Bitcoin;
A glimpse of the future?
Author:
Anton Blidhem
Bachelor thesis spring of 2013
Thesis supervisor:
Martin Strieborný
Lund School of Economics and Management
Department of Economics
Abstract
The aim with this thesis is to investigate the relatively new currency Bitcoin and shed some
light over its structure and composition from a macroeconomic point of view. Not a lot of
academic work has been published on the subject it is therefore interesting to dive deeper into.
By using macroeconomic theory and published academic work I will try to determine if the
new digital currency has a chance to gain traction and change part of our monetary system.
The problem partly lies in whether legal authorities can prevent the usage of the currency or
not. But with that taken aside, what Bitcoin will do is leaving a dent in the economic system.
It has shown us that it is possible to create a system with no centralized authority at all and no
government is needed to enforce rules. With only the users self-policing the system it has
shown us that we need not to be bound down entirely by governments monopoly on monetary
control. Is Bitcoin to be a new “world currency”? Probably not. But ripples have been created
in the economic system and new forms of digital currencies are emerging. But only time can
tell what the future might hold for us in the world of digital currencies.
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ABSTRACT ........................................................................................................................................... 2
1. INTRODUCTION ............................................................................................................................. 4
1.1 BACKGROUND ................................................................................................................................... 4
1.2 PROBLEM FORMULATION ................................................................................................................ 5
1.3 QUESTION FORMULATION ............................................................................................................... 5
1.4 INTENTION ........................................................................................................................................ 6
1.5 METHOD AND DELIMITATION .......................................................................................................... 6
2.0 EMPIRICS ....................................................................................................................................... 7
2.1 THE EMERGENCE OF A CURRENCY.................................................................................................. 7
2.2 MONETARY STANDARDS .................................................................................................................. 8
2.2.1 COMMODITY STANDARD................................................................................................................. 8
2.2.2 FIAT STANDARD .............................................................................................................................. 9
2.2.3 COASE DURABLE STANDARD ......................................................................................................... 9
2.2.4 SYNTHETIC COMMODITY STANDARD ........................................................................................... 10
2.2 THE EMERGENCE OF BITCOINS ..................................................................................................... 14
2.2.1 BRIEF HISTORY ............................................................................................................................. 14
2.2.2 HOW BITCOINS ARE CREATED ...................................................................................................... 15
2.2.3 TRANSACTIONS ............................................................................................................................. 17
2.2.4 LACK OF CENTRALIZED SUPERVISION .......................................................................................... 18
2.2.5 HOW IT IS TRADED/USED .............................................................................................................. 19
2.2.6 THE LEGITIMACY OF BITCOIN ....................................................................................................... 20
3.0 ANALYSIS ..................................................................................................................................... 21
4.0 CONCLUSION .............................................................................................................................. 23
5.0 SOURCES ...................................................................................................................................... 24
5.1 LITERATURE ................................................................................................................................... 24
5.2 ACADEMIC WORK ........................................................................................................................... 24
5.3 ELECTRONIC SOURCES .................................................................................................................. 24
5.3.1 ARTICLES ...................................................................................................................................... 24
5.3.2 WEBSITES ..................................................................................................................................... 24
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1. Introduction
1.1 Background
Since the begging of humanity man has been trying to figure out how to get rid of excessive
goods while trying to obtain goods they require. At first man resorted to a barter economy but
this has several impracticalities. Later people started to trade goods in change for valuable
metals and the like. After some time this was changed into trading with money in different
forms. After a while commodity money appeared which later evolved into fiat money.
These money could not be given out by the common laymen and monetary authorities
emerged with monopoly on supplying the people with money.
Some liberal economists have for a long time questioned states and central banks monopoly
on printing and giving out currencies. It has been surrounded by harsh laws and restrictions
worldwide. Libertarians argue that an unregulated market benefits the society since the
market powers allocates capital and resources to where it is needed the most. The Internet has
provided a new forum where you can bypass the laws and regulations created by central
banks and governments regarding fiat money. The latest advance has been made through the
emergence of the digital currency Bitcoins that was created in the beginning of 2009.
The emergence of this digital currency is not entirely uncontroversial in the academic world
for instance Nobel Laureate Paul Krugman writes:
“The economic significance of this [Bitcoin] roller coaster was basically nil. But the furore
[sic] over bitcoin was a useful lesson in the ways people misunderstand money — and in
particular how they are misled by the desire to divorce the value of money from the society it
serves.”
