Bitcoin – Currency and Stability can be Orthogonal
There’s been a lot of debate lately on whether or not crypto currencies – e.g. Bitcoin (AKA BTC) – are viable. I believe crypto currencies such as BTC are quite capable of facilitating transactions of goods and services, which is often the stated reason for establishing currencies in the first place.
First off, currencies – today, the physical thing like a dollar bill – aren’t meant to be kept in quantity. Stuffing hundred dollar bills under your mattress is not recommended as a general investment strategy for the masses. Remember our economics lesson from “A Wonderful Life”: when you ‘save money’ you’re actually giving it to someone who buys something else (e.g. banks that loan money to others). The aspect of being a currency is merely related to (but not an inherent part of) the other feature of today’s dollars (or euros, etc.) – stability. When someone offers to pay you $50K a year to make cream pies in their bakery, you pretty much know what you can do with that money. And that’s where the government comes in. They create a complex money system (using fiat currency) that offers stability, in exchange for taxes and votes.
But let’s say these two aspects were decoupled – currency and stability. Currency can flow freely (think of the word currency, as in currents in a river). But no one is tasked with the stability aspect. However, stability can be created in other ways. Your ‘savings money’ is more of an investment. You could (and should) own things with intrinsic value. Financial markets are already computer driven (it could all be done by hand, but it would be too tedious and costly). When you get paid, you can ask a financial services company to invest that ‘money’ in stable, tangible assets if you so desire. You can buy parts of oil reserves, loans (bonds), houses (REITs), gold, farms, cotton, etc. Or any other thing for that matter. It’s all computer-driven and happens in an instant at negligible cost (this is a part that is relatively new – it’s happened in the last decade or so).
This flight time and total transaction amounts will have an impact on the value of crypto currencies. For example, if an average transaction takes 1 millisecond, $1B (today’s equivalents, for the sake of this example) is in flight and 22M coins are in existence, each coin needs to be worth about $45K (equivalent). The stability of these values will affect the stability of the currency.
The currency at this point exists only to facilitate this transaction and (except for those true speculators) you own the currency only for a fleeting instant. It’s similar to escrow in that it’s a temporary intermediary. But will there be volatility? As this large network becomes interconnected, game theory comes into play and will result in some amount of stabilization. For example, when you want to buy a car, you might sell enough shares of amazon.com to pay for the car. The transaction is in BTC. But as soon as the dealer gets the BTC, their financial system buys bonds. They aren’t left holding the bag, even if tomorrow BTC decreases in value. Then they guy that sold the bonds gets BTC, which he uses to buy a boat. And so on and so on.
Indeed, this transition will not happen overnight. Currencies – including today’s fiat currencies like dollars, euros, etc. – can co-exist with crypto currencies. In fact, multiple crypto currencies can coexist.
There will be a large impact to governments, who have had the ‘job’ of overseeing official (fiat) currencies and are funded with the current system of dollars/euros/etc. (via taxes). There is a risk to those that control today’s fiscal strategies. These incumbents will try to squelch this innovation, as it threatens their current systems. However, incumbents cannot prevent disruptive innovation forever.
In summary, crypto currencies can exist as currencies in order to buy and sell goods and services. However until they get widespread use and game theory (networked and in large number) comes into play in a more pure market, they will not be stable. In fact they may never be as stable as fiat currencies, and that might be OK. It is likely we are on the verge of the world’s currency system evolving once again (as it has every several decades or so). Currency and stability can be orthogonal.