Bitcoin investors have good reason to worry. Recently, it lost more than 60% of its value over six weeks — the fifth such collapse in recent years — and the Securities and Exchange Commission has launched an investigation of cryptocurrencies and initial coin offerings.
Advocates of bitcoin BTCUSD, +3.10% argue governments are tempted to print too much money to finance spending, instead of taxing, and fuel inflation. Governments entrust control of their money supplies to independent central banks. However, devious politicians can still issue bonds, and central banks must print money to absorb those if investors won’t purchase new issues at desired interest rates.
Government backing and a central bank are not necessary to create a currency. What counts is that a private currency is limited in supply and accepted for the exchange of goods and services throughout a definable community.
Shell wampum was time-consuming and difficult to create and widely accepted among Northeastern woodlands Indians. Eventually, it became a medium of exchange among colonists short on British currency.
Bitcoin balances are recorded on a system of encrypted ledgers on private computers. New balances are created by solving complex mathematical problems, and total bitcoin in circulation will be capped at 21 million.
Individuals keep bitcoin in digital wallets and at commercial exchanges, and depositors can lose their money if those are hacked or badly managed.
Holding bitcoin is like putting currency in a locker at a train station—if the lock gets picked, you’re broke.
Bitcoin does not perform the essential functions of money.
Virtually all businesses only accept dollars or another national currency for payment, as do governments to collect taxes. Holders of bitcoin or any other digital currency must convert those to national currencies to purchase groceries, plane tickets and the like.
Conversions are slow and costly—who would pay a $25 dollar conversion fee to purchase a $4 loaf of bread?
Bitcoin’s value frequently fluctuates by large amounts and is quite slow to convert back to dollars for large purchases—like college tuition. Those make it an unreliable store of value for your savings.
That reduces the purposes of holding bitcoin to speculation and illicit purposes.
In December, about 18% of buyers purchased bitcoin using credit cards and many said they would pay off their balances using profits from their investment. Such buying on essentially zero margin puts banks that issue credit cards at significant risk of nonpayment. Consequently, Citibank, J.P. Morgan, Discover and many other big banks no longer permit cardholders to exchange dollars (or any other national currency) for bitcoin.
In an increasingly cashless economy, those decisions make it even less likely that bitcoin will ever become a medium of exchange and no more than a derivative—a financial instrument whose price is determined by the value of an underlying asset.
The goods-producing capacity of the U.S. economy ultimately is the asset behind the dollar. The full faith and credit of the U.S. government sounds lofty, but it’s the goods and services Americans can make that count.
Bitcoin has no Bitland—or perhaps it does!
Our friends in the grey economy and less-desirable types who are raising money for North Korea and drug lords like cash. The Fed and Treasury can track money moving among banks quite easily but not cash—that’s why the Treasury no longer issues bills in denominations over $100.
Bitcoin ledgers are kept on private computers theoretically beyond the eyes of government officials; hence bitcoin has great utility for all things illicit. However, now governments in China and South Korea are cracking down, and the United States is not far behind.
And if hackers can steal from the exchanges, the Treasury can surely spy on them. Sooner or later we are going to have enough drug busts thanks to such snooping (as necessary, done with warrants) that drug lords and rogue states will have to lug around huge suitcases full of Jacksons and Benjamins for the lack of larger denominations.
When bad actors start dumping bitcoin, its value will drop for good.
Meanwhile, the ordinary investor who trades dollars for bitcoin is merely gambling that he can get out before the bottom falls out and is helping finance some of the worst malefactors on the planet.