ECON430-Topic #2: Bitcoin and Central Banking

Bitcoin is the most popular of the new phenomenon of crypto-currencies. One of the main reasons there appears to be so much buzz about the virtual currency is that there is a definitive limited amount of the currency. Like gold, Bitcoin has a limited amount of currency ever available meaning prices of all goods are expected to fall over time. Unlike fiat currencies which have increased in quantity over time and led to rising prices. However, there are currently 516 crypto-currencies trading on the open market, implying that there are an infinite number of ‘finite’ currencies. So, it could be that the finiteness of crypto-currency is not a novelty after all. Does this undermine the ability to declare Bitcoin the end of government control of currency? Does this eliminate the credit created by banks, or do people demand credit in a way that Bitcoin cannot foreseeably provide?

The current market capitalization of Bitcoin is around $5b USD, selling at a price of around $380. While this is down significantly from the all time high of around $1,110 in December last year, it is still nearly three times higher in value than it was just a year ago. Compare this volatility to other globally accepted currencies and see if Bitcoin (or any other crypto-currency) measures up as a reasonable store of value. While Bitcoin is the most popular crypto-currency, it may not yet measure up as money if it does not serve the reasonable functions of money. Compare Bitcoin to other forms of money to help you determine if it can serve as money.

One 0ther possibility is that these crypto-currencies will never develop into full-fledged money that competes with central bank and bank developed money. For example, the website Reddit is introducing their own cryptocurrency to award their contributors and users. It is doubtful that the recipients of this crypto-currency would expect Reddit to be the only issuer of currency in the world. What role do you think these types of crypto-currencies will play in the future if Bitcoin (or some other) does not actually develop into a currency? What role will crypto-currencies play? Are they a fad, or are they here to stay?

As many countries attempt to devalue their currencies at once, we may be experiencing a race to the bottom. Inflation in the U.S. is low, with expected inflation rates of around 1.7% over the next several years. The ECB is also dealing with low inflation, and even deflation in countries like Italy. Falling global inflation rates have likely contributed to the falling price of gold, a typical inflation hedge. Countries trying to ease credit terms have increased their money supplies at relatively more rapid rates than before the financial crisis, and the ECB is easing the types of activities it is conducting. While this might be inflationary in the long term, it hasn’t created inflation to date, nor has it raised inflation expectations among the general public. Is this general easing of credit conditions expected to stabilize markets which have suffered large price declines (e.g., housing) and allow for more labor market and credit market flexibility? Would this flexibility open up the economy to a more rapid recovery? Or should we simply allow the economy to take the necessary time to return to a healthy state? What role should fiscal policy play in this economic reconstruction if any?

There are a lot of questions I posed above, so pick one and go with it.

13 thoughts on “ECON430-Topic #2: Bitcoin and Central Banking”

  1. The exchange rates between the dollar and the over 500 different cryptocurrencies are wildly different. Bitcoin is currently running at $370.18 per BTC. The second highest market capitalization on a cryptocurrency is Ripple (XRP). The dollar to XRP rate is less than half of one cent. (coinmarketcap) That’s only because Bitcoin is the most popular and most well known. As miners hit cryptocurrency ceilings, the demand for other substitute cryptocurrencies (that can be created by anybody with a computer and experience in coding) will increase, and the price of those substitutes will increase to the price level of a Bitcoin, and eventually prices will all move together.

    So what does this achieve? Absolutely nothing. Bitcoin had the novelty of being similar to a gold standard that would control inflation, but since they can be created out of thin air, how is it any different than the Fed printing off dollars and causing inflation? It becomes electronic cash that rises and falls just like the dollar does, and is basically no different than a government issued currency. Without a regulatory agency to control how much currency can be created, Bitcoin could potentially have worse inflation than a government issued currency. Because of this, Bitcoin doesn’t successfully avoid the dangers of a government currency that it’s trying to skirt.

