Cool Video: CNBC Fast Money: Bitcoins

This Cool Video is my appearance on Fast Money yesterday (Dec 2) discussing the Bitcoin. I suggest that there may be a role for digital currencies, of which Bitcoin is simply the best known. However, claims that it can replace the dollar or other currencies seems quite a stretch 

A major bank research note on Bitcoins, said that they are "more interesting than the IMF's SDRs from a reserve manager perspective because it is independent of major currencies". The report went on to say that "Reserve managers will not be the first to adopt internet currencies but they have incentives not to the best last and that the US dollar would likely be undermined on its international role, were this to occur."

I, for one, don't have a clue what this means about incentives that central banks have not to be the last. The analyst's assessment begs the question: How do central banks think of reserves ? Typically, there is an emphasis on liquidity, security and return. Most of the reserves are not kept in cash. Economists generally agree that the depth and breadth of the US Treasury market underpins the dollar's role as the most important international currency. The digital currencies, including the Bitcoin, have no bond market and have no yield. On top of this add the fluctuation of the Bitcoin. It is too great.

There are critics of paper money, which is regarded as legal tender by government fiat (they command it to be so). What makes the Bitcoin any different ? It is not backed by gold or silver or any asset. It is money because some people say it is. This clearly runs counter to claims by such economists at Hayek, a favorite of the libertarian/anarchist faction, of what money really is.  

It is understandable why some (and that some is still very limited) vendors are willing to accept Bitcoins. It is a marketing stunt to attract business. It is interesting what they will do with the Bitcoins they receive. One start-up company, in what has been dubbed the Bitcoin ecosystem, called Bitpay, allows a seller to accept Bitcoins, without really knowing anything about it and automatically converts it into the seller's local currency. A merchant accepting Bitcoins takes on currency risk that they often do not want.  

The real issue is not, as some would have it, whether digital currencies are for real or just a speculative bubble/fad. There may be a useful economic function of digital currencies to help facilitate internet commerce.  This is still to be determined. It is a far cry from supplanting national currencies, including the US dollar. 

There seems to be a lot of sloppy thinking about Bitcoins, as many get caught up in the polemical zeal.  To claim it has first mover advantage is to confuse analogy with argument.  Tell Netscape about first move advantage or Yahoo's search engine.  It misses a more important consideration.  Think about the QWERTY keyboard.  There may be better, more ergonomic designs, but it cannot be just a little better to get people to switch.  It is not clear what Bitcoins offer that paper money does not.  To claim that it is superior because its offers anonymity is not fully true and it is not a compelling argument that Bitcoins lend themselves illicit activity.

The value of the discussions about the Bitcoin may lie with spurring thinking about money in general.  What makes money money?  Economists generally see three attributes of money:  a means of exchange, a unit of account and a store of value.  Being a means of exchange requires a large number of people and businesses willing to transaction in it.  A unit of account requires that a broad range of goods, services and financial instruments and measures are denominated in that currency.  A store of value implies some stability and reliability. 

Under present conditions, the Bitcoin and other digital currencies are hardly units of account or a store of value.  They still are working on acquiring the network effect of increasing the people and businesses who will use it.  One survey found that more than 2/3 of the Bitcoins are being hoarded.  Therein lies what we have called a fundamental contradiction.  The more the Bitcoin is embraced as an alternative to paper money (though remember it too is not backed back precious metal or commodities or anything) and is hoarded, the less it will be used as a means of exchange.  The less it is used a  means of exchange, the less likely it will achieve the networking effect that is needed for its "money-ness" quality. 

A Dali painting may be a good store of value and some one may  use it to retire a financial obligation.    It still is not money.    Substitute Bitcoin for the Dali painting and the result is the same.