The Bitcoin

The bitcoin is the new fashion. The Economist explains how it works here, discusses its future here, Paul Krugman talks about it in his blog for the New York Times here, and El País has translated his comments here.

To evaluate a currency or a candidate for currency, the first thing you have to do is ask if it is actually money or not. That is, if it is used frequently in transactions. For this to happen, the more people who accept it as a means of payment because they trust that others are going to accept it, the better – the first appearance of the Nash Equilibrium in this blog.

From a global point of view, the U.S. dollar is a better currency than the euro in this sense and the euro is much better than the zoquito – a social currency used by a few hundred consumers of ecological products in Jerez de la Frontera, in the south of Spain.

Yet it is true that, from a more local point of view in the eurozone, the euro is clearly a better means of payment than the U.S. dollar and it is possible that that someday the zoquito will dominate the euro in the ecological marketplace of Jerez.

First, a bit of theory ;-). The history of money is the history of technological innovation that has the ultimate goal of improving three functions of money: account unit, means of payment and deposit value. The function of the means of payment of the currency improves when transaction costs decrease. And the contribution of credit cards is not so clear because when losing anonymity and requiring a third party – the banking entity that issues the card or Visa – to guarantee payment, transaction costs become greater than those of paper currency.

The function of the deposit value of money improves when the value of the money becomes more stable. That is, when money is exchanged for goods at a stable price, without inflation or deflation, and when ownership costs go down and money becomes more secure.  In terms of the original ownership, credit cards don’t improve anything because they do not define the account unit – even though it’s true that there are some exceptions to this general rule. Recall, for instance, in the mid-1980s when at some gas stations in Minneapolis the price of gas varied if you paid in cash or with a credit card. This price difference redefined the account unit. And, in respect to money security, one could argue that since they are nominative, credit cards represent an improvement over paper money.

And now about the bitcoin. Is it a good currency? Right now, it is probably better than zoquitos, but it is certainly a worse currency than U.S. dollars, euros, sterling pounds or slotys. And in the future? At the moment, Graphic 1, which I have taken from the second article in The Economist, shows that prices in bitcoins are not very stable.

What advantages does the bitcoin have? Supposedly, its transaction costs are less than those of any other means of payment. This assertion, however, should be qualified because networked computers take about 10 minutes to confirm the validity of transactions. For some, another advantage is that the bitcoin is a means of payment among equals (peer-to-peer), which means that government intervention is unnecessary.What drawbacks does this have? Like gold, it is costly to produce. Even though to acquire bitcoins, instead of excavating, you have to resolve mathematical problems. And that its availability is supposedly limited, which makes permanent deflation inevitable when approaching the limit.  Of course, this problem has the hidden advantage that central banks cannot raise taxes imposed every time emission increases.

What’s going to happen? In a globalized economy, real and virtual money compete and will continue competing against each other. The physical form is what matters least – it’s easy to demonstrate that, in addition to being necessary, trust in a currency is enough to give it value. And it is likely that we will use currencies in diverse forms in the not-so-distant future.

I, for example, keep waiting for the day that we have a means of payment that makes it feasible for readers to pay me one euro cent for this blog post – but only those of you who liked it, of course.

Challenge for engineers: read the article signed by the mysterious Sataoshi Nakamoto, “Bitcoin: A peer-to-peer electronic cash system,” and explain to us economists and others exactly how the bitcoin functions. I’ll invite you to have a beer if I like the explanation.