Already during its short life in the public imagination, reams have been written about Bitcoin—what it is, how it works and, most breathlessly, how rich you can get by trading it. This has all of the hallmarks of a speculative bubble, the most significant aspect of which is analysts’ general inability to link the value of a Bitcoin to anything real. As Bloomberg columnist Matt Levine observed, on fundamental grounds, the fair value of Bitcoin lies somewhere between zero and $5m. Who knows? It’s an existential question.
If it is to be considered a currency, Bitcoin’s worth rests on its usefulness as (a) a store of value, (b) a medium of exchange and/or (c) a unit of measurement. On all three grounds, there is room for considerable doubt.
As a store of value, Bitcoin looks promising, given its swift adoption—helped, no doubt, by the lure of rapid price appreciation. However, trust in Bitcoin remains fragile, given the proliferation of copycat cryptocurrencies, the threat of dilution through “forks,” and the recurrent hacking of Bitcoin vaults. As a medium of exchange, Bitcoin’s use is hamstrung by high transaction costs and the resulting unwillingness of merchants to accept it. Finally, it is of no use as a unit of measurement given its extreme volatility; Bitcoin’s prices swing far more than those of the goods and services for which it might be used.
These challenges are real and immediate, but not insurmountable. Over time, the attractions of Bitcoin, and the powerful Blockchain technology upon which it rests, will probably attract more market participants, generating increased liquidity and diminished volatility. That could foster a virtuous circle of rising acceptance and improved market efficiency.
However, there are other, more binding, constraints on Bitcoin’s long-term future: the energy-intensive nature of Bitcoin mining and transactions, and governments’ unwillingness to cede control over the issuance of money, which affords valuable seigniorage and a means of social control. The attraction of Bitcoin lies precisely in users’ ability to evade such controls. However, the energetic cost of replacing trust with technology is extraordinarily high. It is an understatement to say that the vast waste of energy incurred by those trading Cryptokitties demonstrates that the environmental cost of Bitcoin is not priced fairly in the markets. I expect that it will be, in the not too distant future.
Thus far, governments have been indulging Bitcoin users’ fantasies, most likely for the information that will eventually be revealed about those who are keen on the technology. Rest assured that authorities will crack down on alternative currencies if and when their monetary prerogatives are threatened. There are many ways they can do so: by regulating Bitcoin as a security; by demanding transaction information for purposes of collecting investment income taxes; and by limiting merchants’ ability to transact in Bitcoin. Small firms might find it easier to evade such controls, but Bitcoin transactions are prohibitively expensive for them. Larger firms will be unwilling to sacrifice their cozy relationships with government regulators when other, more cost-effective, payment mechanisms exist.
If you doubt governments’ ability or willingness to control the use of currencies and their alternatives, look no further than the EU’s recent decision to limit citizens’ ability to carry any amount of cash (or precious stones, metals and prepaid cards), the Indian government’s 2016 monetary “reform,” or the US government’s 1933 decision to ban private holdings of gold (punishable by up to ten years in prison!)
So, enjoy the fun while it lasts—but don’t expect it to last.