(Krugman, 2013)
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Whilst other argues the opposite, and cannot stress the importance of Bitcoins enough. Eric
Voorhees on the libertarian website von Mises institute writes:
“But, there is a very real chance it [Bitcoin] will succeed, and this chance is increased with
every new user, every new business, and every new system developed within the Bitcoin
economy. The ramifications of success are extraordinary, and it is thus worth at least a
cursory review by any advocate of liberty, not just in the US but around the world.”
(Vorhees, 2013)
1.2 Problem formulation
Bitcoin has lately attracted the medias attention partly through increased acceptance as a
legitimate means of payment with some multinational corporations and partly through large
private investments. (See for example Popper & Lattman, Never mind Facebook, Winklewoss
Twins Rule in Digital Currency, New York Times, Apr 11th 2013.)
As previously stated this new form of currency is not entirely uncontroversial. It stems from
the notion that no central monetary authority should be exposed to the whim of a politician or
monetary economist. The system in which the money is created should only be under the
control of all of the people using it.
The system is based on complex algorithms and cryptography but despite this, users that are
not computer whizzes or hackers are starting to adopt the new currency.
But the question remains: is this just a short trend generated by increasing media coverage or
is there a real currency behind? Can Bitcoin persevere and serve a real currency like the
established ones we use in daily life?
1.3 Question formulation
Can Bitcoin become an established currency and a legitimate means of payment?
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1.4 Intention
The intention with this thesis is to investigate Bitcoin’s emergence and acceptance and to
examine whether it is possible to use the currency as a legitimate means of payment in the
future. In order to do this I want to gain a deeper understanding of how it is constructed and
created and compare this to conventional currencies.
1.5 Method and delimitation
Not many scientific articles and academic papers have been published on the topic, which is
delimitation in its own. However, lately media has started to cover the phenomenon more
closely and that is why I have chosen to use articles published by well renowned news papers
and magazines, such as The Economist and the like. There is a small amount of academic
work that has been published, but most of it from a legal point of view. I have deliberately left
this part out since it is beyond the scope of this thesis.
Some have highlighted the subject from an economic point of view and I intend to use them
in order to create a framework for my analysis. There is of course a great spectrum of views
in how a currency could or should be structured but I have chosen to limit this part to the most
prevalent points of view. Furthermore I will use standard macroeconomic monetary theories
and viewpoints in order to shed some light on the Bitcoin’s advantages and disadvantages.
I will take a qualitative approach to the subject in order to answer my question formulation.
Starting with standard economic monetary theory to later examine the currency more closely.
I will also use examples of other currencies that exhibit resemblance in its structure compared
to Bitcoin.
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2.0 Empirics
2.1 The emergence of a currency
The purpose of money is very easy to understand if we try to imagine a world without them.
Without money as a means of trade we would have to resort to a barter economy. In a barter
economy trading soon gets complicated and time consuming. Goods can be traded directly or
indirectly. For a direct trade to take place the condition known as “double coincidence of
wants”, minted by economist Stanley Jevons, has to be fulfilled. This means that two people
owning goods the other party demands has to find each other in order for a direct trade to take
place. However, trade can take place without this condition being fulfilled. This is through
indirect trade, when there is a middleman who has access to two suppliers demanding each
other’s goods. Furthermore it is difficult to have uniform pricing since everything is set in
relative prices to other goods. (Fregert & Jonung, 2010)
To solve these problems man has created money. Traditionally money has three functions:

Unit of account

Store of value

Medium of exchange
As mentioned earlier it is difficult and time consuming to measure all goods in an economy
by its relative prices. Money solves this by unit of account. With money it is now possible to
have one good or currency that expresses the value of all other goods in an economy with
monetary units. When all prices are expressed in one currency unit it eases the transactions
and trades can be made faster for firms and households. It also makes it easier to compare
prices, keep accounting and so forth. (Fregert & Jonung, 2010)
In a barter economy it is always necessary that you have something to trade with when you
demand something ergo you have to sell and by at the same time. But with money as a store
of value you can separate the buying and selling in time. However this does not mean that
money have a constant value, it can lose its purchasing power (inflation) and fluctuate in
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value over time. With the help of money we can store purchasing power for the future.
(Fregert & Jonung, 2010)
But perhaps the most central role for money is as a medium of exchange. If the money in
circulation is accepted as means of payment. It is not necessary that the money have an
intrinsic value as long as the people using it have faith in its value. (Fregert & Jonung, 2010)
There are goods that exhibit all these features and they have throughout history functioned as
money. But it is also essential that money or a currency is liquid, easy to trade and at the same
time exhibits these three other features I have listed. Money is to date the form that best fulfil
these conditions. (Fregert & Jonung, 2010)
2.2 Monetary standards
2.2.1 Commodity standard
To circumvent these issues with big transactions costs involved with a barter economy we
introduce a currency. The units used as currency has varied much throughout history from
shark teeth to metals such as gold or silver. This has become the base for one of the two
regular standards used when creating a currency. The commodity standard is based on some
kind of asset/good that is scarce by nature, most commonly gold or other scarce metals. This
is not to be confused with specie standard where the money is backed by an underlying asset.
