Bitcoins, Back from the Crash, Still Aren't as Good as Cash

Back in August, I wrote that BitCoin, the peer-to-peer currency, was, among other things, a scam. The electronic money was suffering under a series of hacking attacks that resulted in hundreds of thousands of dollars in losses, and a few short months later, the value of the currency crashed—the world’s Bitcoins were valued at approximately $100 million last summer; today they are worth about $30 million.

But we’re seeing some signs that Bitcoin might be getting its sea legs—and it’s not just the digital money’s cameo on The Good Wife last month. The value of a single Bitcoin has been relatively stable for the last few weeks, at about $5 each. People are starting to ask if Bitcoin could be the currency of the future, or at least a useful “metacurrency” to smooth international transactions.

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And there is some promise: A universal, decentralized, anonymous digital currency would solve a lot of problems in the modern economy. It could speed payments and improve privacy. If it were a truly democratic currency, not linked to any one government or company, that could be even better.

Unfortunately, Bitcoin’s problems linger. It’s still vulnerable to electronic theft. You still can’t really use it in your day-to-day life, unless your day-to-day life involves currency speculation, money laundering or purchasing drugs on the internet—there are few places where you can pay with Bitcoins, though that may change the longer Bitcoin lasts. Even so, it’s hard to see confidence building when Bitcoin users are still living with the constant risk of hacks and scams.

Worse, though, are the economics of Bitcoin. Rather than creating some equivalent of a central bank to control the amount of currency, like the U.S. Federal Reserve does for dollars, it has created a system where “miners” use computing power to crack codes and create new Bitcoins. It’s analogous to the old school gold standard, where the value of a dollar is connected directly to the price of gold. Today, the value of the Bitcoin is connected directly to the price of computing power.

This presents two problems: One is that the number of Bitcoins miners can create maxes out at 21 million—as a comparison, there are about 2.1 trillion dollars out there in the world, and steadily growing. By capping the total amount of currency, Bitcoins are guaranteed to be create deflation; that is, if they catch on in large numbers and millions of people want to use them, they’ll quickly increase in value, leading to hoarding and perhaps the collapse of the currency.

The second is the problem of linking your money to any one commodity, whether it’s gold or, in this case, computing power, is that your money becomes dependent on it—and any changes in the commodity’s value, whether it’s a new gold mine, a sudden advance in computing technology, or just cheaper chips—can dramatically affect the value of bitcoins.

That’s why it’s funny to hear people talk about Bitcoin as a “social currency.” Bitcoins aren’t a social currency; despite their peer-to-peer infrastructure, algorithms and physics govern it, not people. Ironically, the U.S. dollar is a far more social currency than Bitcoin—rather than depending on any one commodity, the U.S. dollar is backed by the country’s democratic political process, and the money supply is controlled by a central bank, which while flawed, is led by people our elected representatives appoint.

So, while Bitcoin remains an interesting experiment—and clearly an ongoing one, as long as it is the "currency of choice for the discerning cybercriminal"—it isn't a likely candidate to be the next thing in money, unless it solves some of its very fundamental problems.