    One of Bitcoin’s claims to fame is that you can make these transactions without the need for a middle-man, such as a bank. (Bitcoin Business Model) While that may be true, it’s not necessarily a good thing. In a world where computer developers are at a race to the top, hacking into someone’s private network is easier than ever. It wouldn’t be all that hard to steal someone’s Bitcoin, which makes your personal “wallet” almost as open source as the currency. (Network Cultures) To avoid this, you could use it only to make transactions (instead of holding Bitcoin in your Wallet for an extended period of time) but in that case, you might as well just use cash or credit. (ESPECIALLY if you’re using Bitcoin for illegal activities; the paper trail is still there with Bitcoin.) Once you look at the way it works and compare it to your other options, Bitcoin seems pointless.

    http://coinmarketcap.com/currencies/ripple/
    https://bitcoin.org/en/how-it-works
    http://networkcultures.org/moneylab/2013/12/19/media-narratives-on-bitcoin-common-arguments-against-the-crypto-currency/

  2. Bitcoin probably couldn’t take over as the main source of currency. However, even if it did, there is no way that Bitcoin could lead to the end of government controlled money. This is due to the fact that even if Bitcoin takes the lead over the dollar, the government and the Federal Reserve will do everything in their power to try and then control and stabilize the price level with respect to Bitcoin. But for Bitcoin to even have a chance to take over the dollar, we have to look at why Bitcoin is even ahead of the other 500+ crypto-currencies. This is primarily due to faith. The reason why the dollar is still the leading currency in the U.S. is because people know that the dollar will never completely lose its value. Whether we look ahead to tomorrow, or 40 years from now, we believe the dollar will somewhat maintain its value and will be worth something anytime we want to use it. Other crypto-currencies could not figure this out because of technological problems. People don’t trust that their “online money” will always be there. With Bitcoin, although the value changes rapidly, people have faith that their Bitcoin will always be there because of the safeness that comes with this crypto-currency compared to others.
    The one main flaw of Bitcoin is its tangibility. People believe in the dollar because they can go to the bank and take out tangible cash to hold onto. Early Bitcoin adopter Mike Caldwell saw this problem and actually created “fake” Bitcoin to try and show people a tangible view of the currency. A picture published by George Frey of this currency has become very popular. Caldwell says he created the fake money because “No one is going to get this if I can’t show the something,” referring to the tangibility of Bitcoin and how it will never take off as an investment if people can’t see it.

    http://www.bloomberg.com/news/2014-09-30/what-s-a-bitcoin-look-like-popular-photograph-has-story.html

  3. Volatile, unsecure, and limited, all adjectives used to describe Bitcoin. Although those words describe Bitcoin fairly well, does it mean Bitcoin is something not worth getting into? Running Bitcoin against the principles of actual money, we may find it is not worth getting hold of, cryptically speaking of course. It does not appear to be a good store of value, seeing as it was trading at .75BTC/$1 in early 2011 to a high of $980/1BTC according to coindesk.com. [1] Bitcoins worth as a standard of deferred payments is only as good as its ability to be exchanged for cash, which was the only concern for the Lamborghini dealer in California who accepted BTC for a Tesla Model S. [2] This problem also describes Bitcoins use as a medium of exchange and a unit of account. So, does Bitcoin have the potential to undermine current governments’ ability to control monetary policy? And can it provide credit in today’s modern financial arena?
    As of right now, there is not foreseeable future with Bitcoin as the end all to government’s control of currency. As long as governments do not accept Bitcoin as a form of tax payment, then it cannot ever have a full “take-over” of currency. While Bitcoin is extremely volatile, Bitcoin is trading against other currencies at a different rate than the U.S. dollar. [3] This implies that Bitcoin holds value other than that of the US dollar. However, what that value relates to is up for debate. Is it a currency or a commodity? According to the U.S. government, bitcoin is property subject to capital gains taxes. [4]
    In conclusion, it seems as though Bitcoin cannot provide credit in a way that is demanded by the public. It all ties back into Bitcoins ability to act as a secure store of value. The volatility associated with Bitcoin in just the past year would send borrowers and lenders crazy. What’s more, Bitcoin doesn’t have an intrinsic value, meaning its perceived value is for the most part associated with its exchange price. The only thing keeping Bitcoin up is business’ acceptance of payment through bitcoin. It seems as though Bitcoin is headed for a dismal future.

