Bitcoin(s) are widely
discussed in places from conspiracy blogs to the main stream media and even the
government..
Depending on the news
source bitcoins are a replacement for fiat currencies, a replacement for gold,
an anti-establishment currency etcetera etcetera.
We decided to look at
a couple of attributes of money/currency for easy comparison.
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Gold
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Bitcoins
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Dollars
(Fiat currency)
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Cost of production
/ extraction
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Aside from particle
accelerators humans do not produce gold, we only extract it .Real resources
are used to extract and process gold.
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Real resources are
used to produce bitcoins. Bitcoins are created through a calculation intense
process but ultimately that is/was somebody's decision. Somebody decided
bitcoins existed where there were none before.
In effect the
creation of bitcoins requires one to burn coal/ resrouces to create something which
ultimately is somebody's edict.
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Production of
physical dollars requires resources. In the case of certain coins the value
of resources consumed may exceed the assigned value of the coin. Keep in mind
though that this is a choice, not a physical necessity. Virtually no
resources are used to produce electronic dollars.
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Store of value
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The value of gold
is in the eye of the beholder. In specific circumstances the value can
even be negative to the holder. Go swimming with your pockets filled with
gold coins.
(marginal) cost of
production has no bearing on value.
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The value of
bitcoins is in the eye of the beholder. Judging by valuations visa viz other assets they don't keep their value very well. Bitcoin's value can in/decrease significantly without any apparent reason.
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The value of fiat
currency is a function of the value of other currencies as well as the supply
/ demand characteristics for dollars
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(negative) carry
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It requires
resources to store gold. One can argue that over time the cumulative storage
cost will exceed whatever value gold has. Ask yourself what the cumulative
cost was to keep a gold coin, created and stored away in 3000BC,
safe and secure until now.
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It requires de minimis, but greater than zero
resources to store bitcoins. As technology marches on eventually storage
costs are likely to go up because required hardware and software safeguards
will increase.
Until bitcoins can
be lent out and generate a return greater than the safekeeping costs they
generate negative carry.
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Dollars come in two
forms, physical and electronic. The former has storage costs if not lent
out but with respect to the electronic form market liquidity allows for
saved dollars to be lent out which provides an opportunity of positive
nominal carry.
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Valuation
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Gold has
established trading / exchange mechanisms with known price discovery and
market depth. (marginal) cost of production - a longer term de facto
floor in an increase of the quantity of gold extracted - is relatively
well known and flows from non-tradable stocks to tradable stocks are widely
known and followed.
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Bitcoins have
relatively poor liquidity with little market depth and significant bid/offer
spreads. As the number of bitcoin holders and transactions increases though
that likely will change.
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Dollars currently
have established trading / exchange mechanisms with known price discovery and
market depth. This was not always the case though and is likely not always to
be the case going forward.
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General
observations
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The main problem
with gold as hypothetical centerpiece of a financial system is that the
quantity of gold grows at a slow rate, by en large determined by physical
boundaries on the rate of extraction and the difference cost of production
and sales price. Therefore the connection between the real economy and the
available stock of gold is only very loosely connected. Gold as currency may
have made sense in a time when the real economy grew very slowly - more or
less keeping pace with the increase in available gold - but as rates of
change between the quantity of gold available and the real economy diverge
the apparent relationship has become more tenuous. Gold does have a real
demand as disaster insurance.
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The number of
bitcoins which will be created is (at this point) predetermined and seemingly
arbitrary.
To my knowledge
there is no mechanism to reduce the number of bitcoins which exist.
Similar to
gold it makes no sense to have a static number of currency units in a dynamic
economy. IF bitcoin creators - the functional equivalent of the much maligned
commercial banking system - were to decide to increase the number of bitcoins
they will face the same issue that the monetary authorities and the
commercial banking system face now.
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Dollars can be
created and destroyed at will. In order to keep the quantity of dollars in
line with the real economy society has to be able to accurately measure the
size of the real economy, and collectively have the discipline to change the
number of dollars in existence accordingly.
Historically though
most fiat currencies have been inflated into oblivion, largely because individual interests were not the common interest.
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A number of
people say that the difference between currency and money is that money has to
be a store of value and currency is not. The moment any currency is used in
exchange for anything - which usually is the main purpose of a currency in the
first place - the value becomes relative rather than absolute. The notions that
a currency can be a store of value and a medium of exchange are by definition
in conflict.
That aside, the
generally accepted aspects of money are:
- Unit of account
- Medium of exchange
- Store of value
- Measure of value
Bitcoins are a medium
of exchange, but when the value relative to other media of exchange can move by
huge amounts in a very short period of time it's hard to see how they can be considered to
be a store of value, or a measure of value. With respect to Unit of account,
are (for example) dollars measured in bitcoins or are bitcoins measured in
dollars)?
Finally, bitcoins
already are a fiat currency ("Let it be done"- the collective decided
that bitoins can be used in exchange of value) but if/when the supply of
bitcoins are arbitrarily changed all bets are off.