Why bitcoin’s valuation doesn’t really matter

by on April 5, 2013 · 632 comments

Bitcoin on front page of the Financial TimesOver the past few days, interest in bitcoin has exploded as its valuation has reached stratospheric levels. Most of the media attention has been focused on that valuation and on bitcoin’s viability as money. For example, the Financial Times had the run-up in bitcoin’s price on its front page yesterday, emphasizing its volatility and its commodity-like qualities. It quoted one analyst saying, “It’s gold for computer nerds.” For many folks, this is how they will be introduced to bitcoin, and it’s a shame because it misses what’s really interesting about the crypto-currency.

It’s no secret that bitcoin excites libertarians above all others. What’s less understood is that there are two distinct reasons driving this enthusiasm. The first is that bitcoin is not issued by any authority, so there’s no central banker to monkey the money supply. This attracts what we can affectionately call the “gold bugs” or “audit the Fed” types. They are interested in bitcoin as a new, more moral form of money. And bitcoin as money is what’s been getting all the attention given it’s rising valuation.

But there is a second reason libertarians should be excited about bitcoin, and it’s the reason I am an enthusiast: bitcoin as a payments system. As the world’s first completely decentralized digital currency, there is not only no central banker, there is no intermediary of any kind needed for two parties to make a transaction. Today we rely on third parties to transact online, and when government wants to restrict how we can spend money online, it’s these intermediaries they turn to. PayPal, Visa, MasterCard and other traditional payment processors don’t let you transmit money to WikiLeaks, or to UK gambling sites, or to people in Iran, or to buy illegal goods and services on anonymous black markets. Bitcoin disrupts the ability of governments and intermediaries to control your transactions, and because there is no bitcoin company or bitcoin building anywhere, it can’t be shut down.

Tim Lee gets this when he writes that bitcoin is no competition for the dollar as a currency,

Rather, the future demand for Bitcoins will largely come from applications where conventional currencies don’t perform that well. Bitcoins have some unique properties that no other financial instrument has. They combine the irreversibility of cash transactions with the convenience of electronic transactions. And, the lack of middlemen and regulations greatly reduces the barrier to entry. You don’t need to get permission from big banks or financial regulators to create a Bitcoin-based financial service. All of this means it makes sense to think of Bitcoin less as an alternative currency than as a new platform for financial innovation.

One objection to this view comes from Felix Salmon in a very thoughtful and nuanced essay. He recognizes that bitcoin is “in many ways the best and cleanest payments mechanism the world has ever seen,” but he laments that it is “an uncomfortable combination of commodity and currency.” He goes on to ask rhetorically, “If the currency of a country ever fluctuated as much as bitcoins did, it would never be taken seriously as a medium of exchange: how are you meant to do business in a place where an item costing one unit of currency is worth $10 one day and $20 the next?”

The answer is that bitcoin doesn’t need to be a good unit of account or a good store of value to be a good medium of exchange. Indeed, the prices of products and services being sold for bitcoin online today are denominated in dollars and are converted at the market rate for bitcoin when the transaction happens. This is how WordPress, one of the most prominent companies accepting bitcoin, does it. In fact, WordPress never even handles bitcoin. They employ the services of a very interesting company called Bitpay that manages bitcoin payment processing for them.

When you check out at WordPress using bitcoin, Bitpay quotes you the total of your dollar-denominated shopping cart in bitcoin at the current exchange rate, takes your bitcoin payment, and then deposits dollars in WordPress’s account. This allows WordPress to sell to persons in Iran or Haiti or anyone of the dozens of other countries where PayPal, Visa and MasterCard are not available. It also highlights bitcoin’s true disruptive quality as a payments system—one that is unstoppable, largely anonymous, and incredibly cheap to boot.

To answer Salmon more directly: It doesn’t matter what the price of bitcoin is for it to operate as the amazing payments system that it is. It doesn’t matter if it is very volatile. Dollars go in and dollars come out and the fact that some folks are (probably unwisely) treating it as a store of value doesn’t really matter.

That all said, there are some caveats to point out. Bitcoin will work as a seamless payment system so long as you can get in and out of it quick enough to mitigate volatility. That is largely a technical consideration, but it could also depend on the market’s liquidity, which conceivably could be hurt by speculative hoarding. I haven’t given this much thought yet, but given that bitcoin can be denominated down to eight decimal places, I’m not sure it will be a big problem anytime soon.

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