    Citations-

    [1] http://www.coindesk.com/price/
    [2] http://www.bloomberg.com/news/2013-12-06/bitcoin-meets-tesla-in-california-dealership-model-s-transaction.html
    [3] http://www.bloomberg.com/news/2013-12-23/bitcoin-more-speculative-than-real-currency-study-finds.html
    [4] http://www.bloombergview.com/quicktake/bitcoins

  4. “It’ll go down in history as the destroyer of the dollar,” said former Senator Ron Paul about Bitcoin. There is no doubt that the idea of using a single cryptocurrency is a controversial topic in the financial community, and for good reason. Some believe that Bitcoin is the currency of the future because of its lack of third-party intervention (i.e. no taxing, transaction costs, and no tracking). However still others believe that Bitcoin is unrealistic due to the lack of buyer protection, the built in deflation and the fluctuation of Bitcoin’s price. All of these characteristics are relevant to the conversation about if Bitcoin will soon replace government mandated currency, however the most important issue is: how will the government employees react.

    Currently, the United States government employs 6.9% of the workforce, which is a decrease from the last twenty years. If Bitcoin were to truly take precedent over the dollar, these government workers would be trying to buy Bitcoin with dollars that would be essentially worth nothing. The only way that Bitcoin could succeed is if the government decided to switch to Bitcoin to pay their employees. However, it is difficult to believe that the government would do so without being able to trace or tax the currency and if they do get to regulate the Bitcoin then it defeats a large part of the purpose of this particular cyber-currency and leaves demand for others.

    http://money.cnn.com/2013/12/04/technology/bitcoin-libertarian/

    http://cs.stanford.edu/people/eroberts/cs201/projects/2010-11/DigitalCurrencies/advantages/index.html

    http://cs.stanford.edu/people/eroberts/courses/cs181/projects/2010-11/DigitalCurrencies/disadvantages/index.html

    http://www.forbes.com/sites/mikepatton/2013/01/24/the-growth-of-the-federal-government-1980-to-2012/

  5. While Bitcoin began in 2008 as a response to the global financial crisis and an attempt to overcome the shortcomings of our global financial system, it has rapidly transformed into a growing economic force and a unique experiment for new ideas about money, value, and methods of buying and selling. In an era of e-commerce, where paper money is becoming more and more difficult to come by and everything is done electronically, Bitcoin and similar crypto currencies may have more of an impact than people initially thought. While “it won’t replace the dollar or euro”, states Jerry Brito, an analyst at the Mercatus Center of George Mason University, it does compete with similar payment technologies such as PayPal and offers many advantages, one of these advantages being the lack of a middle man in transactions. Excluding cash, most payment systems require a middleman (typically a bank) to transfer funds to the seller’s account from the buyers account. Bitcoin allows buyers and sellers to deal directly with each other which, Brito claims, can create enormous savings . While some worry this lack of regulation by a middleman could lead to counterfeiting and individuals reusing the same unit of currency over and over, Bitcoin’s pseudonymous creator, Satoshi Nakamoto, came up with a solution to this issue. His solution is an online ledger that anonymously records every Bitcoin transaction. Bitcoin “miners” create this ledger through code-breaking work that is designed to be difficult and resource intensive so that the amount mined remains steady each day.

    This is a technological era where innovative thinkers are leading us in directions that neither they nor we fully understand. Despite Bitcoin’s many advantages over other payment technologies in virtual world, its volatility still makes it a financial gamble. Towards the end of 2012, the price of 1 Bitcoin was roughly $10 US dollars, by the end of 2013, it had reached close to $1,000 and today 1 Bitcoin is currently worth about $355. This extreme volatility creates an uncertain future for Bitcoin and its acceptance in society, and only time will tell if it will succeed as a electronic payment method and generate wealth.

    http://www.forbes.com/sites/paularosenblum/2014/01/27/bitcoin-the-currency-of-the-future/

    http://eds.a.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=11&sid=1f527f8e-1db9-4548-a1a1-c49dcf6d626c%40sessionmgr4002&hid=4113

    http://www.bloombergview.com/quicktake/bitcoins

    http://www.economist.com/blogs/economist-explains/2013/04/economist-explains-how-does-bitcoin-work