The physical money itself has an intrinsic value when we are talking about commodity
money. (Fregert & Jonung, 2010) I will use gold as an example to simplify. If you have a gold
coin you have two uses for it. Firstly it can be used as a medium of exchange with all goods
having a relative price to it. Secondly it has an intrinsic value, the gold in the coin is actually
worth something. It is also by nature a finite recourse, which means that the total amount
available is predetermined. This in turn implies that it is scarce by nature, and if people
consider it desirable and worth owning its value will be high. The downside is that technical
innovations and discoveries of new sources for the good can be found. This in turn can result
in supply shocks that erode the value and purchasing power of the good. (Selign, 2013)
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2.2.2 Fiat standard
Fiat money has no intrinsic value more than the paper it is printed on. The marginal cost of
production is close to zero and has to be made artificially scarce by its issuer and thus
contingent. The issuer will have incentives to print more money since its lacking a stable
equilibrium, this can go in until you have printed so much that you in the end have a paper
standard. Of course this comes with the price of lost purchasing power, but in the short term it
can seem tempting to make short-term gains. Its value rests upon the belief that the issuer will
not print more money than that it becomes worthless. The only way to maintain an
equilibrium above the paper and ink price (or the marginal production cost) is to give the
issuer monopolistic rights. However, the issue remains, by merely making the issuer a
monopolistic producer does not entail that the incentive to print more money is gone. The
producer also have to limit its supply of money to a below profit-maximizing quantity. This
entails a money authority to be surrounded by regulations and/or laws so they do not succumb
to an excessive printing of money. (Selign, 2010)
Selign presents a money matrix in his paper where different base monies are presented:
Money matrix (incomplete)
Nonmonetary Use?
Yes
No
Scarcity
Commodity
Absolute
Fiat
Contingent
Figure 1
Source: Selign, 2010
Note: Altered to be incomplete by author
2.2.3 Coase Durable Standard
Now we have defined the two standard base monies. As visible from the matrix we can see
that the basic functions of money is whether the monies scarcity is natural or has to be
artificially made, contingent, or if its scarce by nature, absolute. It also shows if the money
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has some kind of nonmonetary use, or in other words has an intrinsic value. For example
commodity money has an intrinsic value per definition (just think of gold) and there is a
limited amount we can extract from nature whereas fiat money is artificially made and has no
(or a very low) intrinsic value. The scarcity is not limited but has to be contrived by the issuer.
What also become evident when studying the matrix are the two blank spots. Firstly we have
to find some sort of money that has some kind of nonmonetary use but has a contingent
scarcity. Selign proposes that this could be something called Coase Durable Money. As the
name suggests this includes a monopoly player. (Selign, 2010) If the monopoly actor has
monopolistic rights to a good, which is not scarce by nature, he can control the supply of the
good and thus the amount of the good in circulation in an economy. It is also possible that the
monopolistic player has monopolistic rights to the technology needed to reproduce it. It is
essential that the good is durable. Otherwise its value would diminish rapidly and be rendered
useless. A Coase-durable standard poses the same problems that Friedman pointed out with
fiat standard. The monopolist has incentives to issue more money to make short run gains.
This will continue until its exchange value in the economy is equal to the marginal cost of
production. A rational consumer will anticipate this and will therefore not be willing to pay
more then the marginal cost of production, regardless if it is the first or the last unit offered.
Coase proposes that you can get rid of this problem if the monopolistic actor offers a buyback for a slightly lower price thus ensuring that the monopolistic player has an interest in
keeping the good scarce (Coase, 1972). Another way for the monopolistic issuer to ensure the
consumers it will not overproduce currency is something called public destruction. This
requires the monopolistic issuer to publicly destroy units of its issued good to show that they
are willing to maintain a price above the marginal production cost. (Bulow, 1982) This way
the issuer gains the publics trust and convince them that the good is a sustainable means of
trade that fulfil the prerequisites (unit of account, store of value and medium of exchange)
earlier listed in this paper.
2.2.4 Synthetic Commodity standard
So for the final blank space in the matrix, a monetary standard that is absolute in its scarcity
but has not got any nonmonetary use.
