Bitcoin, the open source cryptocurrency made famous by the collapse of the Mt. Gox exchange in 2013 and the seizure of the illicit goods site Silk Road in the same year, presents a conundrum for governments worldwide who are accustomed to their monopoly in the issuance and destruction of money. On the side of the civic good, governments are concerned about the ability of an unregulated currency to aid criminal enterprises. On the other side of the civic ledger, governments are concerned about the inflationary pressure alternative currencies place on fiat currency, eroding their ability to fund their budgets and exercise control over their economies. There are also underlying issues of power and political hierarchy at stake, of which the users of alternative currencies like bitcoin are nakedly trying to usurp. It is a monetary death match, and some of the biggest players in the financial markets are getting some skin into the game to make sure they are on the winning side.
I’m betting on the governments to win this contest, particularly those from the G7.
Why? Well, for one thing, because bitcoin and most other cryptocurrencies are not money. That’s right, bitcoin, because it has no intrinsic value, is a lousy medium of exchange and store of wealth. Instead, bitcoin is just a commodity. In fact the U.S. Internal Revenue Service says so, which is interesting in itself. The IRS, because it has the unenviable task to collect taxes for the U.S. government no matter their source, often introduces surprising clarity to seemingly intractable financial problems. And in the case of virtual currencies like bitcoin, the Service has struck to the core of what they really are–mediums of exchange whose value is only what interested parties are willing to pay for them.
So why does anybody buy bitcoins at any price? Since bitcoin is not backed by any store of wealth (such as gold) and cannot be used to pay taxes (the main virtue of a fiat currency), why does bitcoin trade at all? In short, the answer is security. Bitcoin has value because it provides a service–a way of transacting commerce in an untraceable and secure manner (at least as long as the blockchain–or distributed ledger database–remains secure). Thus if one bitcoin is valued on any given day for 100 USD, then this is the value being placed on currency privacy on that date. Since there are a finite number of bitcoins, one can compute the market capitalization of currency privacy as represented by parties supporting the mechanism of exchanging bitcoins. As of December 2015, that number was about 6.9 billion USD. This may seem like a lot, but it really isn’t. Consider that the M1 money supply (the closest U.S. fiat currency analog to the value of the bitcoin blockchain) of the U.S. alone is about 3 trillion USD, one can see that bitcoin is still a bit player. And because of its inherent limitations, it is bound to remain one.
In the end, Bitcoin’s real value may be in its means. The blockchain is a rather ingenious way of tracking things, whether they be bitcoin, or stock certificates, or even pork bellies. The technology works–and it may be the best way as an interested investor to play the virtual currency market.
So for all of you still stuffing money into your mattresses or squirreling gold coins away in your safe deposit boxes, go ahead and breath a collective sigh of relief. Bitcoin is much ado about nothing.