The economics of Bitcoin

The lesson here is that enough of you ask me about a topic, eventually I will blog it.  Here is Wikipedia on Bitcoin — it’s less than transparent, which I take to be informative in its own right.  If you are late to the party, here is the confusing opening paragraph:

Bitcoin is a digital currency created in 2009 by Satoshi Nakamoto. The name also refers to the open source software he designed that uses it, and the peer-to-peer network that it forms. The total value of the Bitcoin economy as of April 2011[update] is 4,500,174 USD.[1] Unlike most currencies, bitcoin does not rely on trusting any central issuer. Bitcoin uses a distributed database spread across nodes of a peer-to-peer network to journal transactions, and uses cryptography in order to provide basic security functions, such as ensuring that bitcoins can only be spent by the person who owns them, and never more than once.

Huh?  When I hear about monetary economics, I think first of convertibility, credibility, and repurchase agreements.  Then my mind turns to Ponzi schemes and frauds.  Finally there is government-issued paper money, which can be used to pay taxes.  Via Matt, here is the best piece I’ve seen on Bitcoin, and a follow-up.  Here is Jerry Brito on Bitcoin, more  links here.

I’ll still admit to some confusion, but I am inclined to think the following.  It is a privately created fiat currency, bundled together with an anonymity scheme for transactions.  The anonymity scheme means there is some reason to grant one-time seigniorage to the original currency issuers.  Eventually the anonymity scheme, in some form or another, will be available without the fiat currency.  At that point, or more likely before then, the fiat currency will fall to near-zero in value.  Hold it at your own risk.  The original issuers will have kept some of their initial gains.

In the meantime, it’s mostly a fun topic for the internet.  Private fiat currencies have potential value only during hyperinflations, or extreme deflations.  Even then (especially in the former case), people may prefer real assets and investment assets.  The new Bitcoin asset simply isn’t a useful one and I’ve yet to see a source on it which explains how it could be or should be.  That said, here is a list of sites which accept Bitcoin, on what terms I am not sure.

I thank numerous loyal MR readers for the query.


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