Here Selign introduce us to something he calls
Synthetic Commodity Money. At a first glance a synthetic commodity standard might seem
very similar to a fiat standard. Once again the money itself lacks an intrinsic value and rests
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upon the users faith in the currency. The big question is how its scarcity is absolute rather
than contingent. It could be argued that synthetic commodity money is just a type of rulebound fiat standard. Selign writes:
“The difference warranting the separate designations is that real resource costs alone limit
monetary base growth in a synthetic commodity-money regime, whereas in rule-based fiat
money regimes, as these are conventionally understood, base growth is limited by positive
transactions costs, including any penalties to which rule-violating authorities are subject”
(Selign, 2013)
To clarify, the difference lies in how the money is controlled. In a ruled-based fiat standard
the money authorities have rules they have to follow in order to not erode the value of the
money and so forth. If these rules are not followed the authority can be penalized. These rules
can be self-imposed or set by an outside party, for example a government. Selign points out
that self-imposed regulations are subject to bias since the authority has the mandate to change
rules accordingly to their own actions beforehand and can therefore escape with impunity. A
synthetic commodity standard is not bound by such rules by legislatures and the like, but has
the rules built into the system. Selign refers to Buchanan discusses this as an “automatic
system”, which can be compared with the “managed system” that a rule-bound fiat standard
constitutes (Buchanan, James, (1962) “Predictability: The Criterion of Monetary
Constitution”). This implies that no central monetary authority is needed and the system
works all by itself. It does not need discretionary management nor rule enforcement, no
penalizing system is needed in order for it to work. But since the system is artificial it is not
just controlled by nature, so the standard is not vulnerable to sudden supply shocks stemming
from discoveries of new sources of the currency. We do have control when constructing the
system and can incorporate tools as automatic stabilisers and so forth if we desire to do so.
(Selign, 2010)
Monetary policy has for long been a topic of discussion amongst economists. Two of the
more prevalent economists have expressed their views as following:
“Money is too important to be left to the central bankers.” (Centralbanking.com, 2002)
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And Keynes asserting the money is too important to be “sacrificed [...] to the operation of
blind forces” (Keynes, 2006).
In this regard the synthetic commodity standard can be viewed as a compromise. Money is
not left to the central bankers, but is not subjected to the whim of nature. The only time man
has to agree is when constructing the system. After the system is started it cannot be altered
neither by man nor nature. Given that this is agreed upon beforehand.
The completed matrix can be viewed in figure 2 below.
Money matrix
Nonmonetary Use?
Yes
Scarcity
Absolute
Contingent
No
Commodity
Synthetic Commodity
Coase Durable
Fiat
Figure 2
Source: Selign, 2013
2.2.4.1 Iraq Swiss dinars, an unexpected experiment with synthetic commodity money
Synthetic commodity money has never been implemented and/or tested in an economy by a
monetary authority. However a after a historic event a new form of monetary standard
emerged, the synthetic commodity money. (Selign, 2013)
Before the invasion of Iraq in 1990s the monetary system constituted of the Iraq Dinars as a
currency. The money was printed with Swiss plates, hence the name, in the U.K. and then
distributed in Iraq. But during the American invasion sanctions was imposed against
importing the currency into Iraq and Saddam Hussein implemented a new currency, the
Saddam Dinar. He ordered for the old printing plates in Switzerland to be destroyed so no
more could be printed. He also deemed the old currency illegal and forbid it to be used as a
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means of payment. The new currency was put into the economic system and after heavy
printing of the money it soon started to depreciate. The overproduction of bills was not only
by the government but also by counterfeiters. The new money was easy to forge which led to
a large amount of illegal money circulating the system, worsening the depreciation of the
Saddam dinar. (King, 2004)
In the north of Iraq, in Kurdistan people refused to trade with the new currency and resorted
to use the Iraq Swiss dinar instead. A new system was created with a fixed amount of money
in circulation and with no monetary institutions surveillance it. (King, 2004)
There was no monetary authority that could intervene in the economic system and it was
entirely self-policed by its users. It had no intrinsic value and furthermore it was not based on
or backed with any commodity. One issue was the deterioration of the actual bills. Since no
new bills were put into the system the bills got worn and after a while, started to fall apart.
