Looked at in another way, think of Bitcoin as something more like MMORPG loot. If people are willing to spend vast amounts of "real money" on items for their WoW character, spending that money on Bitcoins instead makes it seem like a sane investment rather than just flushing it away.
What is the intrinsic value of Bitcoins, then? That people are willing to spend money on Bitcoins?
As an investment vehicle these are terrible. Commodities (diamonds, zinc, gold, wheat, oil, etc.) will always be demanded as factors of industrial production or farming. Equities generate real-world wealth for investors in the form of dividends. Both are demanded because they generate real value for investors.
Bitcoins have no intrinsic value. If you're in to make a quick buck, that's fine--this is a big arbitrage opportunity. But for any decently-sized time T, Bitcoins --> $0 as t --> T.
Part of the value is in their utility as an anonymous currency: try taxing the guy that's paid in Bitcoins.
Another part is the integrity of the currency: the currency is backed by math, rather than men, and not subject to hyperinflation resulting from corruption (i.e. the US Fed can create money out of thin air, but there is no authority that can create Bitcoins out of thin air: they must be mined).
I didn't downvote you, (I don't think I'm allowed to!) but the "US Fed" (the Federal Reserve) does not simply add $X million to the money supply--it actually purchases Treasury bills on the open market. The net transaction is $0 (an exchange of currency for T-bills of equal value), but the market now contains more paper money.
Meanwhile, I've already discussed Bitcoin's potential as an alternative currency (or lack thereof) in other comments. If people demand Bitcoins as a "tax haven" from the government, then Bitcoins aren't long for this world.
>The net transaction is $0 (an exchange of currency for T-bills of equal value), but the market now contains more paper money.
Whatever the mechanism, fiat currencies are subject to inflation through the pressure of an ever-increasing money supply.
>If people demand Bitcoins as a "tax haven" from the government, then Bitcoins aren't long for this world.
It'll be interesting to see how the state tackles this. It'll be easy to drive it underground, but preventing its use will be another matter. Bitcoin transactions through a VPN seem hard to prevent.
Whatever the mechanism, fiat currencies are subject to inflation through the pressure of an ever-increasing money supply.
As they should be, given that populations increase.
Anyway, even if Bitcoins go underground, they'd have to be priced such that they'd be cheaper than other money laundering channels. Due to their finite supply, though, money laundering through Bitcoins will get very expensive. So their utility re: taxes will be squashed by either the government or the black market.
I think this is a very important thing that people don't understand. Static money supply in a world where as you point it out population increases means deflation. And increasing popluation is only one example of the need for inflation. We create wealth all the time, people in other countries are buying their first car etc... the more goods are purchases and sold the more money you need. At least that's what I understand from my couple Economics classes.
> As they should be, given that populations increase.
Is the U.S. Population increasing like this? [1] That's what the U.S. monetary supply looks like.
More correctly, fiat money supply should ideally match total economic output, not population. But the GDP graph also doesn't look anything like that monetary supply graph.
Given this, the BitCoin phenomenon is understandable: savers are looking for a currency that's not subject to manipulation and is most of all predictable in terms of supply. Whether or not it succeeds, I'm glad there's the pressure of a competing, not-centrally-manipulated currency.
Milton Friedman disagrees and measures inflation relative to output in his book on monetary phenomena [1]. Since you're an economist (right?) I'd be interested in why you think he's got the wrong measure.
Read the sentence "Prices might even fall gradually as higher incomes led people to want to hold a large fraction of their wealth in the form of money." Inflation is a Money Supply / Money Demand phenomenon. In the long term, Money Demand tracks real output, but in the short term (such as the recession we're currently in) you can see major swings in demand that counteract what would normally be a quite inflationary money printing exercise.
So you agree that in the long term, money supply should closely follow real output. It's only in the short term that the Fed is allowed to untether them for the purposes of intervention. Let's not forget that the Fed's monetary policy in the 2000's helped create this situation: economic intervention necessitates further economic interventions. It's no wonder people are heading for the exits via BitCoin.
Compare those two graphs from say 2006 on. I am mystified that you would look at a graph with a giant, dominant spike, and conclude my point was about the shape before the spike.
Edits: To make it clear I'm not arguing with the statement that money supply has tracked GDP fairly well until recently. Or that GDP has trended up exponentially.
Oh I get it: this is one of those "man, the Fed is messing up" rants!
Yeah, I won't take part except to say (a) you're sampling 4 years of incredibly volatile economic activity, and (b) the other, uh, 96 years exhibit a pretty strong exponential trend.
