This post is from staff writer Richard Barrington.
I almost sprained my neck last week from shaking my head while reading stories about wild fluctuations in the value of the Bitcoin, an electronic currency.
Bitcoins began 2013 with an exchange value of less than $20. Their value started to climb, and that climb accelerated until they reached a peak of $266 on April 10. Then the bottom fell out, and within two days the Bitcoin exchange rate was down to $61.11. I’ve seen my fair share of crazy investor behavior over the past 30 years, but this was really one for the record books.
Of course, plenty of investments have gone through boom-and-bust cycles in recent years, so what was it about this story that particularly drew my curmudgeonly ire? Let’s examine a few details of the story:
- One analyst explained that the Bitcoin might yet rally in the future because “(e)ven assets that have no underlying value have people willing to trade in it.” Too true, but hardly reassuring.
- An exchange which handles Bitcoin trading attributed the precipitous decline in price to a rush of new customers trying to buy into the currency. If that’s true, it’s got to be the first time in financial history that surging demand has caused prices to plummet.
- Bitcoin was developed by an anonymous hacker. Is that really good enough to earn people’s trust? A person who participates in illegal computer activities and won’t be identified wants your money. Any takers? Well, apparently yes.
The Bitcoin has an appeal to both liberals and conservatives who don’t like Big Brother monitoring their money, or using their currency (via monetary policy) for political purposes. On a more sinister level, this online exchange system also appeals to people pursuing illegal objectives such as tax evasion or money laundering.
Bitcoins strive to be free from monetary policy manipulations by limiting the amount of the currency in existence. Unfortunately, any number of decisions about managing distribution of the Bitcoin constitute a de facto monetary policy, including the decision to let new participants buy into the currency, how many are allowed to buy in, and on what terms the currency can be exchanged for other currencies. Even the decision to limit the supply of Bitcoins is a form of default monetary policy, and unfortunately one that threatened to turn this currency into more of a Ponzi scheme than a stable exchange medium.
This doesn’t mean that the Bitcoin or an idea like it can’t succeed, but it does mean that so far, this specifics of this concept are badly flawed.
What’s to like about the Bitcoin?
Like many attempts at innovation, the Bitcoin may prove to be learning experience that leads to better things later on. After all, there are things to admire about the idea:
- It is easy to imagine major currencies becoming available globally. The assorted troubles of the euro have provided a cautionary tale about trying to coordinate a currency backed by several nations. However, the idea that in the future technology will allow consumers and merchants to choose from a variety of major currencies and have the digital means to make exchanges seamless is both readily conceivable and desirable.
- Payment systems are already becoming increasingly electronic. Money itself has long been a symbol rather than anything carrying intrinsic value, and more and more that symbol is expressed in electronic rather than in physical form. So, the idea of a fully online currency doesn’t seem very far-fetched.
- Frustration with the conventional banking system is understandable. The whole “too big to fail” concept continues to leave a sour taste in many people’s mouths. It’s like an abusive relationship, where one person continually behaves badly but then keeps telling the other one “you can’t live without me.” I agree that the banking system has done a lot to lose our trust; I just don’t think the Bitcoin has done anything to gain that trust.
- Frustration with central bankers is also understandable. Central banks use money to try to manage complex economies, which can make people holding that money feel like a pawn in a chess match. Recent examples are the near elimination of savings account interest by the U.S. Federal Reserve in an attempt to stimulate the economy, and the threat (which they later backed down from) by the European Central Bank not to honor the insurance on Cypriot deposits. Our money would feel much more secure if it were not being used as a tool for managing economies and financial systems, though I’m not sure it is possible to isolate any form of currency from those realities.
Unfortunately, recent events demonstrate that the Bitcoin is a long way from becoming a stable, universal currency free of supply-and-demand issues and of speculative manipulation.
If you choose to support the Bitcoin because of what it represents, then by all means do so. Just understand that it is still an experiment, so limit your investment in it accordingly, because experiments sometimes blow up.