(King, 2004)
The Swiss dinar currency stabilized in 1998 and kept its value remarkably well As we can see
in figure 3. Not until next American invasion in 2003 did it lose its value, and this because the
Americans wanted to regulate its currency and make the whole country using only one
currency. (King, 2004)
Swiss dinar/Dollar exchange rate
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Figure 3
Source: King, 2004
2.3 The emergence of Bitcoins
2.3.1 Brief history
In 2009 an article called “Bitcoin: A Peer-to-Peer Electronic Cash System” was published by
the author Satoshi Nakamoto. It spoke about an electronic currency that you could only find
on the Internet without any central authority. Another prerequisite for the system was that it
should not rely on trust. (Nakamoto, 2009) Shortly after the publishing the system was
launched, and this was the beginning of Bitcoin as a currency. Satoshi Nakamoto is now
believed to be a pseudonym and he/she hasn’t been heard from since the launch. (Economist,
2011)
The creation of the currency was at most met with a lukewarm interest. Spikes can be seen
between 2009 and 2012 but it did not gain any big amount of attention until 2013. This can
also be observed as you go into statistics about the amount of users of the additional service
Mywallet. Mywallet is used as a virtual wallet on your computer where you can store the
currency. The growth rate of the amount of users took accelerated rapidly in
December/January of 2012/13. At the moment of writing it is now at 263 100 individual users
and growing. (Bitcoin Block Explorer)
Amount of users of Mywallet
Figure 4
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Source: Bitcoin Block Explorer
One Bitcoin is devisable to eight decimal places; hence the smallest amount is 0,00000001
BTC which is also referred to as 1 satoshi. This means that in 2030 when production of
Bitcoins stop there are going to be about 21 × 1014 currency units in circulation.
(Bitcoin.org)
2.3.2 How Bitcoins are created
Bitcoins are designed to mimic mining of minerals. Take the extraction of gold as an
example. To begin with it is easy to find new gold and the rate at which it is extracted is very
high since it is easily accessible and there is a large supply. But as the extraction continues it
gets harder to find since it is scarce and becomes even scarcer as more is mined. The mining
continues until every piece of gold has been mined and all of it is in circulation in the
economic system. Similarly with Bitcoins; at the beginning the supply increases rapidly but at
a decreasing rate until the creation-rate declines to zero. The rate is predetermined by
algorithms and is automatically changed. The creation is to stop sometime in 2030 when
around 21.1 million Bitcoins have been created. (Economist, 2011). Figure 5 illustrate how
Bitcoins regressively are put into the system.
Figure 5
Source: Grinberg (2012, p. 161)
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The process of creating Bitcoins is in itself fairly technical for those not familiar with
cryptography and computer programming. But I will try offering a simplified explanation.
The technology builds upon peer-to-peer networks, similar to downloading Bitorrents when
downloading movies. (Economist, 2011) Peer-to-peer is when computer are exchanging
information without a server in between. In other words when computers are exchanging
information without a middleman that can be shut down.
To begin with the very first transaction the creator’s computer forged 50 Bitcoins. This is
announced in a network of users, also referred to as “miners” which has to authorize the
creation and certify that the creation of the units is in fact legitimate. As a reward for this
some of the 50 Bitcoins are distributed amongst the certifying users. After that the miners
creates blocks of currency units that has to be approved and certified by the other miners.
Using complex encryption techniques users are confirming each block of currency created.
All certified blocks are published in a public log where you can view the verification of the
money. (Economist, 2011)
This work is costly for individuals in terms of time and computer power but can be consider
cheap for the network as a whole as the system grows. Making the verification-process into a
forced-work task solves this i.e. all users are involved in this process. The verification process
is constructed as a mathematical puzzle adapting to the current computing power i.e. if the
network grows the mathematical puzzle gets more complex and conversely if it shrinks it gets
easier. This is to maintain the constant growth rate of the currency creation. The time frame to
create and approve one block is set to ten minutes. This means that a new block of currency
units are sent into the system every ten minutes. By altering the size of the block, and thus the
amount of currency created, the growth rate of the currency can regressively decline. As I
mentioned earlier this is an automated process built into the algorithms. Figure 6 depicts the
amount of Bitcoins that has been created since the start and it also shows the first decline in
Bitcoin mining in December 2012. (Economist, 2011) At the moment of writing the amount
of Bitcoins in circulation is around 11 128 000 Bitcoins. The rate at which they are created is
about 300 coins per hour on average at the moment. But every four years the sizes of the
blocks are halved. At the moment one block contains 50 currency units but will soon contain
25 units, after around four years one block will contain 12.5 units and so forth. (Bitcoin Block
Explorer)
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Amount of Bitcoins Created
Figure 6
Source: Bitcoin Block Explorer
2.3.3 Transactions
When one user wants to transfer currency to another party he/she receives a virtual key,
another key is created which is made public. The recipient using his/her private key retrieves
the public key and all parties are now verified by the usage of their keys associated with their
accounts or wallets. By using public-key encryption, which is often used in many other online
dealings, a transfer cannot be made without the approval of both the transferring party and the
recipient. This system is setup to side-step theft, and does so neatly but does not circumvent
the problem with double spending. Spending money twice in this system could be said to be
the cyber version of counterfeiting. In the real world funnelling the money through a single
database that approves all transactions being made by checking a serial number on the money
solves this. But since the whole point of Bitcoin is an open network with no centralized agent
involved this has to be done another way, and this is where most other digital currencies has
got stuck. This nut is cracked much like the creation of Bitcoin is, by complex mathematical
algorithms and certification from the users. (Economist, 2011)
The cost related to the transactions is close to zero. Some costs are affiliated with the
hardware and energy used to control the system. There are also small fees for those who
whish not to be a part of the mining process but only want to exchange (read: buy) currencies
such as dollars or euros into Bitcoins via websites such as Mt. Gox. (Economist, 2011)
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2.3.4 Lack of centralized supervision
The system itself evidently relies upon the users self-policing it. The system is constructed so
that one person can not control it as long as it have not got more than half of the network’s
computing power. The incentive for making sure no counterfeiting, double payments or
illegal creation is taking place is both the payment for helping to mine Bitcoins and making
sure your own Bitcoins aren’t eroding in value from an over production of illegal currency, or
in economic terms: inflation. (Economist, 2011)
However, this implies that a community of users can pool their computing power and can then
be able to mine more per person then they otherwise would be able to if they worked
individually. This means that you actually can solve the mathematical problems faster then
the algorithm has calculated, since the algorithm is based on the individual’s computer power.