  6. The ECB needs a policy change before the entire European zone starts experiencing deflation. During September the euro zone had an average inflation rate of .30% which is far from their goal of just below 2.0% inflation. During these low inflation periods some countries are even experiencing deflation such as Italy (-.1%), Belgium (-.12%), Greece (-.8%), and Spain (-.2%). Currently the stimulus program for the ECB is to purchase bank loans and give banks cheap loans to increase liquidity and lending. The ECB has a benchmark rate of .05% which is about as low as the rates can go. These instruments are targeting making credit cheaper and more abundant for companies, in the hope that companies will borrow, expand and hire. This policy effect on inflation is still unknown, and will not be known for months until it is given time to take full effect. Which is why the ECB should change their strategy because even if the rise in employment does happen it is unknown if the inflation will increase enough to achieve the rough goal of 2.0% inflation. The ECB needs to start devaluing the Euro through large scale bond purchases, or quantitative easing. A lower euro will help raise inflation and it will increase exports because goods will be cheaper for foreign markets. A combination of raising employment, decreasing interest rates, and devaluing the currency through quantitative easing will raise inflation quicker to Europe’s 2.0% goal. If the ECB is ineffective in changing inflation it could risk Europe falling into a deflation trap, where consumers postpone spending to wait for lower prices and debts will rise each time inflation falls. So it is time for the ECB to show that it has the authority and capability to fix this crisis by expanding the money supply and returning inflation to its targeted goal.

    https://www.ecb.europa.eu/home/html/index.en.html
    http://www.tradingeconomics.com/euro-area/inflation-cpi
    http://uw8rw3ad9q.search.serialssolutions.com/?genre=article&issn=00999660&title=Wall%20Street%20Journal%20-%20Eastern%20Edition&volume=264&issue=78&date=20141001&atitle=Italy%20Woes%20Highlight%20Dilemma%20For%20European%20Central%20Bank.&spage=A14&pages=&sid=EBSCO:Business%20Source%20Complete&aulast=LEGORANO,%20GIOVANNI
    http://www.newsobserver.com/2014/10/02/4199940/european-central-bank-to-detail.html

  7. This fad of crypto-currencies will definitely be out since it is one of the most risky short term investments. Most people find themselves worrying about the short-term when they invest and will find that a crypto currency that can fluctuate within $700 a year, clearly should throw up a red flag that it is not stable. The stability of the currency plays a huge role when it comes to the demand for credit. In a time that interest rates are a mere 0, borrowing is keeping the economy afloat. The economy bounced back from the pitfall that it took in 2008 due the Modern Monetary Policy that was instated.
    With crypto-currencies and the finite amount of currency in circulation prices would be extremely low and there would be no way to increase that meaning the economy would be in constant deflation which is not good for any economy. So the argument of this fad becoming a real “permanent” currency is a hoax and folds on itself.
    In terms of credit, consumers would essentially not have a way of financing a new car, home, remodeling, or really anything that would require them to start a line of credit to do something new that requires a greater amount of capital than one possesses. Bitcoin cannot provide credit how consumers are used to having it and due to the reliance on credit and crypto-currencies lacking it makes them a non-threatening substitute, or a game when compared next to the dollar or ANY REAL currency.

    http://www.bloombergview.com/quicktake/bitcoins
    http://www.bloomberg.com/news/2013-11-11/race-to-bottom-resumes-as-central-bankers-ease-anew-currencies.html
    http://online.wsj.com/articles/italys-economic-woes-highlight-dilemma-for-european-central-bank-1412110302

  8. The problem with quantitative easing and other easing methods by central banks is that it is having nowhere near the desired effect central bankers thought it would. Pumping money in to the system will not be able to return the economy to a health state until the psychological effects of the financial crisis wear off.
    The whole lending process is almost at a stand still as lenders and borrowers are cautious, still reeling from the beating they took in 2008. The idea is that central banks will buy up assets, which will increase reserves, which will in turn lead to loans being made and an increase in money supply through the multiplier effect. Without loans being made, the increase in money supply is limited to the amount that central banks put in to the system.
    The Fed is also not giving banks any incentive to loan their reserves out, rather they are giving them incentives to do the opposite. The Fed is giving banks interest on reserves held with them. This is a risk free asset while loans come with a large amount of risk, which was never made more evident than during the financial crisis. Higher capital requirements that came as a result of Basel III give banks even further reason to not lend money out.
    So what does this all boil down to? Until lenders and borrowers gain confidence in the economy, the measures central banks take won’t be able to return the economy to a healthy state. Quantitative easing and the low interest environment might put the economy in a better position than it would be but until confidence in the economy returns, nothing will be able to fix it.

