Wednesday, June 15, 2011

Some Thoughts on BitCoin

There has been a lot of buzz lately about BitCoin, a new alternative "currency" that exists entirely online and without any sort of central authority. Previous electronic currencies have been hindered by theft and double-counting, but BitCoin seems to have solved these problems by using a clever peer-to-peer interface. The Economist has a pretty comprehensive description of some of the technical details of BitCoin, but to get the basic gist here's a totally biased marketing video:

Although BitCoin is certainly an interesting idea, it has some pretty massive flaws:
Bitcoin does not have a central bank capable of printing and lending bitcoins; it has an "algorithm" which through some convoluted mechanism allows bitcoins to be "mined". Essentially it randomly allocates bitcoins to early adopters. This is a very good system for early adopters (free money!) It is a nonsensical system for a real currency, not to mention being obviously unscalable (what happens when everyone tries to mine bitcoins all day long?). To solve this second problem, the supply of bitcoins is algorithmically limited, which is again good for early adopters. But that brings us to...
The macroeconomic qualities of BitCoin make it extremely vulnerable to a depression-like collapse of demand, where everyone wants to hold onto BitCoins and not spend them. Add to that the riskiness of convertibility (exchanging BitCoins for U.S. dollars, for example) and the notion of BitCoin-as-a-game-changer seems ridiculous.

But many critics (and supporters) are getting too sensationalistic about BitCoin's scope and prospects. If you look at BitCoin in the context of other alternative currencies it's clear that this asset exists merely to promote and foster certain social or philosophic values. Some alternative currencies, like Ithaca Hours, promote local community. Some have built-in time horizons for spending or rapid value-loss in order to limit saving and boost consumption. BitCoin is merely an experiment that fits nicely into the quickly-emerging anti-authoritarian, tinkering, globalized, open-source anonymous internet civilization. Although fascinating, ultimately BitCoin is not nearly as important as the political fight to keep all internet transactions (denominated in major currencies) tax-free.

Check out this great EconTalk podcast about BitCoin.

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