Is bitcoin dying, or transitioning to ultimate purpose?

January 21, 2015 09:36 AM

So if money loses value slowly, why do people keep any money in their checking accounts? Because they need it to buy stuff. If you want assets that will tend to go up over time, you buy stocks,  bonds or real estate.

At least, if you’re sensible, that’s what you do. If you’re a gambler, you might consider something along these lines:

“At some point, people are going to switch to a using a different kind of money. I bet I can predict that switch, and get in ahead of the game. I’ll buy up a bunch of the future money, and when people switch to using that, I’ll be sitting on a whole pile of cash!”

That’s the implicit thought process of the people who buy bitcoins as a speculative investment. It’s also the implicit thought process of gold bugs. “Gold is money,” gold bug websites stubbornly repeat. But it isn’t. You can’t buy stuff with gold. David Andolfatto, vice president of the Federal Reserve Bank of St. Louis, explains this very well. Bitcoin is a bit more currency-like, but most things still can’t be bought with bitcoins.

What gold bugs hope -- almost certainly in vain -- is that people will switch to using gold as money in the future. What bitcoin speculators hope -- possibly correctly, possibly incorrectly -- is that people will switch to using bitcoins as money in the future. They’re not funding any sort of productive activity, they’re just making risky speculative bets about future currency regimes.

But speculative bets on bitcoin don’t actually help it become a true currency. More likely,  they hurt it. There’s a rule in economics called Gresham’s law, which is that when you have two currencies, people tend to hoard the one with greater material value and spend the one with less material value.

If people think bitcoin has value as a speculative asset, they will hoard it, and buy their groceries with greenbacks instead -- after all, they expect bitcoin’s price to go up, and the price of the greenback to go down. This makes it more difficult for bitcoin to establish itself as a medium of exchange, because no one wants to actually spend them!

So I suspect that the people who have invested in bitcoin- related companies and technologies are not too upset when bitcoin prices crash. The sooner people give up the hope that bitcoin will skyrocket in price, the sooner they will be willing to spend bitcoins in everyday life, the way they now spend dollars. The quicker bitcoin as an investment dies, the quicker bitcoins as currency can come to life.

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