    Source:
    http://www.forbes.com/sites/francescoppola/2014/01/21/banks-dont-lend-out-reserves/

  9. Bitcoin cannot be conceived as money simply because it does not serve the basic functions of money; such functions as 1) store of value and 2) medium of exchange.
    1) Bitcoin has seen drastic changes in its value since its creation. Quoted at over $1100 in December 2013, it has fallen %67 to today’s value of approximately $360. Not only are long-term changes significant, but daily/weekly fluctuations make BTC appear more like a stock than a currency. Just today, 10/9/2014, BTC has bounced around between a high of $382.67 and a low of $347.19. On the other hand, internationally accepted forms of currency are not susceptible to the same instability. Using the same time frames as BTC, the US/Euro exchange rate has only changed 5.4% and has daily fluctuations of less than 1%. BTC’s do not hold value over time compared to currency like the $US and the EURO. Because of this, Bitcoin will not become a currency because no one will take on the risk of keeping their wealth in such a volatile asset.
    2) Only in very rare situations can one walk into a store a purchase a good/service with Bitcoin. This means that BTC fails as a medium of exchange. In order for a currency, it needs to be acceptable at a national/international level. Although the prevalence of companies that are accepting BTC (Dell, Cheapoair.com, Overstock.com, and a few BTC denominated sites) is growing, BTC will not be a ubiquitous medium of exchange for a few reasons. Firstly, Unlike $US, BTC cannot be split up into smaller values which means that one cannot purchase good/services unless they cost whatever the value of BTC is at that time. Lastly, there is a finite amount of BTC that can be created so there would not be enough liquidity to meet the trillions of dollars of annual exchanges in the US if it were to serve as the primary currency.

    Because BTC does not meet these requirements for monetary exchange, it will not evolve into a widely accepted currency. Right now it is a fad, a commodity to be invested in, and will continue to be no more than that until people come to their senses.

    http://www.oanda.com/currency/historical-rates/
    http://www.bloombergview.com/quicktake/bitcoins
    http://www.coindesk.com/information/what-can-you-buy-with-bitcoins/
    http://www.coindesk.com/price/

  10. Global economic growth in the first quarter of 2014 was reported a full percentage point lower, at 2.75%, than from the growth experienced in the second half of 2013.The idea behind the easing of credit conditions is to help spark economic activity and growth. Countries trying to ease credit terms have increased their money supplies at relatively high rates with a potential underlying theme to increase consumption. This increase in consumption is supposed to increase aggregate demand resulting in a shift outward and an increase in price level. It also is supposed to stabilize markets that have suffered from large price declines like the housing and markets. Increased consumer spending is supposed to increase home buying, which would bring the price level up. Additionally, businesses will borrow more and desire to take on more projects, leading to an increase in demand for labor, increasing wages. Theoretically, the easing of credit conditions and an increase in the money supply is supposed to result in these positive effects on a countries economy like the U.S. However, this scenario has not led to an increase in inflation or expected inflation. Rather, the U.S. is experiencing low inflation and part of the reasoning can be explained through the current level of interest rates.

    As a result of the financial crisis, U.S. interest rates reached historical lows as the demand for money collapsed and employees were laid-off in large numbers. Although fluctuating moderately at times, rates are currently low with short-term rates hovering under 10%. Interest rates rise as an economy exits a period of negative or slow growth, and increased growth creates a greater demand for money. Taking it a step further, if the Fed temporarily raises interest rates it potentially could create a greater demand for money. With eased credit conditions, a greater demand for money could lead to an increase in consumption, which would spark economic growth, leading to higher inflation and expected inflation.

