On occasion I have taught an economics class at the local community college. To begin a discussion of money, I would offer students a $10 bill (which is just a printed piece of paper) or an equal size piece of white paper. Of course, every student took the $10 bill.
The students took the $10 bill because from experience they knew that this was money. They knew others would accept it as payment (a medium of exchange). They knew it would have value next week and the weeks after (a store of value). They had a sense of what $10 would buy in the current economy (a measure of value).
Throughout our history we have used many things as money including gold, silver, shells, furs, tobacco and our current Federal Reserve notes and coins. Some have worked better than others. We can now add Bitcoins to this list.
Bitcoin is a virtual currency created in 2009 by an unknown person(s) using the alias Satoshi Nakamoto. The goal was to create a currency that could be used anonymously worldwide outside the control and regulation of banks or governments.
Several Bitcoin exchanges exist which allow people to buy and sell Bitcoins that are stored in digital wallets. Think of the wallet as a digital bank account that you can use to send or receive money and pay for goods and services.
New Bitcoins are created by a process called mining. Think of mining in the sense of mining for gold. But in the case of Bitcoins, the mining is done by solving complex mathematical problems rather than digging in the dirt. The idea was that mining for Bitcoins would be as difficult as mining for gold.
When the Bitcoin algorithm was created, a finite limit on the number of Bitcoins that will ever exist was set at 21 million. Of those, 12 million are in circulation leaving only 9 million still to be mined.
All this said, for Bitcoins to be accepted, they must ultimately meet the definitions of money like the $10 bill I offered my students or they will go the way of shells, furs and tobacco.
Bitcoins are becoming more accepted as a medium of exchange. Although the number of major companies who accept Bitcoins is now very limited, the field is expanding. Companies such as Overstock.com, TigerDirect and Zynga are current examples of those that accept Bitcoins and there are thousands of others mostly small and online.
However, Bitcoins have many problems to overcome before they gain the trust of the general public. For example, the value of Bitcoins has been fluctuating wildly. Last December, the value of a single Bitcoin hit an all-time high of $1,200 but has recently been valued at less than $500. This sounds more like a speculative investment than a medium of exchange.
This week Bitcoins took a serious hit when Mt. Gox, one of the largest Bitcoin exchanges, filed for bankruptcy. The CEO blamed hackers for the loss of 850,000 Bitcoins worth $425 million at recent prices. It is estimated that 600,000 people in the United States had Bitcoins tied to Mt. Gox. Think of this as Bank of America suddenly disappearing and no one knowing where all the money went.
The anonymity of Bitcoins also makes it attractive to those dealing in illegal activities and money laundering. Not to mention what hackers might do.
However, a respected financial company, SecondMarket, thinks enough of Bitcoin to become the first United States Bitcoin exchange. And in a congressional hearing this week, Senator Joe Manchin felt it worthwhile to question the new Federal Reserve Chairman, Janet Yellen, about Bitcoins. Her answer was that “The Federal Reserve simply does not have the authority to supervise or regulate Bitcoin in any way since it functions outside the banking system.”
Whether Bitcoins will be become a commonly accepted form of money or remain the haunt of speculators and techies may take years to determine. But who knows, maybe in a future economics class I will have to offer the students the choice of a Bitcoin or a white piece of paper.
Charles Wilkinson, Publisher