This has to some extent occurred, but has not yet posed to be a valid concern. (Selign, 2013)
As mentioned earlier one of the foundations or pillars, if you will, of the system is that it has
no centralized agent, institution or government supervising it. It is solely controlled by its
users. The currency is atypical in this regard. However, according to Grinberg this is a matter
is could be argued upon. Bitcoin has a five-member team assigned to debugging, maintaining
and improving the system. Since the system by design is open access these people can
actually create new updates to alter the system but it in turn has to be accepted by the users.
They do not however have authority to impose the new updates on the users. Some might
argue that this is “the bitcoin version” of a central bank or authority. But since all updates has
to be approved by the users and cannot be forced upon the users this cannot be equated with a
central bank. But Grinberg asserts that “most users would probably accept the new version
[…] because of the trust in the development team”. Whether this is likely or not is entirely up
to the users. With the right lobbying in various forums and the like the newer version might
be accepted by a big portion of the users who chooses to download and implement the newer
update containing, for example, a new creation rate effectively changing the inflation.
Grinberg adds that this might result in two competing currencies when on part of the users
accept the new currency and one chooses not to. (Grinberg, 2012)
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2.3.5 How it is traded/used
Since there are no banks that have to be open in order for the system to be administered
transactions can be carried out instantaneously to whichever part of the world you would like
at any time you like. There are also no actual costs involved with a transfer or payment since
there is no middleman but only the two users transferring the money to each other.
(Economist, 2011)
Another feature that stands out from conventional money is that there is no banking sector.
The only way to store them is on your computers hard drive. The cyber equivalent of storing
money under your mattress. This raises two issues, if your computer crashes your money is
gone, but by keeping back-ups you can avoid this problem. However, this is not the
interesting part, opponents of the system has claimed that Bitcoin is a heaven for money
launderers and drug dealers, since it is big parts of it is still outside laws and regulations.
(Economist, 2011) There are people claiming that the authorities cannot freeze Bitcoin
accounts which leaves thieves and other scums free to use money however they like while
keeping away from the police and the like. This can be solved by seizing the computer,
keeping the money from the perpetrator since it stored on the hard drive, effectively freezing
the account. (Economist, 2011)
The other, perhaps more interesting part for economics, is that you now have not got someone
to store, protect and increase the money in circulation in the system. Especially the part where
no loans can be handed out by a central authority and thus create more money. For now
Bitcoins works as a complement for regular fiat standards but for a majority of its users but in
a hypothetical world private actors with big fortunes in Bitcoins might start to lend their
Bitcoins to other users. It is not far-fetched that one user needing a loan can put up his house
as a security for a loan to another private user and create a binding contract of the deal
agreeing on a payment plan and interest rates. 1
However, not having a bank means no fractional-banking. No new loans can be approved and
thus the money in circulation cannot increase, this means limiting growth in an economy. For
instance, if you can get a higher return from a project than the interest you can get for a bank
1
Some businesses have been surfacing lately that are marketed as Bitcoin banks. If they gain
momentum they can start to mimic conventional bank where they can let the outgoing loans
exceed the amount of deposits they have, thus effectively starting a fractional banking system.
