing to the anonymous (opaque might actually be a better word) and unregulated nature of Bitcoin transactions.
But these benefits are tempered by spectrum of issues that undermine the efficacy of the Bitcoin platform as a credible alternative to conventional currency systems. The unregulated nature of Bitcoin, seen as an advantage by some, is fertile ground for the creation of a speculative market where superusers can capitalize on wild swings in the value of the currency often to the detriment of the uninitiated. It has neither intrinsic value nor the backing of the full faith and credit of a stable national economy. It’s dubiously secure, subject to a convoluted set of rules that could be gamed by criminals and superusers. From a practical standpoint, there’s a limited market for Bitcoin among purveyors of goods and survives due to the potential for dramatic shifts in value. And lastly, let’s not forget that we still live in a world where hard currency has a role to play, which makes Bitcoin at best a partial solution. In total, all of these factors make Bitcoin a highly inefficient alternative to legacy currency systems and digital payment options.
As an honest to God currency, Bitcoin leaves a lot on the table. I would go so far as to argue that it’s not really a currency at all – at least not in any conventional sense of the word. But does it lower the friction of economic transactions in some material way?
Maybe. And this is where the Bitcoin idea shows potential to positively influence standing currency systems.
Fifty years ago, economic transactions were predicated on physical media (e.g. paper, coinage, etc.). Today, the dominant mode of commerce and exchange is electronic. But this evolution has done little to influence our currency systems, which are still reliably tactile. The void has been filled by a range of electronic money transfer and payment “services” that facilitate the flows of currency required to underwrite the modern digital economy.
To the extent that currency is the medium of financial interaction and financial interaction is increasingly (if not predominantly) digital, it’s worth taking a step back and considering whether national currency systems should take out the middlemen and embody electronic forms of conveyance.