July 25, 2014
Why Bitcoin is 'Good Money' for the Global Digital Era
There are many facets to discussing and understanding the potential role in the world of digital money such as Bitcoin. A great deal of the discussion focuses on what I would describe as “policy issues” – e.g. what market and policy mechanisms are needed to ensure price stability, combat financial crime, ensure tax compliance, and provide adequate protections to consumers holding these assets. While important, these issues are distinct from a more imperative discussion around the essential characteristics of the underlying asset itself.
One of the most common statements made about Bitcoin is that it holds no intrinsic value. Gold, under popular perception, holds immense intrinsic value. Fiat money holds value because it is backed by the credit of the governments who issue it. But neither of these currency formats makes much sense in our modern world of international trade and commerce. So what form of “good money” should we support as we build a 21st century, globally integrated, Internet-based world economy?
I want to focus on the argument that Bitcoin lacks physical traits that make it “good money,” unlike gold or other precious items such as diamonds, or the reputation and credit-worthiness of governments and their associated proprietary payments rails. Indeed, I believe that Bitcoin holds value as a form of “good money” that is superior to any previously discovered or developed form of money.
Gold became money when users discovered it holds characteristics that made it a strong form of currency. Gold is divisible, and given its unique chemical composition, extremely difficult to counterfeit. As a physical commodity buried in the earth, gold is scarce, which also makes it attractive to its users. Finally, and critically, gold is a physical asset that can change hands, a bearer instrument. This idea that value can be transferred by simply giving a physical object to another person is fundamental in the history of human perception of value. It also explains why 85 percent of the world’s retail transactions are still performed using physical currency.
For centuries, these core traits drove gold to dominate world trade. Through the Industrial Revolution, during the growth of global commercial banking, and after World War II, the gold-backed dollar became the foundation of the world economy. It wasn’t until the 1960s that a recovering Germany and a war-immersed, massively indebted US government broke with the gold standard and decided that a politically independent form of money no longer mattered. However, Nixon’s abandonment of the gold standard in 1971 and the birth of fiat money are not the end of the history of currency.
Bitcoin may herald the dawning of a new age in currency. It holds superior traits as a form of “good money.” As a tangible form of asset (its core tangibility being its mathematical basis), it could become an incredibly important building block for the 21st century’s global economy.
At the foundation of Bitcoin’s intrinsic value is the proof-of-work system that regulates the discovery and distribution of bitcoins and is anchored in the aggregate computing energy required to secure the Bitcoin network. This self-regulating mechanism defines the core economic value of the units of account, independent of their trade or exchange value. Further, this energy and computing power bound paradigm creates a dynamic such that, as economic activity in Bitcoin expands, it naturally drives humanity to find sources of energy efficiency, thereby aligning Bitcoin with our global need for sustainable, inexpensive energy sources.
Bitcoin’s near infinite divisibility and computational verifiability make it a highly attractive global unit of account. Value can be expressed and exchanged in micro-cents, and the ownership of these units of account can be instantly and independently verified by any transaction counter-party.
Bitcoin offers ubiquitous distribution and reach. Unlike existing forms of money, Bitcoin has the reach of data and the Internet, a medium of exchange (software, the Internet, mobile devices) now reaching nearly 3 billion humans. Bitcoin can be programmed, metered, and exchanged by connected devices, enabling more efficient usage of our planet’s resources and services.
By design, Bitcoin is a scarce resource with a predictable supply of new issuance. And it is this scarcity and predictable supply that make it so attractive as an underlying asset to bind to economic activity and trade. Bitcoin is also politically independent. It belongs to the commons, a technology based on open intellectual property and the Internet. As we work towards building a more globally integrated society and economy, it seems increasingly critical that the form of money that binds us not be tied to any single nation-state.
Naturally, policy makers and central bankers should be asking questions and trying to understand the implications of this profound invention. Importantly, like the centuries of global trade that were supported and mediated by a nation-state independent gold-backed monetary policy, we now need to begin to think about a world of digital asset backed monetary policy and how to integrate and support innovations like Bitcoin into the mainstream of world trade.
This post first appeared on Business Insider.