(Unknown, A new specie, Economist, Apr. 13th 2013)
19
you should borrow the money and do the project. So at first you might think that this will lead
to more projects being invested in since you will always (discarding for projects with a
negative return) get a higher return on a project than keeping them in you virtual wallet. Quiet
the opposite, if you cannot get a loan you cannot lever your investment and thus more people
will be deterred from making the investment. (Fregert & Jonoung, 2010)
2.3.6 The legitimacy of Bitcoin
Proponents of Bitcoin praise the open-access and how it is not regulated in any way unlike
conventional currencies. The system in itself is safe and is impossible (or at least vary hard) to
alter. It is not subjectable to the whim of a politician or to central bankers that can fiddle
around with it without being informed properly. But this is also the weakness of the currency,
without someone with a monopoly on violence that has regulated that only one currency is
permitted it is vulnerable to competition. Nothing is secret in the open system and people are
finding ways to improve Nakamotos idea and are creating their own currencies. (Selign,
2013)
Grinberg asserts that another issue may be raised regarding how the currency is constructed.
Since creation of Bitcoins are to stop in 2030 with 21 million units in circulation the supply is
to be fixed afterwards. Meanwhile other currencies will continue to increase in stock. This
means that Bitcoins will become scarcer relative to other currencies thus depreciate the
currency. Grinberg continues with:
“As prices denominated in Bitcoins fall, producers may respond by lowering production,
leading to lower wages, lower demand, and further decreases in prices. The end result of such
a spiral is underemployed human capital and other means of production and destruction of
wealth. Thus, industries using Bitcoin that fall into such a spiral may decide to abandon
Bitcoin. Even the possibility of such a spiral may limit Bitcoin’s reach.”
-Grinberg, 2011
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3.0 Analysis
Bitcoins does exhibit a store of value function, it is possible to separate buying and selling in
time. But as previously stated this does not imply that it will be with the same purchasing
power. This is a big concern with Bitcoin since it is so volatile but however, not relevant o the
store of value as the model is constructed.
As for the unit of account we do run in to some trouble. Theoretically the values of all goods
can be expressed in Bitcoins, however it is not at the moment. Since all goods are not for
purchase in exchange for Bitcoins. But this goes for other currencies as well. Sometimes the
only way to express a price is thorough the exchange rate between the country that wishes to
purchase the good and the country producing it. The same goes for Bitcoins, not all goods are
sold for Bitcoins but since there is an effective exchange system working it is possible to
express prices just as good as with another currency.
It does fulfil the prerequisite of medium of exchange. It can be used as means of payment for
goods that are tradable on the Bitcoin market, however not all goods are. Once again one
might need to exchange Bitcoins for other currencies in order to make a purchase, but as we
all know this is how cross-border trade works today as well.
As for Selign’s model with the money matrix it does show the four standards in an easily
accessible way. But the standards can be divided even further into sub-categories. For
instance you do miss out on the difference between specie standard and the paper standard.
Which might be useful when discussing currencies. I would also like to incorporate the digital
aspect into the model in an attempt to incorporate more information into the matrix. However,
it does make more easily accessible when containing just the scarcity and non-monetary use
categories.
As I presented earlier history with the Iraqi Swiss dinars has shown us that currencies not
backed by governments without institutions can gain momentum and become an excepted
means of payment. The similarities with a synthetic commodity standard are striking. There is
a fixed amount of currency units, however no exact number of how many is known. Just like
the Iraq Swiss dinar Bitcoins does fulfil the prerequisites I listed in the beginning; store of
value, unit of account and medium of exchange.
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The legal status is also subject to further investigations, I have deliberately left out big part of
the currencies legal status. There is no clear way for it to be monitored or taxed and different
governments are at the moment trying to incorporate it in its judicial systems. This may result
in big losses for Bitcoin if it gets restricted in parts of the world.2
Proponents also emphasises that there are no transaction costs involved with a Bitcoin
transfer, which would decrease the cost for corporations when making business. Although this
is true it has to be put up against the income you get from the savings interest on a bank, that
you miss out on when keeping your assets in Bitcoins.
The issue Grinberg highlights with the end of the creation if new units in 2030 whilst other
currencies will continue to grow in stock thus depreciating the currency. This, however
possible, might not be as big of a problem as Grinberg make it out to be. One Bitcoin is
devisable to eight decimal places, or one satoshi. This means that you can in a foreseeable
future still trade with Bitcoins without it becoming impractical. Furthermore it is possible that
new updates can increase the divisibility if it is needed.
