Every day I see people asking similar questions regarding the speculation and economics behind Bitcoin. I wrote this essay in the hopes of creating a source where newcomers could get answers to questions like:
- Why does
BTCitcoin have value?
- What needs to be done in order to achieve widespread adoption?
-What it will mean for society and economics in the long run?
Hopefully this essay will help the reader gain a better understanding of why
BTCitcoin has the potential to change world economics for the better.
Enjoy!
http://www.scribd.com/doc/189353359/An-Introduction-to-the-Basis-for-Speculation-and-Potential-Value-in-the-Widespread-Adoption-of-Bitcoin-and-Crypto-CurrenciesAn Introduction to the Basis for Speculation and Potential Value in the Widespread Adoption of BTCitcoin and Crypto-Currencies
Precursor
I decided to write this paper to address the widespread and often misunderstood speculation regarding the economics and potential value of crypto currencies, more specifically Bitcoin. I must start out by stating that I do not claim to be an expert in crypto currencies nor economics. My interest in the subject was sparked a few months ago and in that time span I have done significant research regarding the nature and speculation of crypto currencies. For those who question my background, I am currently a student studying Finance and Economics finishing up my final year to get my degree. In addition to the research I have done in this subject, I have applied knowledge that I have picked up at school to the claims in which I make in this paper. In this essay I will clearly outline why Bitcoin has value, the reasons which I believe Bitcoin has the potential to change the global economy, what needs to be done in order to make this speculative claim come to fruition, and state my beliefs on what this means for the future in terms of economic and social reform. I understand that many people who have been familiar with crypto currencies may already understand this information; therefore this paper is tailored more towards people who are new to the subject.
Why is Bitcoin valuable?
Throughout history, there has always been a necessity for a medium of exchange. If you can recall from your early school days, you may have learned about early civilizations in North America using the purple part of sea shells as a form of currency, known as “wampum”. The reason why I bring this up is because it’s a simple example that can be used to highlight the intuition behind understanding the concept of a medium of exchange. This wampum and modern currency’s alike including the Dollar, Euro, and Yuan, are all only worth something because the society who holds them believe their worth something because. Obviously, the purple part of sea shells has absolutely no value intrinsically. You may stop and wonder if the dollar is backed by gold, however the fact is that the United States government abandoned its commitment to convert dollars to gold in 1971. It is only due to the widespread belief that today’s fiat currency’s hold value that it allows it to function as a medium of exchange, and therefore allows the monetary system to operate successfully. So for those who don’t understand why BitCoin may hold any intrinsic value, the answer is that it doesn’t, and neither do the fiat currencies which you use every day. Bitcoin can only be considered valuable if the society at large perceives it as valuable. However, hopefully the later portions of this paper will explain why Bitcoin would end up serving as a better currency or “medium of exchange” than the modern forms of fiat currency which are used today.
The benefit in using Bitcoin over today’s fiat currency’s starts with the fact that it is decentralized. The supply of Bitcoin in the marketplace is determined by mathematical protocols and can under no circumstances can it be manipulated by human intervention. This is a good thing because throughout history we have learned or are in the process of learning that fiat currency’s which are manipulated by governing bodies have for the most part failed, or are in the process of failing. Actually throughout history there were 609 currencies that are no longer in circulation, of which 153 were destroyed as result of hyperinflation (Hewitt). Even last year, European currencies almost suffered hyperinflation as a result of the European Debt Crisis. Further, the question must be asked of where the dollar will be in terms of value in the years to come considering the enormous pile of debt that the United States is obligated to pay and its necessity to default on its debt ceiling each time it comes due. Also what is going to happen when the Federal Reserve stops pumping money into the economy with its quantitative easing program in order to keep the economy and financial markets artificially stable? If what we learned from history remains true and today’s fiat currencies don’t stand the test of time, then theoretically Bitcoin can serve as a viable form of currency when most or all other fiat currencies are in effect devalued. This assumption is derived from the fundamental nature of the currency considering that there is a finite amount of Bitcoins that can be mined (21 million) and the supply of the currency is not manipulated by a governing body. Bitcoin’s are created through a process where computer hardware must compute mathematical functions for a long period of time to be “awarded” a Bitcoin when solved. Also, for each sub sequential Bitcoin mined, it becomes harder for this computer hardware to mine the next one. These truths are a function of the protocol on which Bitcoin operates.