> The net transaction is $0 (an exchange of currency for T-bills of equal value)
That is only true if T-bills are generated slower than the rise of other money instruments. In the last few years, that has not been the case (and evidence for that is seen in the tanking dollar value compared to any other currency, including gold).
>Easy - I collect taxes at the point where physical goods are exchanged for bitcoins or are used to deliver products.
Or just collect the taxes at the point where it's converted from BTC to a real, government-backed currency. It's simpler, because there needs to be a paper trail there.
> The state does this, but people already get around this by conducting cash transactions. Bitcoin creates another option for this.
Govts tolerate a certain amount of black market because it costs too much to reduce the black market to 0. However, that toleration goes away when govts are seriously hurting for revenue.
The taxation of non-cash income has been a settled issue for decades (in the US).
They would tax Bitcoin receipts the same way they tax service-for-service or service-for-property exchanges. The government will calculate the fair market value of the services/property received at $X dollars (based on facts and circumstances such as the amount exchanged in similar cash-based transactions), deem the taxpayer to have received $X in income, and impose a tax of $Y on that deemed income.
Gold has very little - it is used in jewelery, CDR coating, teeth and a few other industries -- but you can't live in it, nor can you eat it. Beans have more intrinsic value than gold of the same weight....
Yet, no one doubts gold as a currency.
The main, strike that, ONLY, relevant feature of a currency is the willingness of others to exchange stuff for it. At this point in time, bitcoin possesses this feature.
Can you exchange your bitcoins for gold or beans? Because right now, bitcoin purchasing power amounts to a hill of beans.
Gold is a commodity, not a currency. It is a scarce commodity that is highly demanded as a part of luxury goods. Thus, it commands a high price on the open market.
Beans are also commodities, but they are plentiful. Bean demand is easily met, so they're not priced very highly.
Bitcoins are not production inputs, so their only value is (ostensibly) as an alternative fiat money or value store. Unlike country-backed fiat money, you cannot exchange bitcoins for goods, so the only demand for bitcoins comes from people "investing" in them. If you want to play the bitcoin market, that's fine--in that case, you're generating wealth for yourself. Not value.
> Can you exchange your bitcoins for gold or beans?
At this point in time, you can. Next week, that might not be true. But the same could be said of the currency of Belarus, which was devalued 50% overnight last week (the USD in 1931 suffered the same fate after physical gold was confiscated). Which is all that is required to make it a currency.
> Gold is a commodity, not a currency. It is a scarce commodity that is highly demanded as a part of luxury goods. Thus, it commands a high price on the open market.
:) That's a game of semantics. Gold's current price has little to do with its luxury good status, and everything to do with its scarcity and historical claim to fame as a currency. That was historically gold's role in the last 3000 years or so, and it hasn't been dethroned yet.
> Unlike country-backed fiat money, you cannot exchange bitcoins for goods
But you can. And people around the world are not accepting USD as much as they used to 20 years ago - in the past, in most middle eastern and south american countries, you were able to pay with US dollars everywhere. That is no longer true. Does that make the fiat US dollar less of a currency?
You can play semantics all you want, but gold and to some extent silver are used as currencies.
First: I admit I wasn't aware that retailers accepted bitcoins when I posted that comment. I've discovered otherwise now, so the "hill of beans" comment is wrong. Sorry.
:) That's a game of semantics. Gold's current price has little to do with its luxury good status, and everything to do with its scarcity and historical claim to fame as a currency.
"Semantics" have nothing to do with it. Commodities [0] != currencies [1], whether you're familiar with the definitions or not. One exists as a medium of exchange, while the other is a good with no differentiation between sources. Currencies are differentiated by the trustworthiness of the governments that issue them (you'd probably accept a US dollar today before accepting a German papiermark [2] in 1924).
Also, gold's price is a function of the market's supply and demand for gold as either (a) an investment vehicle or (b) an input in the production of goods. Investors don't give a damn that the US dollar was pegged to gold 200+ years ago--they're simply investing in it to make money.
The idea that gold is "currency" is ridiculous. Name a first-world country where gold is widely accepted as currency. Some places in some parts of the world might accept gold, but it's not backed by a central body nor does it carry a relatively stable value (unlike fiat money).
> "Semantics" have nothing to do with it. Commodities [0] != currencies [1]
Semantics have everything to do with it, as I will demonstrate below.
> One exists as a medium of exchange, while the other is a good with no differentiation between sources.
Well, as long as the USD is not fake, you don't care what the source is :) Similarly, for non-fake gold.
> Currencies are differentiated by the trustworthiness of the governments that issue them.
