The Problem with Bitcoin


One purpose of writing this piece is a vague hope of being proven wrong by some economist who knows better than me. That would be nice. Because what I have come to think about Bitcoin is not nice. Before writing this piece, I presented my common-sense critique to Bitcoin proponents, and so far nobody has provided answers. Perhaps I asked the wrong people. So make my day—prove me wrong. Here goes.

Bitcoin is not a currency. It is a virtual commodity. You can place money in a commodity, like gold. But gold isn’t money, and neither is Bitcoin. It is not issued by a government. It is not backed by an economy using it as the standard medium of exchange. It is not governed by a central bank that keeps it from going nuts. And, indeed, Bitcoin has gone nuts. Or, rather, it’s gone tulips. That’s a pun, I’ll come back to that.

People trade in commodities that they don’t use, like gold. So why should you not trade in Bitcoin? After all, we know for sure, based on some solid (we think) cryptology, that the supply of available Bitcoins is predictably exact. With gold, someone can find a new mine, flooding the market and lowering the price. Not with Bitcoin. With gold, you need a third party to carry out a secure transaction. Not with Bitcoin.

So Bitcoin is better, right? Wrong! Bitcoin might be a robust technology. But the Bitcoin market is crazy. Either that, or I am.

You see, gold is like an air raid shelter. If investors lose trust in cash as an investment, they can’t shift to bonds or shares, because they too depend on cash. At that point it’s a good idea to invest in a commodity—something that is less volatile than cash. Like gold. Investing in gold means protecting yourself against a loss of trust in the dollar. So after the financial crash of 2008, the dollar price of gold went up. Now trust in the dollar is coming back. Gold has dropped in price against the dollar by 25 percent since 2012.

But Bitcoin investors seem to be living on a different planet. While gold has gone down since 2012, Bitcoin has soared from $5 to $1,000 (it had dropped back to $879 at the time of publication). If this is about distrusting cash, if Bitcoin-buyers are securing themselves against a currency crash, if $1,000 will have the buying power of less than $5 before long, well, that currency crash will be such a horrible crisis that owning Bitcoins won’t be much help. Better, then, to dig a hole in the ground and fill it with canned beans, warm clothes, and shotguns. Some people do that, too. They might just be the levelheaded ones in this comparison.

Is there anything other than a weakening dollar that can bolster Bitcoin? Well, yes. If there were a strong economy backing up the Bitcoin, exchanging products and services in Bitcoin and outcompeting products and services from other economies, including the US economy, then Bitcoin would do well. If the Bitcoin economy GDP goes up, so will the exchange rate for the Bitcoin. I’ve never heard of any Bitcoin economy like that, but let’s talk about it anyway.

Let’s say a new coffee chain opened in 2012, StarBits. They proudly belong to the economic zone of Bitcoinia, meaning they do all their financials in Bitcoin, write contracts in Bitcoin, pay wages in Bitcoin, sell their products in Bitcoin and so on. Now, they sell totally mind-blowing cafe lattes, and they sell them for only 0.20 Bitcoin each. I went there a year ago and bought a divine latte. It cost me only $1 (I paid seamlessly with my smartphone Bitcoin exchange app.) Well, today, with the appreciation of Bitcoin, that latte will cost me almost $200. Will I buy the world’s best latte for $200 a pop? Do I have a hole in my head? StarBits would have been out of business by now! No customers!

This is one reason to why real currencies, like the dollar, have central banks. The central bank keeps the currency in check so that people can rely on it for doing business, pricing their products, paying … Next Page »

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David Nordfors is the CEO and Co-founder of IIIJ. Follow @dnordfors

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