“Paper money eventually returns to its intrinsic value – zero.” (Voltaire, 1694-1778 )
Although the fact remains that Bitcoin is a decentralized currency, a dilemma arises in the way that it is set up to create a deflationary based economy opposed to the inflationary economy which we are all used to today. In an inflationary based economy, the value of a single unit of currency would decrease through time since there are more being created. As an example you may consider the inflationary nature of the dollar when the Federal Reserve prints money. In the case of Bitcoin, as more and more Bitcoin’s are mined, the effect would result in scarcity of the currency resulting in an increase value, especially if combined with an increase in demand. The resulting increase in value is compensated by the way Bitcoin is denominated to 8 decimal places. Therefore as the value of the currency increases, the value of .0000001 BTC may eventually be comparable to the value of 1 dollar in today’s marketplace.
Furthermore, in a deflationary based economy there would be an incentive to produce quality and durable products that last as opposed to producing products that are designed to fail like many firms do in the present inflationary based economy. This is because in a deflationary economy there is less incentive to spend, because by holding your money it would be worth more tomorrow than it is today. In an inflationary economy the opposite is true; there is less inventive to sell because firms wouldn’t want to receive money which will be worth less tomorrow than today. This is the basis by which firms in an inflationary economy must create products that are designed to fail. To expand on this claim, in order for firms to keep up with the devaluation of currency through inflation, they must maintain constant profit streams by forcing the consumer to return and buy more products. On the contrary, in a deflationary economy, in order to get consumers to want to spend their money which they know will be worth more tomorrow than it is today, firms will have to compete on offering the highest quality product or service in order to sell their product. Not only is this good for consumers and competition among firms, but it could help towards creating a more environmentally friendly marketplace by creating products which do not contribute to the negative effects of industry such as waste as much as they do today. For those who may argue that there would be no incentive at all to spend in a deflationary economy, it must be noted that there will always be a necessity for a medium of exchange since there will always be goods and services demanded which one person cannot produce themselves.
Bitcoin’s place in the world economy
As you may have realized, Bitcoin could in theory serve as a more efficient form of currency than the fiat currency’s we use today. However the question remains that even though this is true, where would Bitcoin fit in as a predominant form of currency and how would it help or hurt trade? First off, Bitcoin will give the seller a shorter waiting period to confirm the transfer of funds than credit cards, debit cards, and checks require. When a transaction is made with Bitcoin, the funds are confirmed within 45 minutes or even sooner. Secondly, since Bitcoin is based on a peer to peer network the transfer costs that are incurred with today’s forms of electronic payment are basically eliminated. This in effect eliminates the huge sum of money which businesses pay to banks every year in order to accept these forms of electronic payment such as credit cards and debit cards. Thirdly, the block chain which holds a record of all Bitcoin transactions ever completed is a more efficient system of record holding than has ever been in existence with respect to transfers of money. Also, the block chain give you access to view the actual balances of money in every single Bitcoin wallet at any given time. The existence of the block chain is a huge advantage for people or businesses who wish to confirm that a customer has a specified amount of money available before providing them with a good or service, something that sellers have to assume without such information.
Ultimately, Bitcoin could be used as the predominant currency throughout the world, especially considering the trend of globalization given our instantaneous access to knowledge and unlimited social interaction through the use of the internet. Given the information listed so far, it makes sense why the world would benefit from a utilizing a uniform currency like Bitcoin. However, in my opinion Bitcoin is not yet ready for widespread adoption. Even though the fundamental truths of the currency are strong, there are still things that need to be done in order to achieve widespread recognition and adoption.
