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Bitcoin: Fad, New Monetary Order, or Something in Between?

Bitcoin has been in the news a lot lately, sometimes for its wild multi-thousand dollar price swings and sometimes because someone holding an important position with a government or major corporation has spoken out about it. Why is it such a controversial topic?

First, a quick primer on what it is: Bitcoin is a currency-like asset based on cryptology and a technology known as a “blockchain.” Bitcoin was invented by an unknown person or group of people under the name Satoshi Nakamoto in 2009. Since then, many other assets based on the same technology have been created, with various different features and names. As a group, Bitcoin and its “descendants” (such as Litecoin, Ethereum, and Monero) are often referred to as “crypto assets.” For ease of understanding, I’m only going to explain crypto assets whose primary goal is to act as a store of value—cryptocurrencies.

A “blockchain” is a ledger that tracks all transactions that have ever taken place with Bitcoin (or Litecoin, etc.), and therefore, which Bitcoin address currently controls (owns) them. Only the individual with the right cryptographic “key” can access the Bitcoins stored at an address and send them to a new address. These keys are usually stored in a “wallet file” on one or more computers, which should be carefully secured against hackers.

New Bitcoin is created by “miners,” who perform the computational work needed to add the latest Bitcoin transactions to the blockchain. Every time a new block of transactions is added to the end of the chain, the miners who added that block are rewarded with Bitcoins. Like gold miners, Bitcoin miners need specialized hardware to operate their “mines,” and these computers are usually set up in countries where electricity is inexpensive, such as Iceland. Chinese companies hold the majority of the world’s Bitcoin mining power.

You don’t need to know much else about how it works, because really, the why is more important.

Until recently, gold had no industrial use, but was durable, fungible, and divisible, and most importantly, scarce. What if you had something just as fungible, divisible, and scarce, but it were intangible and could be sent around the world instantly and safely?

According to the Austrian school of economic thought, value is subjective, so Bitcoin can have multiple sources of value. Think of just some of the reasons people might find Bitcoin valuable:

  1. It’s becoming recognized and accepted/used by more businesses as an acceptable form of payment around the world.
  2. It’s like digital cash—a way of sending wealth quickly around the world without banks or middlemen, meaning smaller fees and shorter waits.
  3. It’s decentralized, relying on miner consensus, so no one government can shut it down because miners live all over the world—the most that a government can ban is its use inside their borders. To get an idea of how difficult that would be, look at how long governments have been trying to stop peer-to-peer file sharing.
  4. The supply curve for Bitcoin is mathematically modeled after gold, so increasing amounts of computational “effort” will be necessary for decreasing amounts of Bitcoin reward. Changing this feature would require the majority of Bitcoin miners in the world to agree, a requirement that makes Bitcoin much less likely to be devalued than any fiat currency. The supply curve is also public knowledge, making it easier and more certain to predict exactly how much inflation there will be (unlike with fiat currencies or even gold).
  5. If only a small fraction of the world’s population currently owns Bitcoin, and more people want to own it, then demand will outstrip supply and its price will rise, attracting more users over time.

On the other hand, because it’s not tied to any physical store of value, its price has no “anchors,” no clear value but what people give it. Whereas early adopters trade for long-term, rational, or philosophical reasons, mainstream investors typically trade for short-term, emotional, or monetary reasons—so mania is increasingly normal. Rising prices prompt buyers and more rising prices; falling prices prompt sellers and more falling prices. Bitcoin’s price has been extremely volatile since its beginning, swinging by tens, then hundreds, and now thousands of dollars in just a matter of hours. Institutions are talking about ways of trying to stabilize it so that more money can enter the Bitcoin markets, but whether that will work is anyone’s guess.  Another potentially stabilizing factor is that Bitcoin is the first currency to be tied to the economy of every country that uses it, so it is potentially the first truly global currency.

But, let’s look past Bitcoin, because it isn’t the only cryptocurrency out there. Each one has different features, like shorter transaction wait times, more anonymity, or a mining process that doesn’t require specialized computers. Indeed, even Bitcoin itself comes in two versions, “Bitcoin” and “Bitcoin Cash.” A disagreement over how to scale Bitcoin up for mass use led to two competing versions of Bitcoin, both worth multiple thousands of dollars (in other words, no clear winner yet).

This means that Bitcoin may be part of a far larger change that looms on the horizon: We may be looking at different, competing ways of exchanging wealth.  We may be seeing global currencies created by private individuals, rather than government fiat.  This is competition at work.

So, where will it all end? It’s hard to say, standing at the beginning as we are, but one thing is for certain: if money itself stops being one-size-fits-all and starts being tailored with different features to fit different specialized purposes, fiat currencies and their inflationary tendencies may soon be obsolete. Is it any surprise that Bitcoin is such a controversial topic?

Roland F. Sennholz

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