    http://helenair.com/business/interest-rates-express-unfiltered-view-of-economy/article_0cf168a0-acfc-5b25-8ac5-3a917c02cf9c.html

    http://globalpublicsquare.blogs.cnn.com/2014/09/17/world-remains-glum-about-economic-prospects/

    http://online.barrons.com/articles/kicking-into-higher-gear-1412799391

    http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=2014

  11. Since the inception of Bitcoin in 2008, there has a been a split between people who believe that it will soon mark the end of government controlled currency, while another group believes that it is just the next new fad and will soon meet the fate of other crypto-currencies. Bitcoin’s recent steady decline in value has again brought this divide to the forefront as each side have opposing viewpoints to why it’s happening. Proponents of Bitcoin are as optimistic as ever because they may be “simply more tuned in to the currency’s long-term potential than the broader market” (1). Although Bitcoin has dropped below $400 since reaching a high of around $650 in July, many Bitcoin fans will counter this with “Bitcoin has been far less volatile than in the past” (2). Even with this ‘lower’ volatility can Bitcoin actually survive as a currency? When compared to other currencies the answer is pretty clear. Looking at the Argentinian peso, over a span of 3 months from Nov 13’ to Jan 14’, it devalued against the dollar by 30% which sent the country into bankruptcy (3). One of the main functions of money is that it has a store of value. If the past is any indicator, Bitcoin clearly doesn’t. With the current volatile state of Bitcoin, if it served as the sole or main form of money, imagine if one day it was valued at X amount and the next week it depreciated by 30%. The change in asset’s nominal value would cripple an economy.

    (1) http://time.com/money/3479199/why-bitcoin-fans-dont-believe-in-bad-news/
    (2) http://fortune.com/2014/09/19/the-value-of-bitcoin-keeps-sliding/
    (3) http://www.x-rates.com/graph/?from=ARS&to=USD&amount=1.00

  12. Cryptocurrency has been one of the biggest topics discussed in the past year by the economic world on whether it will be the currency of the future. People have appraised cyptocurrency believing it will make banks obsolete and how it will cut transaction costs while skeptics believe it is too volatile and it seems to be another fad. Cryptocurrency is still in its experimental phase and appears it will not gain the momentum needed to be the currency of the future.

    Cyrptocurrency is what technology experts’ dream of while business experts look at it in actuality. When cryptocurrencies like Bitcoin and Dogecoin have good publicity, their values increase. For instance, on December 5th, 2013 a man brought a Tesla model car using Bitcoin. Around that same day, Bitcoin hit its highest peak ever at $1,500. The same can be seen with Dogecoin. When the doge meme hit its peak in February (using Google Trends), it so happens that the peak of value for the dogecoin also happened in February.

    Another reason cryptocurrency will be nonexistent in the future is because the technology for it will never be able to keep it safe. No matter how encrypted it may be, there will always be someone ahead of the technology to exploit it. Businesses and people will never fully trust the currency that can be DDoS attacked, or the value drastically change in a short period of time.

    http://www.cityam.com/1408388669/why-bitcoin-won-t-be-money-future-cryptocurrencies-might-be
    http://www.darkreading.com/risk-management/bitcoin-meet-darwin-crypto-currencys-future/d/d-id/1127655
    http://www.google.com/trends/explore#q=doge%2C%20dogecoin&cmpt=q
    http://coinmarketcap.com/all/views/all/

  13. If crypto-currencies do not end up developing into a currency in the long term, roles in niche online communities seem likely. The relative anonymity involved in a crypto-currency such as Bitcoin has use in communities like Silk Road where users want to pay for goods and services without information linking the transaction to anyone. Reddit’s planned crypto-currency (though very early in development) may end up functioning solely as a reward system for users based on contributions. Users would receive coins based on their contributions to the site, which can be used to purchase equity in the site. Shares would end up being bought, sold, and traded between users. Though one would expect more than just Reddit to be issuers of the currency, it may end up functioning as a reward system or even a premium membership feature for the site’s more dedicated users. Reddit Gold is Reddit’s current premium membership, which offers special features and benefits from the partners of Reddit. Several companies including UPS and Android offer coupons and discounts on various goods and services. Though Gold subscriptions can either be paid for or gifted to other users, it is easy to picture a system in which its planned crypto-currency functions as a payment for Gold or could be used towards goods and services from Reddit’s partners. In the future, crypto-currencies will assume a niche role in online communities in which they will act as currencies within certain sites or be used towards things such as special features or gift cards for featured partners of these sites.
    https://www.reddit.com/gold/about
    http://techcrunch.com/2014/09/30/reddit-scoops-up-50m-series-b-from-sam-altman-a16z-sequoia-at-500m-valuation/
    http://nakamotoinstitute.org/bitcoin/

Leave a Reply

Your email address will not be published. Required fields are marked *