On Bitcoin, Gold and Monetary Policy

This negative article on bitcoin indirectly brought together a few disparate thoughts for me. The article's position/bias is clear - the digital currency, which has grown significantly vs. the dollar  is a speculatively bubble:

(source)

What is even more interesting, however, is the set of comments which mostly defend bitcoin. These online comments, to me, show exactly the misconceptions which drives bitcoin, gold and many arguments about US monetary policy. Let us begin!

1) Misconception: Bitcoin is a valid and perhaps best currency because it is not manipulated, transparent and free from government control. It is true that there is no government control and transactions are automatically tracked. What about manipulation? There may be no group trying to set a price, but the alternative is a currency that changes by 100%+ in a year. Is that what currencies are? A reminder: typical characteristics of a currency include 1) medium of exchange 2) unit of account and 3) store of value. The first two could arguable, but the store of value? While the currency has been gaining versus G10 currencies, its volatility could easily swing the other way by double digit % points.

Finally - no manipulation or adjustment also means no flexibility. There is a set formula that grows the supply until a specified limit in the future. Why that limit? If there are 100 dollars in circulation for 100 people now, and still 100 dollars for 500 people later, what will happen? Deflation. <- this, incidentally, makes a consistent price rise nearly rational, as deflation is literally designed into the system. As a result, speculation will override traditional usage (why sell goods via bitcoin when bitcoin will rise in value the next day?) Assuming more goods are sold/bought using bitcoin system, bitcoin value will rise - the result is what we see today, where most bitcoin usage is actually speculation vs. use in commerce.

This reflexive (ref: Soros) rally is self-reinforcing and may indeed reach new heights for sometime. However, bitcoin's ultimate usefulness is supposed to be its use as legitimate currency, which in my opinion will ironically be a smaller and smaller part of bitcoin usage as the currency rises. So, bitcoin gains in value are self-reinforcing in the short run but ultimately self-defeating in the long run (perhaps an apt definition of a bubble). If bitcoin mania continues and commercial usage lowers, there may very well come a point when the crowd discovers that they hold more money than there are goods possibly to buy it with.


... to be continued