The issue of a majority of the users opting for new updates that changes in the system is a
valid one. One scenario might be if users start pushing for a new mining process when the 21
million Bitcoins have been created. Another scenario might be, if the currency survives for
that long, is to increase the amount of units it can be divided into, granted that it has
appreciated in value to the extent that it has become impractical. With the right lobbying in
forums from the development team the changes can be accepted especially if the network of
users is not that big. However, the more the system grows the more users you will have to
convince in order to accept the changes. Furthermore, the users have bought in to the system
as it is constructed now, and not to the hypothetical changes that could come with time. To
me, the most likely scenario is for the system to remain unchanged in the future. But just the
fear of change and/or the knowledge of it being possible might be enough to deter possible
adopters and sceptics from adopting the currency.
2
The 25th of May charges with money laundering against Liberal Reserve were brought up in
in the U.S.. Liberal Reserve handles transactions with Bitcoin, although no charges against
Bitcoin were brought up. (Albergotti, Reed & Sparshott, Jefferey “U.S. Says Firm Laundred
Billions” Wall Street Journal, May 28th 2013)
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How a digitalised standard commodity will work and at which rate money should be put into
the system as well as for how long is a subject best left to future economists and politicians.
But if you want to create a synthetic commodity standard that is sustainable in the long term it
is important to remember that many factors has to be taken under consideration. The world
around it is always changing so what might seem appropriate today might not be such a good
idea for tomorrow. Automatic stabilisers can always be built into the system. But as soon as
you start the process it will be hard to change. As far as Bitcoin goes it will probably not
influence the common layman to a great extent. It is only when a government decide to
implement this for a country as a whole this might be of interest.
4.0 Conclusion
So is Bitcoin going to be the new currency used worldwide and be the new “world-currency”
that economist Gustav Cassel uttered on his deathbed as he took his last breaths? Probably
not. The currency is by many considered to volatile to be used as a serious alternative to the
government backed currencies. I also think that Bitcoin has started to exhibit signs of a bubble
with its growth in investments, exchange rate and amount of users the latest months.
Furthermore the common layman will probably remain suspicious towards the complicated
system the currency is based on. A fear of getting cheated by computer hackers and the like
will probably deter the general public from accepting the currency and using it in everyday
life. Nor is it likely that companies and corporations will use it as payment in dealings since it
remains too volatile to be used effectively in in trading.
So to what extent can Bitcoin be accepted? Well, for libertarians and computer loving people
it can continue to work as long as it not regulated. But this group is quiet limited in quantity.
But what I think Bitcoin will do is leave a dent in the economy, it has shown that a currency
can be created without a central authority or a central bank. Alternatives are already starting
to emerge as a consequence of Nakamotos ingenious self-policing system. This could be a
gateway for new digital currencies that are even better than Bitcoin. This might put pressure
on the established banking systems and credit card companies to come up with new systems
that are not as expensive as the ones currently in place for transferring money cross borders.
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5.0 Sources
5.1 Literature
Fregert, Klas – Jounung, Lars, 2010. Makroekonomi: Teori Politik och Institutioner. 3rd
edition, Lund.
Keynes, John Maynard. General Theory ofEemployment, Interest and Money. Atlantic
Publishers & Dist, 2006.
5.2 Academic work
Selign, George (2013), “Synthetic Commodity Money”, University of Georgia.
Nakamoto, Satoshi (2009), “A Peer-to-peer Electronic Cash System”
5.3 Electronic Sources
5.3.1 Articles
Bulow, Jeremy (1982), “Durable-Goods Monopolists” Journal of Political Economy, vol. 90
no. 2.
Coase, Robert (1972), “Durability and Monopoly” Journal of Law and Economics, vol. 15,
April.
Grinberg, Reuben (2012) “Bitcoin: An Innovative Alternative Digital Currency.” Hastings
Science and Technology Law Journal, vol. 4 no. 1.
King, Mervyn (2004) “The Institution of Monetary Policy” American Eagle Review, Papers
an Proceedings, vol. 92 no 2, May.
Krugman, Paul, (2013) “The Antisocial Network”, New York Times, 14th of April 2013
5.3.2 Websites
Bitcoin.org, Website, [electronic] Available at: http://bitcoin.org/en/about
Collected: [15th of May, 2013]
Bitcoin Block Explorer, Website, [electronic] Available at: http://www.blockchain.info/charts
Collected: [15th of May, 2013]
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J.P., (2011) Bits and Bobs,
http://www.economist.com/blogs/babbage/2011/06/virtual-currency
Collected: [25th of April, 2013]
Pringle, Robert, (2002) Interview With Milton Friedman,
http://www.centralbanking.com/central-banking/opinion/1428941/interview-milton-friedman
Collected: [15th of May, 2013]
Voorhees, Erik, 2013 Bitcoin – The Libertarian Introduction,
http://www.mises.se/2013/03/21/bitcoin-en-libertariansk-introduktion/ Collected: [29th of
April, 2013]
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