By Paul Nathan
Let me say from the onset that I am happy to see the introduction of a free market medium of exchange. In this technological age there is absolutely no way to predict what form a new money, or a new monetary system for that matter, will take, should one develop. The keys to any successful money or system however, lie in competition, use value, acceptability, and of course, integrity. Any lasting money must be market-originated and market-tested to survive.
Down through the ages almost every conceivable good was used as money, from sea shells, to tobacco, to olive oil, to metals. It wasn't until the 1500s and well into the 1600s that an international system of money was contemplated and eventually implemented. It was the gold standard. Nicolas Copernicus and Sir Isaac Newton were two of the great minds that contributed to this effort in their respective times. And in fact the gold standard reigned for centuries virtually unimpaired.
While gold has been around for over 5000 years as a medium of exchange in one form or another, bitcoins have been around for about an hour and a half -- in millennial terms. And therein lies its problem. No one really knows how viable this currency will be over time - it's not tested. The Euro has been around for a lot longer than the bitcoin, but has still to pass the confidence test. I peg 1933 as the year the new fiat dollar was created. That was the year the US government confiscated gold and made it illegal for Americans to own. That was the year that the dollar became a true fiat currency, not dependent on the market value of an underlying commodity, but reliant completely on government decree. Not only was the supply of money now controlled by the Fed, but convertibility of what were paper claims to gold, was now outlawed by the government.
The Pound has actually survived the longest as a currency, both gold-backed and as a fiat currency. Which brings us to the inescapable conclusion that fiat currencies can survive and function even though that functioning is dubious at best. They have historically lost value. The dollar has, since the Fed took over the money supply in 1913, lost 98% of its value. But it still exists as a medium of exchange and functions effectively. Milton Friedman believed a fiat standard was the best standard as long as the money supply was controlled. This is what Bitcoin is attempting to create, a non-political currency based purely on supply and demand. The one difference between this fiat currency and others is that the supply will eventually be fixed at 21 million bitcoins. This has never been done before.
The bitcoin is the ultimate fiat currency. Currencies like pounds and dollars originally built their reputations and value as commodity money first. They were paper claims to a commodity -- freely convertible into something of use. The fact that commodity money always has an objective value tied to its use value brought confidence to money, back in the days of the gold standard.
Bitcoins are convertible to nothing, and more, they don't even really exist in any tangible form. They are digital money. They have absolutely no use except as a medium of exchange. However, they have managed to become acceptable in a very short period of time and without the benefit of legal tender laws. No one forces anyone to accept bitcoins and no government sets or influences its value. Yet they are accepted to some degree by people around the world. In fact I would say that today bitcoins are used more than gold to purchase goods. So bitcoins are a medium of exchange and a form of money by definition.
There are a number of questions and tests the bitcoin will need to answer and meet before it gains any meaningful market share in the currency markets. Will it stabilize and become a viable unit of exchange and unit of account? Given its fixed supply, will it lead to a generalized deflation in terms of the goods and services it buys and will that be a problem? Will it be secure? In other words, can it survive hackers, competitive mimickers, periods of economic trauma, and geo-political events? What about computer blackouts, breakdowns, and, grid attacks? Will a virtual currency become virtually non-existent at times, as distinguished from a tangible currency in hand which people can always use in times of emergency? And finally, will the bitcoin system remain transparent and fraud-free?
Personally, I am willing to let the free market answer these questions and not presume that the bitcoin experiment is absurd. A free market currency is no more absurd than a government fiat currency. Both can work as long as they are acceptable to individuals. Yet, both also can end up on the trash heap of history a hundred years from today as most others have.
As always - time will tell. And that's why I will continue to hold gold and silver coins.