Economist: Money from nothing

This Economist article, Money from nothing, discusses whether Bitcoin can be understood as money. Money is defined as follows:

Economists reckon money is anything that serves three main functions. It must be a “medium of exchange”, which can reliably be swapped for goods and services. It should be a stable store of value, enabling users to tuck some away and come back later to find its purchasing power more or less intact. And it should function as a unit of account: a statistical yardstick against which value in an economy is measured. The American dollar meets all three conditions. Bitcoin has some way to go.

Here’s how they reckon Bitcoin stacks up against that definition:

  1. “Bitcoin does best as a medium of exchange, thanks to its clever technical design… The combination of functionality and user interest means that people are finding it easier to swap coins for both goods and services and for other currencies. This rising credibility as a medium of exchange supports Bitcoin values.”
  2. “… Bitcoin is not exactly a stable store of value. It is technically equipped to do the job: coins saved in an encrypted wallet on a hard drive can be retrieved for later use in purchases. But the currency’s worth is prone to wild gyrations.”
  3. “Volatile values could prevent Bitcoin from ever establishing itself as a medium of account. Even the few retailers who accept Bitcoin use other currencies as their principal accounting unit. … until Bitcoin values are less volatile relative to the currencies that now dominate real economies, users are unlikely to change their monetary frame of reference.”

The article also discusses how Bitcoin’s inflexibility on the control of the money supply (encoding the money supply decisions into the protocol rather than trusting them to government fiat) will be unpopular with governments that have become accustomed to using the money supply as a tool, and unpopular with societies that have come to expect and rely on slow inflation.

There is also this Economist blog commentary on the article: Bitcoin: New money. The commentary touches on three interesting bits:

  1. Control of the money supply, and modest inflation, are vital to avoid economic shocks and collapses. By the article’s reckoning, these tools serve as shock absorbers to lessen the impact of major economic events.
  2. Bitcoin/cryptocurrency will need reputable banks and exchanges, combined with guarantee schemes to limit the risk of systemic disruption caused by the failure of one or more large actors (i.e. Mt. Gox) or very large bank heists (Mt. Gox, again).
  3. The Bitcoin protocol should be modified to permit control of the money supply, instead of setting a fixed cap on the total possible number of Bitcoins.

2 thoughts on “Economist: Money from nothing”

  1. This is the big long argument (discussion) I had with Philip Rosedale, founder of Second Life. He said that Lindens just didn’t work without a dedicated “central banker” to adjust the money supply as it required.

    But where we got to “synthesis” of our opinions was when he suggested an anonymous, algorithmically generated elasticity – much like bitcoin. Of course, this was six or so years ago when we were talking about it.

  2. I am definitely a proponent of some form of reliable entity within the Bitcoin world. It doesn’t have to be centralized (see Mt. Gox’s demise), but reputable and stable within the system. I believe this is necessary both on a transactional level (secure and efficient processes) and an emotional level (trust in the system). For Bitcoin to be successful it needs to also deliver on the emotional level, which it doesn’t right now. But if it isn’t the banks and it’s not everybody collectively, who/what is that reliable entity?

    I’m a little surprised that this model of the ‘central banker’ didn’t work in second life. Douglas, can you say a little more about Rosedale’s reasoning for why it didn’t work for them?

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