One world, one currency – could the bitcoin solve all our problems?

5th September 2011

Serious commentators and indeed countries including China have suggested that perhaps the world needs a separate international reserve currency to prevent, among other things, the US abusing its position and getting itself massively in debt.

But does such a currency – the bitcoin – already exist in cyberspace?

In 2009, the bitcoin was created as a virtual means of trading online while by-passing banks and inflation prone currencies and has proved surprisingly popular in cyberspace. It buys goods and services and is even tradable. 

Technology Review, the website for Massachusetts Institute of Technology notes that "the bitcoin, was an invented currency that people could earn-or, in bitcoin's jargon, "mine"-by lending their computers' resources to service the needs of the Bitcoin network. Once in existence, bitcoins could also be bought and sold for dollars or other currencies on online exchanges."

The website notes that tens of thousands of bitcoins are traded each day, but is slightly sceptical about suggestions that it could replace the dollar.

"Bitcoin is not going to make government-backed currencies obsolete. But while the system's virtues, such as anonymity and the lack of bank fees, may not matter much to most consumers, one can envision it being useful in a variety of niche markets (some legal, others not, like recreational drugs). Where anonymity is valuable, where trusted third parties are hard to find or charge high rates, and where persistently high inflation is a problem, it's possible that bitcoins could in fact flourish as an alternative currency."

All appeared to be going well, but as the article notes, people did not really view the bitcoin as a tradable currency but perceived it more like an investment. Indeed last year it saw values jump tenfold over a 5 day period – the sort of week that would give central bankers nightmares if it happened to their currencies. (Actually the Swiss, the Australians, and even to a lesser extent the British are suffering from safe haven status and seeing currencies rise. Not tenfold though).

Arguably with such jumps perhaps the ‘currency' is behaving more like a ‘commodity' such as gold – which is of course has seen its price rocket as faith in traditional assets falls.

But if it is behaving like a commodity, isn't a tenfold increase a sign of a huge bubble. Well, arguably, yes. In fact it may have burst already.Then again

Forbes technology writer Tim Lee points out it's not really like a commodity either.

He writes: "Most assets have a "fundamental" value: the value that reflects the practical use to which that asset can be put. You can always live in a house regardless of what happens to the real estate market, so we can be confident that house prices won't fall to zero. Similarly, if the price of gold fell too much, people could always use it to make jewelery, so gold is a relatively safe investment.

"The puzzling thing about bitcoin, which I pointed out back in April, is that the currency doesn't seem to have any fundamental value at all. True, you can currently purchase a limited selection of goods and services with bitcoins. But the volume of bitcoin-denominated commerce is small enough that Bit Coin-denominated prices seem to be driven by the current value of bitcoin rather than the other way around."

Well quite. Lee goes on to say that because there is no floor and there is little use for the bitcoin, its current decline may well be terminal.

Marginal Revolution shares that view. Tyler Cowen writes: "Eventually the anonymity scheme, in some form or another, will be available without the fiat currency.  At that point, or more likely before then, the fiat currency will fall to near-zero in value.  Hold it at your own risk.  The original issuers will have kept some of their initial gains.

"In the meantime, it's mostly a fun topic for the internet.  Private fiat currencies have potential value only during hyperinflations, or extreme deflations.  Even then (especially in the former case), people may prefer real assets and investment assets.  The new bitcoin asset simply isn't a useful one and I've yet to see a source on it which explains how it could be or should be."

Marginal Revolution does provide a a list of sites which accept Bitcoin, adding ‘on what terms I am not sure'.

Bit Coin Exchange gives the rates here. It currently stands apparently one bitcoin to £5 though it was a lot higher a month ago.

Mindful Money suggests investing at your peril though it may make interesting Phd. material for an economics student. Back to the drawing board on that replacement for the dollar then.

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