A Bitcoin Economy?

Is Bitcoin money?

Global Market Update - Claudius_II_coin

Source: Wikipedia

Bitcoins have been accepted by some online merchants for payment on their systems. The crypto-currency is designed to work like digital cash, changing hands anonymously, with no centralized ledger keeping track of who owns what. As such, it’s been the currency of choice for anyone who doesn’t want the government to trace their transactions—notably drug-dealers and libertarians.

But could Bitcoin become mainstream? It seems possible. After all, there’s no reason someone selling candy bars couldn’t take something else as payment. Merchants near the border with Canada take “Loonies” all the time—at a discount, to cover the cost of exchanging them for US Dollars. As people have started to consider Bitcoin’s potential, its value has fluctuated wildly.

Global Market Update - BitStamp

Source: Bitcoincharts.com

If it became a common medium of exchange Bitcoin would cause significant headaches for governments who want to collect taxes. They would likely move to stop it. But there’s an internal problem with Bitcoin that would cause its demise before this. It’s one of the problems that helped bring down gold as a currency: mining.

Bitcoins are issued by “miners”: computer operators that solve complex math problems. The algorithm is set up so the problems become increasingly difficult. As a result, issuance gradually slows. But as Bitcoins are used in more transactions, their value rises. It becomes economic for more and more resources—electricity, computers, labor—to be committed to solving these obscure equations.

Eventually, the degree of effort devoted to mining Bitcoins would impact the real economy. That’s what happened with gold in the 19th century. The drain on labor caused by the California and Alaskan gold rushes was significant. Communities were decimated by “Yukon Fever.” Fields and factories couldn’t find enough workers to be productive. But digging holes in the ground didn’t provide anything of real value to the economy.

The same problem applies to Bitcoin. If Bitcoin were the global currency now, one coin would be worth approximately $17 million. And if the economy grows faster than the number of Bitcoins, that value increases. We would see another gold rush—and the global economy would suffer. A large Bitcoin economy would make computer-mining a major industry—maybe the only industry.

Currencies have always been issued by governments to enable commerce. Any private currency must confront the problem of creation: where does it come from, and who benefits?


Douglas R. Tengdin, CFA
Chief Investment Officer
Phone: 603-224-1350
Leave a comment if you have any questions—I read them all!

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