[Note: This is the third entry in a three part series. You can read the introductory post here and part two here.]
The Disadvantages of Bitcoin
For people who are not obsessed with anonymity and are not waiting for the U.S. to return to the gold standard, the reasons for avoiding entering the Bitcoin market are numerous:
1. Convertibility – Whereas other currencies are convertible into other financial instruments (dollars to checks to certificates of deposit, etc.) and through numerous third-party services (e.g., Visa, PayPal, Citibank), commodity currencies like Bitcoin can only be exchanged for fiat currencies—and then only through an online exchange. Indeed, unless your computer is working overtime on Bitcoin mining, the only way to acquire the currency is to buy it from one of the 30 online exchanges.
These exchanges are completely unregulated and are subject to problems that do not affect other financial markets. For instance, in 2011 the largest Bitcoin exchange, MTGox, had a security breach that resulted in the theft of nearly $9 million worth of Bitcoins. The theft caused the value of Bitcoins to crash from $17.50 to one cent before the market was able to recover.
2. Instability – The MTGox breach—and the subsequent market crash—taught Bitcoin owners a harsh lesson about commodity currencies: they can be wildly unstable. Over the 8 month span from October 1 2010 to June 9 2011, the market value of Bitcoins skyrocketed 9667-fold from a value of $0.06 to $29.
The rate had dropped in 2012 and at the end of last year a Bitcoin was worth only $13.51. Last week, though, Bitcoins were trading as high as $266 before plummeting to less than $100. Anyone who had bought $1,000 worth of currency in October 2010 would theoretically have $4.4 million worth of Bitcoins. However, the convertibility problem would make it nearly impossible to extract that money without crashing the market and devaluing the entire currency. A gradual sell-off over an extended period of time would be necessary to take advantage of increase in valuation.
Still, being the seller of the overvalued currency is preferable to being the buyer. The Winklevoss twins, millionaires famous for their legal battle with Facebook, claim to own around one percent of all Bitcoins currently in existence (around 108,000). They began buying the currency in 2012, making some early Bitcoin holders very rich.
Indeed, the only way to ensure that you make a profit (or at least not lose money) is to have bought Bitcoins in 2009: Three million Bitcoins—13 percent of the total number of Bitcoins that will ever be created—were minted that year. Few people, mainly readers of cryptography mailing lists, were even aware of Bitcoins then and so were able to acquire a disproportionate share of the currency. Somewhere on the planet, economically savvy hackers (including, perhaps, Satoshi Nakamoto) are making a fortune by slowly selling off their digital currency.
3. Limited protection against fraud – Satoshi Nakamoto made it a point to make Bitcoins transactions non-reversible. But this is one of the primary features that encourage people to trust ecommerce systems. If you know that your money is lost and can’t be returned if you are scammed, you are less likely to trust buyers online. This has the effect of dampening trust in all merchants, not just the fraudulent ones, and reducing the desire to exchange money in a virtual setting.
4. Limited sources for goods and services – Once you acquire Bitcoins, what can you spend them on? Mostly online services, such as software, tech support, and webhosting—services that can easily be paid for using current ecommerce systems like PayPal. Few offline merchants currently accept the virtual currency. Although it may change in the future, the lack of places to buy goods and services limits the usefulness of the currency as a medium of exchange.
5. Waste of capital and resources in creating the currency — As Jordan Ballor recently asked,
[W]hat does a Bitcoin block represent in terms of actual human utility? I worry too that this is a system that relies parasitically on real-world resources, e.g. coal which provides a large part of the electricity, which is used to run computers so that they can then in turn “mine” something entirely virtual.
This is similar to Adam Smith’s concern about the fundamental foolishness of relying on gold and silver currency:
The gold and silver money which circulates in any country, and by means of which, the produce of its land and labour is annually circulated and distributed to the proper consumers, is, in the same manner as the ready money of the dealer, all dead stock. It is a very valuable part of the capital of the country, which produces nothing to the country. The judicious operations of banking, by substituting paper in the room of a great part of this gold and silver, enable the country to convert a great part of this dead stock into active and productive stock; into stock which produces something to the country. The gold and silver money which circulates in any country may very properly be compared to a highway, which, while it circulates and carries to market all the grass and corn of the country, produces itself not a single pile of either. The judicious operations of banking, by providing, if I may be allowed so violent a metaphor, a sort of waggon-way through the air, enable the country to convert, as it were, a great part of its highways into good pastures, and corn fields, and thereby to increase, very considerably, the annual produce of its land and labour.
6. Bitcoin is a prone to deflation and speculative bubbles — Deflation, a decline in the general price level, occurs when the price of goods and services decline relative to a specific measure. The value of the goods and services themselves do not have to decline for deflation to occur; all that is required is for the value of the currency itself to increase. This is exactly what has occurred for the entire existence of Bitcoin.
