In the 1930s, when the Federal Reserve let the money supply contract, there was a true shortage of currency. At least 150 communities experimented with scrip—printing their own money to grease the wheels of commerce. None worked, and all have disappeared.
Today, because of worries about the Fed printing too much money, a private online global scrip, called Bitcoin, has been created. This scrip is supposed to protect society from inflationary monetary policy.
Could Bitcoins become an alternative to the money or monies that exist across the globe? One of the biggest investors in Bitcoins thinks so. The Winklevoss twins, of Facebook FB +2.87% fame, think the market for Bitcoins could increase 100-fold to more than $400 billion. And a Costa Mesa, Calif., luxury car dealer is reportedly selling cars, including a Tesla S and a Lamborghini Gallardo, for Bitcoins.
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Reuters
Bitcoins are "mined" by running a computer algorithm, creating a digitized code. That code can then be used to complete online transactions. The algorithm makes it progressively harder to mine Bitcoins as the total number increases. Preset limits supposedly cap the maximum number of Bitcoins at 21 million, and right now there are roughly 12 million in existence. Rising hope of wider acceptance drove the price of a Bitcoin to more than $1,200 a few weeks ago. But when Baidu.com, BIDU -0.15% the Chinese web services company, said it would not accept the scrip, the price fell sharply and it currently trades near $900.
Bitcoins meet most of the criteria of money. They are a medium of exchange, a unit of account, a store of value and a standard of deferred payment. But what ultimately gives money value is that it is accepted by others in trade for something of value. And that is why scrip doesn't work.
Let's say a barber in a Wisconsin town accepts scrip for haircuts and uses it to eat at a local restaurant that buys its produce from a local farmer. As long as each of these businesses kept all their purchases in the community, all would be well. But why would a scissor manufacturer in Germany or China or even Chicago accept this scrip? The car dealer in California, for example, is not actually accepting Bitcoins for his vehicles—they first have to be converted to U.S. dollars.
To become a true alternative currency, Bitcoins need to be accepted in a wide enough swath of society to facilitate the normal transaction of business. If they aren't, they will always trade at a discount to their potential value.
Right now, total cash and deposits in the U.S. banking system (the M2 money supply), is roughly $11 trillion. Assuming 21 million Bitcoins are mined and they become an accepted currency, each one could be worth as much as $524,000. This is a massive potential appreciation from their current level.
However, the list of companies that accept Bitcoin as payment for actual transactions make up what I estimate to be less than one-hundredth of a percent of all spending, or GDP. Since money gets its value from the goods, services and assets that it can purchase, a Bitcoin is currently worth only 0.01% of its true potential, or about $52.40.
Bitcoins require storage space (in a computer), power to run the computer (electricity), security (from hacking), and computational power (serious encryption) on both sides of a transaction. There are firms that act as middlemen in Bitcoin transactions, and firms that make a market in Bitcoins, but they are new and have no serious financial track record. Many Bitcoin transactions facilitate illegal commerce. The Bitcoin world is not friction-free, or clean.
And is it really true that no more than 21 million Bitcoins can be produced? Hackers keep getting better, and the temptation to expand the supply of money has been powerful (and profitable, for the issuer) since the time of the Romans. These costs and questions all impact the value of a Bitcoin substantially.
To become a real alternative currency, Bitcoins must be recognized by a majority of businesses and consumers. They must be as safe, or safer, than currency issued by a central bank. And they must be transportable. Currently, the Bitcoin does not meet any of these requirements, and this is why it is trading for much less than its actual convertible U.S. dollar value.
If you believe Bitcoin in time will become an alternative to the world's currencies, there are huge potential profits as the value of a Bitcoin rises to $524,000—or higher if drug dealers and other nefarious users are willing to pay a premium for anonymity.
But to be truly successful, Bitcoins have to win the battle of money on all levels of competition and that is a very high hurdle to clear.
Mr. Wesbury is chief economist at First Trust Advisors LP.
Don't ask me how I got that... I googled and hit the link... and somehow got the full article... (always have scripts off..)
http://online.wsj.com/news/articles/SB10001424052702303497804579241790259672808
