Is bitcoin dying, or transitioning to ultimate purpose?

January 21, 2015 09:36 AM

"Bitcoin is collapsing,” BoingBoing recently tweeted. “Will Bitcoin ever rebound?” wonders CNN. “Bitcoin is headed to the ash heap,” USA Today proclaims.

But what all this weeping, wailing, and gnashing of teeth fails to grasp is that bitcoin isn't supposed to be an investment-grade financial asset. It’s supposed to be a medium of exchange. Surprisingly few people understand the difference.

The Washington Post’s Matt O’Brien is one of the few who does:

If Bitcoin were a currency, it'd be the worst-performing one in the world, worse even than the Russian ruble…But Bitcoin isn't a currency. It's a Ponzi scheme for redistributing wealth from one libertarian to another. At least, that’s all it is right now.

O’Brien is correct. The reason for bitcoin’s wild price volatility is that many people -- not just O’Brien’s “libertarians,” but many others -- fail to understand the difference between money and risky long-term assets.

Long-term assets are things like stock. As the human race invents more ways to create value, and as corporations find more ways to capture that value in the form of profit, the price of stock goes up. By buying stock and holding it, you get to share in that value. In return, you lower the cost of capital for the companies -- in effect, you lend them money, and when the stock price goes up (or the stock pays dividends), you get paid back.

But stock isn't money. If you don’t believe me, go to the store and try to use  a share of General Electric to buy a loaf of  bread. Eventually, security will gently escort you from the premises.

Money is a medium of exchange. It’s what you use to buy stuff. There can be multiple kinds of money that exist alongside each other -- for example, in some countries, you can pay for things in the local currency or in U.S. dollars.

But what money doesn’t usually do is increase in value over time. Sometimes it does, a little bit -- for example, in the long deflation of the 1800s. Usually, though, money slowly decreases in value, because of inflation. The central bank tries to keep these decreases slow and steady, so money isn’t risky.

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