Imagine if you used Bitcoin to buy a cup of coffee for 99 cents in October 2011. Had you held onto those 16.5 Bitcoins, you could have used them last week to buy 4,389 cups of coffee. Such ridiculous deflationary effects are the reason sensible Bitcoin holders (at least those that bought them when the exchange rate was low) are hoarding them, rather than spending them at their local tech-savvy coffee shop. Bitcoin is currently a speculative bubble, with people holding on to their e-wallets waiting for the “greater fools” to bid up the price of the currency. When there are no more fools left, they bubble will pop—and thousands of people will have lost real money.
This is probably the primary reason Christians should avoid acquiring and holding the currency: At best they are gambling with God’s money; at worse, they are hoping to sell an object with no intrinsic value to someone more greedy or gullible in the hopes of getting out before the bubble pops.
The Future of Bitcoin
Assuming it survives once the speculation bubble pops, the future of this digital currency can take one of two paths: Bitcoin will either fail to become a legitimate currency—and thus fail to live up to the vision of its users—or it will succeed in becoming a legitimate currency—and thus fail to live up to the vision of its users. Both failure and success would change the nature of the online social experiment in ways that would disappoint its most ardent supporters.
To fail, Bitcoin merely has to prove its critics right—to show that it is, at best, an unworkable monetary system or, at worst, a complete sham set up to sucker late adopters. If it succeeds, though, it will have to become a currency that can be trusted by more mainstream consumers. That will require adding such features as regulatory oversight and a centralized monetary authority—the very features of other currencies that Bitcoin was created to avoid.
But supporters of Bitcoin who are building their business models around the currency are more welcoming of such changes. “Having a legal status for Bitcoin and a regulatory framework would mean that merchant sites, including exchanges, would be accountable and liable,” said Amir Taaki, co-founder of the London-based Bitcoin Consultancy and operator of an emerging Bitcoin exchange, Britcoin.co.uk. Such professionalization might also lead to what Bitcoin’s libertarian users most despise—a central bank. As the libertarian scholar and tech writer Timothy B. Lee explains:
Bitcoin supporters are quick to point out that their system wouldn’t require ordinary consumers to run their own Bitcoin nodes. They predict that as the network grew and the resources required to run a node increased, that nodes would increasingly be run by commercialized entities who made money by providing “eWallet” services to ordinary Bitcoin users.
We might call organizations that are in the business of running Bitcoin nodes and processing Bitcoin transactions “banks.” And we could imagine these banks forming a membership organization whose primary function is to control the size of the Bitcoin money supply. It would announce changes to the Bitcoin protocol that expand the supply of Bitcoins at the desired rate. Member banks would agree to change their software accordingly. We could call this entity a “central bank.”
So one of Bitcoin’s key selling points—a permanently fixed supply—is basically illusory.
In the end, the currency faces a catch-22: For Bitcoin to succeed it has to adopt mainstream monetary policies—which would negate the very reason for Bitcoin’s existence.
Conclusion: Why Does Bitcoin Matter?
If the experiment is unlikely to succeed, then why should anyone bother paying attention to Bitcoin? The reason can be found in another, more successful, completely pernicious, online venture: porn.
“The Internet was completely funded by porn,” said Greg Fitzsimmons at the twenty-third annual adult entertainment industry awards. He was only half-joking. The pornography industry drove or boosted many of the web’s most useful innovations—live chat, streaming video, online payment systems—as well as the popularity of fast connections. As Christians we should recognize that the moral and social destruction of online pornography has been incalculable. But it is hard to deny that the genre has been a driver of innovation in many areas of information technology.
Similarly, the types of people that are interested in the Bitcoin experiment—highly motivated, tech-savvy—are likely to spark new cutting edge methods, technologies, or policies that will change ecommerce, security, and online privacy. For example, I recently noted a story about how the African diaspora—nearly 140 million Africans live abroad—has become such a major source of foreign income that it now outstrips foreign aid sent by Western donors. Unfortunately, about $7 billion a year never makes it into the relatives’ accounts because of high bank fees. Bitcoin may pave the way for future transfer methods that circumvent the current system of exorbitant transaction costs, allowing more money to be transferred directly to needy family members.
As a currency, the story of Bitcoin is likely to become nothing more than a footnote in obscure economic journals, but its legacy on information technology and peer-to-peer based trust systems may be as significant. The question we Christians must ask is whether we should encourage the growth of a system in which thousands of people will eventually lose real, significant wealth in the hope that it might lead to such innovations that last as long as the stones of Yap.
[Note: Since a couple of readers have asked for the full-version of this series, I’ve formatted it into PDF with endnotes.]