What needs to be done
To start off, in my opinion, the major concern with Bitcoin’s ability to achieve widespread recognition is the issue of volatility. Everyone who has been following the value of Bitcoin and even people who haven’t are probably aware of the incredible increase in value of BTC over the past few months. In terms of dollars, the price of Bitcoin is up about 750% from exactly two months ago. This meteoric rise is enough to give concern to economists and speculators, and rightly so. There is no way that a currency, or “medium of exchange”, could be a viable form of payment when the value is so volatile. For example, there were multiple instances in the past weeks when the price would change 10% or more in one day in either a positive or negative direction. How could one expect any of the big businesses in today’s marketplace to take the risk of accepting a form of payment which could be worth 10% less within 24 hours, or 750% less in 2 months from the time of the exchange? The answer is that you couldn’t expect businesses to take this risk and without stable prices there is no chance that Bitcoin could ever achieve widespread adoption.
From this point forward, the question should be “How do we reach a point where the value of Bitcoin is stable?” Of course there is always going to be the effect of increasing value due to the nature of the deflationary economy; however it is necessary that the currency hold a steady and predictable measure of value for a given period of time. A stable value of Bitcoin would be achieved when the value can be predicted by using the deflation multiplier to predict how much more the currency is going to be worth in a given amount of time due simply to the nature of deflationary economy, and not so heavily reliant on speculation and price fluctuations due to investors using Bitcoin as a vehicle for currency swaps, which is ever-so prevalent in the current Bitcoin marketplace.
Although it is clear that Bitcoin’s value needs to be constant, the question of how to go about achieving such a task is very difficult to answer and should be left up for further debate. However there are some things that could be stated with certainty: firstly there needs to be a larger amount of people that hold Bitcoin with the intentions of using it to spend on goods, and not to trade for a form of fiat currency in hopes of gaining a profit. Secondly, at the same time, there needs to be a large amount of firms who accept Bitcoin as a form of payment that offer a wide range of products and services which is comparable to the range of goods and services offered in exchange for fiat currency. However, even before either of these things can happen, there needs to be a better understanding among the masses of the fundamentals of Bitcoin and the reasons why it has such huge potential to do great things for the world economy. This paper was written with the hopes of spreading the knowledge of the value of using Bitcoin beyond the hardcore believers, in turn building upon the advancement of the currency toward widespread adoption.
Conclusion
I hope that what I have outlined in this essay will give the reader a clear understanding of how Bitcoin has the potential to change the global economy for the better. However, although there are great opportunities that the currency offers, what must be realized is the potential political and social reforms and possibly unrest that could result due to a major shift from fiat to crypto currencies. Considering that the world economy is so reliant upon each nation’s respective fiat currency, what must occur for a crypto currency to gain an edge over these currencies is some event which deems them “inferior” to the potential of the use of crypto currencies instead. An example of an event which would cause this outcome could be the United States defaulting on its debt obligations, causing catastrophic damages to the political and social structure of not only the United States but the world as a whole. The results of such an event would most likely include the devaluation of the dollar and widespread distrust in the United States government. In addition, there could possibly be dissolution of some government run organizations, particularly those that deal with the regulation of the dollar and financial markets. Through the midst of these political and social reforms, unrest among large populations could very well occur.
Although one may that argue that the chances of the adoption of Bitcoin may just as well occur through a more gradual process which is not necessarily so extreme, it is undeniable that there will be some social and political reforms as a result. It is for these reasons that I do not believe Bitcoin will be adopted on a large scale in the near future, however the potential is ever present.
In closing I would like to state again that this document expresses only my observations and opinions and it is written in hopes of giving new-comers some insight into what kind of potential Crypto Currencies actually have. Although this essay was not written for the purpose of receiving donations, they would be greatly appreciated if you find it in your interest to contribute. Being a college student, even the smallest amounts help. My address is listed below. Also, I urge you to share this document with people who you believe would be interested. The more people who understand Bitcoin, the closer we will be to widespread adoption!
-Written by Mike. G
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