In Chapter 3 of Escaping Oz, we talked about deflation and some of the things that both precipitate and intensify it. One of those examples was currency/credit substitutes. One such substitute was something called a Bitcoin. A Bitcoin was an electronic currency not subject to issue by a central authority. It was important to bring up the existence of Bitcoins as support for the deflation argument. If the public begins to transact more with alternate forms of credit vs. the dollar or other currency units, there is less need for conventional forms of credit/currency.
One of the challenges of any new form of currency is to ensure it meets accepted definitions of money. Using Webster’s dictionary, money is a medium of exchange, a measure of value or a means of payment. The definition of money in Escaping Oz was, “a medium of exchange, that is a unit of account, and a direct store or representation of wealth.” While Bitcoins satisfy Webster’s definition, they do not satisfy ours. The Bitcoin is not a direct store or representation of wealth. This is not to suggest that our present forms of money satisfy this criterion either. But to look at Bitcoins as an intrinsically superior currency is inaccurate.
The Bitcoin phenomenon also created a speculative bubble. Bitcoins were trading as high as $30 until falling steeply in price to half its peak. Recently, there was a hack on an account in the online Bitcoin exchange, Mt. Gox. The hack involved going into someone’s account and selling all their Bitcoins, an estimated $500,000 worth. This dropped the value of Bitcoins to $0.01 in a matter of minutes. Interestingly enough, the price fall did not show up in other Bitcoin exchanges. This is interesting by itself that a market could be so discontinuous that it could contain a price crash to a single exchange. The Mt. Gox support blog is filled with disgruntled customers ready to take legal action. The exchange indicated they would try to roll back transactions to a point before the crash. However they accomplish the matter, it will be messy and there will no doubt be a breach of public trust. Such declines in confidence are harmful to the existence of a currency. We have never recommended Bitcoins as an “investment” per se but certainly acknowledge the potential impact of these alternative currencies in the future. Whether Bitcoins survive we believe is secondary to the fact they came to exist at all.
Jim Mosquera is the author of Escaping Oz: Protecting your wealth during the financial crisis and is the editor of The Sentinel Financial Report.
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