Bitcoin fever gripping the world, part 3: Outside the system

Based on what I wrote about the anonymity of Bitcoin, many might think that it should be outlawed by all means possible. Of course the question is not so clear-cut. The fact is that in situations of economic stress, it could be an excellent diversification tool. In autumn 2008, the world was on the brink of money markets collapsing and unleashing total chaos. I won’t go here into how realistic that threat was or what the ramifications of such a collapse would be. It should be noted, however, that Bitcoin is immune from that kind of universal systemic risk (or at least it’s not directly at risk), simply because it’s not part of the system. It’s not affected by budget deficits, sovereign debts, base rates, money supply or the proportion of non-performing loans. It stands outside the traditional monetary systems, and governments, national banks and commercial banks have no influence on it. None of the following could happen in a monetary system that operates according to the Bitcoin principle:

  • the losses of a bank that has gone bust are covered from money deposited on accounts at the bank (Cyprus, Iceland)
  • capital flows are centrally restricted (Cyprus, Iceland)
  • sovereign debt is covered by printing money with abandon, thereby running the risk of soaring inflation in the future (USA, UK, Japan etc.)
  • a transaction tax is imposed on money transfers (Hungary)
  • the appreciation of a currency is centrally contained (Switzerland)
  • negative interest is introduced (Switzerland)

It is surely no bad thing if the world has a possibility of diversification so that the above risks can be avoided. Of course something similar has long existed, namely gold. However, keeping gold is expensive and risky (it needs to be guarded or it risks being stolen, or interest is payable in the case of a futures contract). It cannot really be used to pay for goods and transferring it is also problematic. However, when the credit crisis broke out, there was no better tool for eliminating the above risks, so the price of gold rose between 2008 and 2011 to almost two and half times its pre-crisis price. If the Bitcoin had already been tried and tested at that point, then it could have played a similar role to gold. A lot of investors fled to gold, thereby driving up its price. From that point of view it’s more helpful to think of Bitcoin as virtual gold than as virtual money.

Soaring inflation is another kind of economic stress situation. It’s hard for us to image hyperinflation since it hasn’t been experienced in the developed world for a long time, though the possibility that we’ll witness it in our lifetime cannot be ruled out. In such circumstances economic players limit their production since there is no reliable means of payment, and costs and revenues cannot be planned. Compared to all other stand-ins for money, Bitcoin is the easiest to transfer and the cheapest to keep, so in such an environment Bitcoins could become the dominant means of payment. Traders would prefer to give their prices in Bitcoin, which can stay stable, instead of official money that is depreciating in value from day to day, perhaps even to the extent that it’s not possible to keep up with the changes. That would prevent the total collapse of the economy. Once again, it cannot hurt for the world to have such a tool.

Nonetheless, Bitcoin comes with numerous risks. I’ll write about those next time.

Original date of Hungarian publication: 15 Apr 2013