Today, that is true. However, the Chumash people had a currency that -- like bitcoin -- was not centrally managed, and reflected work put into something, rather than any fiat or backing store of value. http://en.wikipedia.org/wiki/Chumash_people#Culture - I can't remember where I read a more detailed account. Basically, you could sit on the beach all day and make money -- and it took slightly longer than the equivalent exchange rate would get you in food (so you could hunt/gather food, or make money, with comparable time expenditure, and exchange them). The whole system broke down when European drills (as manufacturing tools) were introduced and made money making simple.
> First: I admit I wasn't aware that retailers accepted bitcoins when I posted that comment. I've discovered otherwise now, so the "hill of beans" comment is wrong. Sorry.
So - let's get back to semantics: do you agree bitcoin is currency? (exists as a medium of exchange), or commodity? (a good with no differentiation between sources) because it has both properties, thus showing that the definitions are not mutually exclusive. A USD is currency but not commodity; Beans are commodity but not currency. Gold, Chumash beads and bitcoin are both.
> Name a first-world country where gold is widely accepted as currency.
In NYC where I live, hundreds of stores will accept your gold in exchange for other merchandise (at a bad exchange rate for you...). You can identify them by the sign "We buy gold". You must have seen them in other places too.
> but it's not backed by a central body
True, but ....
> nor does it carry a relatively stable value (unlike fiat money)
Wrong, and if you truly believe that you might be beyond help. The US devalued the USD by 50% in 1931. Belarus did it to their fiat currency last week. Between 2002 and 2006, the EUR/USD exchange rate went from 0.8 to 1.5 (almost 100%) - "stable"?
In fact, up until 1971, the backing for the USD (and most other currencies) was gold - it only became a true fiat currency in 1971! Before that, it was a claim on some amount of gold in fort knox, and value was derived from that.
No, modern currencies are backed by the full faith and credit of nations, and while reasonable people can disagree about the value of the US credit rating, no reasonable person thinks it is zero.
People need to start naming the dubious syllogisms bitbugs deploy in discussions like this.
Bitcoin is, in a way, backed by the value that it brings as a currency-- privacy and anonymity. We can argue whether that value is $10 per BTC, but I also don't think any reasonable person thinks that it is zero.
But that's not reasonable. Its just ignoring the privacy/anonymity value of BTC. Again, we can argue about the monetary value as compared to dollars, (especially given the tradeoffs-- i.e., convertibility to established currency, places to spend, etc) but that's real, practical value. You can't simply ignore it.
Sure it's reasonable. I think bitcoins have zero value. I recognize that there may be people out there who are willing to pay real dollars for it right now, but I think that in the long run, no such people will exist. Hence, I place its value at zero.
Bitcoins don't have to be tradable to dollars to represent nonzero value. Their utility is in and of itself valuable. It might not have value to you, but that's different than suggesting that it has no value at all.
Currency is a placeholder for value. So long as I can exchange bitcoins for value, they will function as a currency. The design of bitcoin makes it very difficult for governments to make such a scenario impossible (or even difficult). For that reason alone, bitcoins will remain valuable, if for nothing other than goods or services that governments don't like.
People who participate in illegal trade (such as drugs, guns, prostitution, etc.) still need most of their purchases to be in the legal economy. Hence, illegal trade still uses real currency.
I couldn't care less about the privacy/anonymity of BTC if the market falls out and my BTC wallet ~ $0. At that point no government will come to my aid because, hey, I invested in something that has no value.
As I mentioned above, Bitcoins value relative to the dollar is irrelevant, because its value is found in its utility. So long as there are goods and services to purchase with Bitcoin (and it seems very difficult for a government to stop such services from existing), the utility of the currency remains valuable, regardless of its exchange rate to the dollar.
EDIT: The fact that government would have a very difficult time shutting down the Bitcoin economy is yet another example of its utility and value.
Utility for what. If things have real, actual value, then they can be exchanged for dollars, even if it's only on the black market. We don't mean there has to be an official exchange rate between bitcoins and dollars. We mean there has to be someone willing to say "I'll give you X USD for Y bitcoins" even if that's just under the table. If no one is willing to do that, then bitcoins have no value.
What I, and others, are saying is that in the future, no such people will exist. Our prediction is that the current bitcoin economy is transient and will eventually vanish. Hence, we say bitcoins have no value. It's similar to saying that a particular stock has no value if you think that that particular company will collapse.
