It’s hard to know which there are more of these days: the number of Bitcoins worldwide or the number of pundits who believe the newly popular crypto-currency is a fad, doomed to failure, or both.
But rather than pile on, I have come up with several reasons why Bitcoin can succeed.
Bitcoin screw-ups have resulted in fewer Bitcoins but never more of them
A natural consequence of a rise in value of something is the creation (or mere appearance) of more of that thing. Whether tulip bulbs, Impressionist paintings or dot-com stocks, a rise in the value of originals begets an increase in the supply of copies. These copies can be legitimate (e.g., follow-on stock offerings), or counterfeits (ultra-rare Ferraris cobbled together from parts of less-rare Ferraris).
But in the four years of Bitcoin’s existence, any increase in the number of available Bitcoins has been through the legitimate Bitcoin “mining” process, governed by the clever software that brought it into existence, and which permits mining of the crypto-currency.
As noted by TechCrunch, “there have been attacks on independently-run Bitcoin wallets and exchanges, [but] the core 31,000 lines of Bitcoin [software] haven’t been compromised despite being available to the world’s best hackers and cryptographers for the last four years.”
So, despite huge profit motives (both legal and otherwise) the supply of Bitcoins is stable, growing in accordance with the algorithms that define the currency, and outside the control or influence of third parties.
The opportunity cost of Bitcoin is negative
Typically, the adoption of a new technology like the horseless carriage or the personal computer required investment not only in something un-proven, but also in a depreciating asset. Think about how fraught it was in the early 1980s to buy a personal computer, which was expensive, came with essentially no software beyond its operating system, and was only useful to someone after reading carefully through a manual, and learning to program the thing.
Compare that with Bitcoin, which only costs roughly the price of the transaction necessary to convert existing currency and which has appreciated considerably in the four years of its existence. In other words, instead of being penalized for being an early adopter, you’ve thus far been rewarded.
Some observers have complained that this anti-inflationary dynamic encourages hoarding, which in turn reduces Bitcoin’s ability to serve as a “medium of exchange,” one of the necessary attributes of any form of money. But this same dynamic cuts in both directions: in our new world where even the ultra-conservative Japanese feel the need to debase their own currency, there is huge utility in adopting a currency that by design can’t be debased.
Ultimately, the adoption of Bitcoin is not “about” the intrinsic value of Bitcoin, but about technology adoption. And in a world with over two billion smartphone users, any one of whom can at low cost put a Bitcoin wallet app on their handset, adoption can happen pretty fast.
Arbitrage will provide a stabilizing mechanism
Even Bitcoin proponents agree that the upward volatility of Bitcoin’s value is a hindrance to adoption. But there are natural (purchasing power parity) and man-made (currency futures markets) mechanisms, each of which harness arbitrage to stabilize any currency. A futures market for Bitcoin already exists: ICBIT.com . Others are likely to emerge.
Yes, a futures market doesn’t mean all market participants will make successful hedges. But the mere availability of the futures market will encourage more use of Bitcoin as a medium of exchange, which will be a self-fulfilling legitimizing force.
Bitcoin tends to make people crazy and not just Bitcoin fanboys, venture capitalists and Libertarians. These latter players are already assumed to have a zealot’s natural surplus of optimism and lack of perspective. For example, money transfer players Western Union and Moneygram are “studying ways” their customers could make use of Bitcoin. In a recent Wall Street Journal article, a Western Union executive was quoted as saying, “[i]f Bitcoin continues to grow and the value is defined more internationally, we may find an opportunity for Bitcoin to be used to pay for commerce transactions through a Western Union business solution.”
That’s a pretty dry assessment. It’s also unlikely: widespread adoption of Bitcoin renders Western Union and Moneygram irrelevant, because the organizing principle of cash-only money transfer is anonymity, which is exactly what Bitcoin facilitates, only without the transaction costs.
If you think I’m an unalloyed ‘Bit Head,’ think again. I analyze technology in general and technology companies for a living; adoption of new technology is extremely hard. Layer onto that the adoption of an entirely new currency and we’re talking orders of magnitude-greater levels of difficulty.
And thoughtful people who have wrapped their heads around Bitcoin have come up with plenty of hurdles for Bitcoin to clear before it could be considered a success. Regulatory and consumer protection issues are just the beginning. And don’t get me started on taxation. Even the naysayers won’t mention it but I will here: financial regulators may tolerate the creation of a new currency, even one (like Bitcoin) that doesn’t require a central bank authority. But no government will cotton to missing out on the collection of sales tax.
And when I say Bitcoin will “succeed,” that isn’t the same as “win.” Existing currencies aren’t going away anytime soon. Even the U.S. dollar’s almighty status hasn’t precluded the issuance and use of hundreds of other forms of legal tender.
Rather, I foresee Bitcoin use and adoption growing, facilitating transaction volumes measured in billions of, yes, U.S. dollars. But unlike the dollar or any other existing currency, Bitcoin has a combination of attributes, like gold’s un-debaseable store of value, the euro’s cross-border acceptance and any modern currency’s electronic transmissibility that give it a unique and powerful utility.
That’s why I’m confident Bitcoin’s many flaws will be ironed out. As with a great piece of open-source software, too many people stand to benefit for it not to happen.
Photo Credit: zcopley