We were recently contacted by someone who had seen our volume on
Bitcoin, cryptically entitled “Bitcoins: What they are and how to use
them” which was written on one of those weekend trysts which economic
thinkers are prone to, in which a flurry of ideas flies at one’s mind
from all quarters and scream to be put on paper.
The book, which was literally cobbled together over the span of four
days, has been our bestseller recently, which naturally has more to do
with Bitcoin than ourselves.
In their inquiry, the reader had three further inquiries which we present below for those who are interested in such matters. Enjoy!
Q: What do you think about the relation between physical and virtual currency?
The Mint: Generally speaking, the relation between physical and virtual currencies can be judged by examining the price for the physical currency expressed in the virtual currency. However, I think it will be helpful to make a distinction, as the concept of virtual currency is simply another extension, or “strata”, as I like to call it, of something I refer to as the “Monetary Premium.” Allow me to explain:
The concept of currency stems from the Monetary Premium that is attached to something, ultimately giving it value in trade. (please read this post for a description of the Monetary Premium concept and its origins: http://davidmint.com/
Over time, as the division of labor has increased, the need for credit and, by extension, something by which to exchange the monetary premium (i.e. serve as money) in order to settle the debt, has increased as well to the point that, today, all currency issued by government’s is a credit instrument (a liability of the Central Bank) and has only an indirect relationship to anything physical.
Given this, virtual currency, to the extent that it is accepted in trade, is synonymous with all other forms of currency in that it represents an indirect claim on physical wealth.
What many consider to be hard, or physical currency, such as gold and silver, will then have a relationship to either virtual currencies (such as Bitcoin) or credit based currencies (such as US dollars or Brazilian reais) which is expressed as a ratio, or price. By extension, both virtual and credit based currencies will serve as pricing mechanisms for goods and services.
I hope the above makes sense, as it is getting to a key misconception that many have regarding money in general.
Q: What is the future of Bitcoin?
The Mint: As with any currency, bitcoin will have value and be traded until people lose confidence in it. That said, bitcoin has two flaws that will make it increasingly difficult to use in trade:
1) By design, there can only be a very limited amount of debt denominated in Bitcoin. While most see this as attractive (indeed, it is what helps support its value), it will severely hinder the expansion of Bitcoin proper in trade as the algorithm ticks closer to the limit of ~21 million Bitcoins (never mind that many Bitcoins that previously circulated are trapped in wallets on hard drives which are in rubbish heaps now, never to be “mined” again!).
2) The limitation on Bitcoin creation will dramatically reduce incentives to support the Bitcoin transaction validation process (known as “mining”) right at the time when it is most necessary. This is where Bitcoin will shoot itself in the foot, and nobody knows what will happen then, but what is certain is that transaction processing will become a paid feature by providers or that it will become so slow that people will gravitate away from Bitcoin to other digital currencies who have no such flaw.
What is likely to occur is that Bitcoin will assume its place as the “gold standard” against which all subsequent virtual currencies will be measured. In the same way that many national currencies are still measured against gold on the open market, so it will be that Bitcoin, given its finite production, will become, as gold has become, little more than an important point of reference for whatever virtual currency is currently predominately used in trade.
Bitcoins: What they are and how to use them
In their inquiry, the reader had three further inquiries which we present below for those who are interested in such matters. Enjoy!
Q: What do you think about the relation between physical and virtual currency?
The Mint: Generally speaking, the relation between physical and virtual currencies can be judged by examining the price for the physical currency expressed in the virtual currency. However, I think it will be helpful to make a distinction, as the concept of virtual currency is simply another extension, or “strata”, as I like to call it, of something I refer to as the “Monetary Premium.” Allow me to explain:
The concept of currency stems from the Monetary Premium that is attached to something, ultimately giving it value in trade. (please read this post for a description of the Monetary Premium concept and its origins: http://davidmint.com/
Over time, as the division of labor has increased, the need for credit and, by extension, something by which to exchange the monetary premium (i.e. serve as money) in order to settle the debt, has increased as well to the point that, today, all currency issued by government’s is a credit instrument (a liability of the Central Bank) and has only an indirect relationship to anything physical.
Given this, virtual currency, to the extent that it is accepted in trade, is synonymous with all other forms of currency in that it represents an indirect claim on physical wealth.
What many consider to be hard, or physical currency, such as gold and silver, will then have a relationship to either virtual currencies (such as Bitcoin) or credit based currencies (such as US dollars or Brazilian reais) which is expressed as a ratio, or price. By extension, both virtual and credit based currencies will serve as pricing mechanisms for goods and services.
I hope the above makes sense, as it is getting to a key misconception that many have regarding money in general.
Q: What is the future of Bitcoin?
The Mint: As with any currency, bitcoin will have value and be traded until people lose confidence in it. That said, bitcoin has two flaws that will make it increasingly difficult to use in trade:
1) By design, there can only be a very limited amount of debt denominated in Bitcoin. While most see this as attractive (indeed, it is what helps support its value), it will severely hinder the expansion of Bitcoin proper in trade as the algorithm ticks closer to the limit of ~21 million Bitcoins (never mind that many Bitcoins that previously circulated are trapped in wallets on hard drives which are in rubbish heaps now, never to be “mined” again!).
2) The limitation on Bitcoin creation will dramatically reduce incentives to support the Bitcoin transaction validation process (known as “mining”) right at the time when it is most necessary. This is where Bitcoin will shoot itself in the foot, and nobody knows what will happen then, but what is certain is that transaction processing will become a paid feature by providers or that it will become so slow that people will gravitate away from Bitcoin to other digital currencies who have no such flaw.
What is likely to occur is that Bitcoin will assume its place as the “gold standard” against which all subsequent virtual currencies will be measured. In the same way that many national currencies are still measured against gold on the open market, so it will be that Bitcoin, given its finite production, will become, as gold has become, little more than an important point of reference for whatever virtual currency is currently predominately used in trade.
Q: What is the effect on the world economy?
The Mint:
While the origins of Bitcoin and other virtual currencies may have been
experimental and ideological in nature, their increasing acceptance is
owed to the fact that they are filling a void in trade. Namely, mediums
of communication facilitated by the Internet have expanded trade
exponentially and created needs for mediums of exchange (a way to
transmit the monetary premium mentioned above) that national currencies
cannot keep pace with.
The
current system of national currencies and banking provide a number of
barriers to currency creation which leaves a void that solutions such as
Bitcoin are able to fulfill, in the process creating a windfall for
those who have successfully speculated in such currencies.
The
effect of virtual currencies such as Bitcoin on the world economy,
then, has been and will be to further facilitate trade and, by
extension, the division of labor in the world economy. This is a very
good thing as it will ultimately lead to a more perfect balance of
trade, one that is not subject to the whim of a Central banker’s
assessment of the need to expand or contract the money supply.
The
latter has implications for the current nation-state which I won’t go
into, but the people of the world now can, through the Bitcoin and
broader virtual currency story, begin to envision a world economy that
is not dominated by currencies emitted by National Central banks, what
will happen with that vision is something that is likely to play out in
our lifetimes.
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