*there has to be someone willing to say "I'll give you X USD for Y bitcoins"
Not really. They have to be willing to say "I'll give you X thing that you value in exchange for Y bitcoins." The entire point is that the design of bitcoin makes that scenario likely to always be true precisely because it is nearly impossible to stop. As I said above, the very fact that it represents a system that is very difficult for state actors to attack ensures that it will almost certainly be used for exchanging goods and services that governments would rather not exist. Not a terribly noble future, perhaps, but certainly one that ensures bitcoins have value.
If people are willing to trade goods for it, then someone will be willing to trade dollars for it (or yen, euros, or any established currency).
For a reason that I am unaware of, you seem to think that just because something can be traded it will be traded. That's not true. People tend to only trade things that are readily exchangeable in the larger economy - things that have value.
Well it's more than people--my government believes the US dollar has value too, and it's willing to insure my bank accounts as a result. That's a hell of a vote of confidence.
> my government believes the US dollar has value too, and it's willing to insure my bank accounts as a result. That's a hell of a vote of confidence.
Really? When dollars were "silver certificates" the bank's willingness to let you come collect your silver was a real vote of confidence in the currency. But nowadays if they "insure your bank account" they only pay you back in dollars. They're insuring that its value doesn't drop in dollars. How does that constitute a vote of confidence in the currency itself? I'd say it's only a vote of confidence in (a) the bank, (b) the government's ability to print more money, (c) the government's ability to tax.
First, assuming you're talking about the US, your bank accounts are insured by the FDIC, and the FDIC is not part of or formally backed by the US government. There are lots of people who believe that if the FDIC were in danger of bankruptcy, the US government would step in to support it — as it did with Fannie Mae and Freddie Mac — but until the government actually promises to do that, you can't call it a "vote of confidence".
Second, the US government's dollar position is short, not long — its dollar-denominated debts are greater than its dollar-denominated assets. In financial terms, a short position is a way to bet against the value of the underlying commodity. The US government is currently about $7 million million dollars "short".
An illustration may help to clarify. Suppose you are a private in the Zimbabwean military in September 2007. Suppose your monthly pay is about US$180, but you are paid in Zimbabwean dollars, so your pay packet is actually Z$5.4 million for the month. The Zimbabwean dollar has been hyperinflating, and you expect it to continue to lose value. You don't currently need to pay any expenses. Consider the following options:
A. Keep the Z$5.4 million in cash.
B. Immediately buy other commodities with it; for example, buy 300 kilograms of rice and store it in Tupperware in the pantry.
C. Immediately buy other commodities with it, and also borrow an additional Z$10 million some poor sucker is willing to lend you at an extortionate 20% APR, and use that to buy rice too.
Option "A" is maintaining a "long" position in the Zimbabwean dollar. This amounts to a bet that the Z$ will retain its value. If you had taken this option, you would have lost 90% of your salary within a few weeks.
Option "B" is maintaining no position in the Zimbabwean dollar. It doesn't matter what the Zimbabwean dollar does thereafter; you still have the same amount of rice. (Practically speaking, in situations like this, there tend to be price controls on most things you can buy with the collapsing currency.)
Option "C" is maintaining a "short" position in the Zimbabwean dollar. If you had somehow found such a sucker, then within a few weeks, you could have paid them back by selling off a tiny percentage of the rice you bought, as the Zimbabwean dollar continued to inflate.
This is the position the US government has taken relative to the US dollar.
There are, of course, other reasons to take long or short positions on commodities other than speculation on their future value.
Third, even if we accept the premise that the implicit guarantee of the US government to keep the FDIC afloat amounts to "the US government is willing to insure my bank accounts", that is simply a further short position. FDIC insurance is for dollar-denominated accounts up to a fixed dollar limit. Whoever is on the hook to underwrite that insurance in the end, they'll have an easier time paying out their claims if the US dollar loses value. If your bank account has $78000 in it and the currency loses ¾ of its value (which happened here in 2001), the FDIC bailout only has to come up with the current equivalent of $19500 to pay you back.
Fourth, the government is not "more than people". It's just people.
Thanks for the great explanation on the US government's dollar position. I also thought about my comment some more later, and realized that inflation really devalues the FDIC's deposit insurance.
I'll take issue with the government being "just people," but that's just a nit in a great post.
What is the intrinsic value of Bitcoins, then? That people are willing to spend money on Bitcoins?
As an investment vehicle these are terrible. Commodities (diamonds, zinc, gold, wheat, oil, etc.) will always be demanded as factors of industrial production or farming. Equities generate real-world wealth for investors in the form of dividends. Both are demanded because they generate real value for investors.
Bitcoins have no intrinsic value. If you're in to make a quick buck, that's fine--this is a big arbitrage opportunity. But for any decently-sized time T, Bitcoins --> $0 as t --> T.