In 2009, the world’s first decentralized currency began circulation.
But this currency isn’t printed, it’s digital.
They’re called Bitcoins, and for many, they’re the wave of the future.
Milton Friedman, a prolific Nobel prize-winning economist, called for the U.S. dollar to be produced at regular intervals and fixed amounts. This would tend to keep things like inflation in check.
Needless to say, the U.S. didn’t really buy into the idea, probably because it’s so darned hard to stop printing money all willy-nilly to pay the bills.
Bitcoins, however, are in fact produced on a regular basis in blocks, at a rate of some 300 coins per hour. Every four years, the rate will be cut in half until, in 2030, the supply will be around 21 million coins, according to an article in the The Economist. This is an effort to both control the rate of monetary production without a centralized regulation entity as well as keep the currency stable when demand increases.
And therein lies the trade-off.
Without a central bank, people holding Bitcoins are fairly well protected against say, someone printing new Bitcoins and devaluing their savings — a good night’s rest we don’t enjoy here in America.
On the other hand, if Bitcoins experience a massive, potentially destructive financial event, there’s no safety net.
And that’s exactly what happened last week when the Bitcoin closed at around $15 per Bitcoin on Saturday from nearly $30 on Wednesday, according to data collected by Mt. Gox, a popular Bitcoin exchange. If you were holding Bitcoins at that time, you could have lost nearly half your holdings. In short, the Bitcoin isn’t for the faint of heart.
The drop came because the denomination lost its backing from PayPal, an online e-commerce payment service, which has a policy of not supporting “virtual currencies.” This essentially means it’s much more difficult to exchange U.S. dollars to and from the coinage, causing an illiquidity problem and devaluing the currency. The “real” markets will shut down automatically to prevent these massive sell-offs and give investors time to calm down and reassess the value of their investments. Not so with the Bitcoin.
It’s now being widely regarded as the first digital depression.
While I wouldn’t go that far, the massive sell-off could be severely devastating if say, you’d accepted payment in Bitcoins the day before for a $400,000 construction project, only to face a huge loss days later.
Potentially more important than the exchange rate is the ability to actually spend the coins. After all, if you can’t use a denomination anywhere, its useless. Intuitively, we’d expect mostly, or only, digital companies to accept the payment — web designers and programmers, for example.
But that’s clearly not the case. You can use Bitcoins to pay for everything from legal services to DVDs and new building construction — real-deal commercial and residential property paid for using the digital coin.
As for keeping the currency safe from hackers and fraud, there are several layers of protection, which have been remarkably successful so far, given the tech-savvy nature of its early adopters. A recent 25,000 Bitcoin theft, valued at nearly $500,000 USD, stands as the only major blemish to the coin’s integrity.
If you’re interested in Bitcoins, be careful. Because the currency is inherently volatile, you may double or triple your cash in a weekend and lose it all Monday. Additionally, the production rate for the coin favors early adopters, who bought at a more favorable exchange rate — around a dollar for most of the coin’s history — so much of the “big money” may already be out of the system.
All things considered, you may be better off investing in coins for the arcade rather than coins for the Internet.
Devin Graham is a 22-year-old economics senior from Prairieville. Follow him on Twitter @TDR_Dgraham.
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Contact Devin Graham at [email protected]