http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2295134Crypto-currencies are digital alternatives to traditional government-issued paper monies. Given the current state of technology and skepticism regarding the future purchasing power of existing monies, why have crypto-currencies failed to gain widespread acceptance? I offer an explanation based on network effects and switching costs. In order to articulate the problem agents considering crypto-currencies face, I employ a simple model developed by Dowd and Greenaway (1993). The model demonstrates that agents may fail to adopt an alternative currency when network effects and switching costs are present, even when all agents agree that the prevailing currency is inferior. The limited success of bitcoin — almost certainly the most popular crypto-currency to date — serves to illustrate. After briefly surveying episodes of successful monetary transition, I conclude that crypto-currencies like bitcoin are unlikely to generate widespread acceptance in the absence of significant monetary instability or government support.
