Most people do not think twice when making a payment with the quick swipe of a credit card. Whether buying groceries, shopping at the mall, or going out to eat, spending real money now has the convenience of carrying around a single piece of plastic. As science and technology have developed in our society, the money and banking industry has also made considerable advancements. It is hard to even imagine a time when transactions were conducted with only weighty cash and metal coins. Now, virtual currencies are also being introduced into society. The most prevalent and widely accepted of these is bitcoin, a private and non-governmental currency transacted entirely through the Internet. However, bitcoin’s inherent technological traits and relatively limited use in the consumer market will prevent it from becoming a prominent currency in modern society.
The bitcoin computer program was developed by Satoshi Nakamoto, although this is believed to be a pseudonym leaving the real developer unknown. Bitcoin serves as the creator and manager of a virtual supply of currency, “bitcoins,” which can be used as payment through online transactions. Bitcoin is a unique currency in its anonymity and public nature. The definite classification of bitcoin as either a currency or investment is greatly contended, though, partially due to its failure to fulfill the three main characteristics of money. The regulation of bitcoin is also under debate, especially because its digital design creates the possibility of money laundering and theft.
Since its inception, this innovative form of money has fluctuated in its role. The obvious use for bitcoin is as a currency, which can be used to pay for goods and services. However, bitcoin has encountered multiple flaws that are restricting it from succeeding as a true currency. As an economic definition, currency must serve as three functions: medium of exchange, store of value, and unit of account. Bitcoin faces obstacles in fulfilling all three of these functions.
As a medium of exchange, bitcoin’s main hurdle is gaining wide acceptance. It is true that an increasing number of merchants are agreeing to accept bitcoin as a form of payment, but this use is still small compared to the greater commercial market. The online bitcoin service site Bitcoinstore.com boasts over 100,000 merchants that accept bitcoin. Although many of these are small companies, a few larger retailers such as Overstock.com and Expedia are also included. Ultimately, the most widely used merchants to accept the currency are computer-based software companies which specialize in bitcoin applications, or actual bitcoin exchanges and marketplaces. It is estimated that only about 20% of bitcoin transactions are purchases of goods or services, and the remaining 80% is comprised of speculative exchanges between investors, proving bitcoin’s “extraordinarily negligible market presence” (Yermack 10). While bitcoin is certainly growing in its merchant base, it is far from achieving success as a widespread medium of exchange.
Bitcoin also faces issues with its function as a store of value, which refers to its ability to represent a certain purchasing power that will hold over time. Ideally, the monetary value at the time of the bitcoin purchase should be equitable to the value when the currency is used to make a purchase. Because of bitcoin’s relatively new creation and the way in which the bitcoins are mined, the value of a single bitcoin fluctuates greatly, even within the course of a single day. Over an eight-month period during 2013-2014, the purchasing power of bitcoin ranged from approximately 60% above to 40% below that of the U.S. dollar (“Bitcoin and Beyond” 7). This variability can at least partially be attributed to the dependence of the bitcoin value on demand and supply. It is most definitely not a commodity-backed currency, because it is merely a computer file without any intrinsic value. It also fails to fit the classifications of a fiat money, though, because the value is not regulated or ensured by the government. Consequently, a steady bitcoin value relies solely on a steady supply and demand.
Bitcoin’s inability to be held in physical form also lessens its security of value. The currency exists only in the form of digital files, which are much more susceptible to theft and, therefore, loss of value. Some virtual wallet service providers are offering increased security features, although the protection will never be as reliable as that of the Federal Deposit Insurance Corporation for U.S. dollars. This causes bitcoin to lack a steady store of value and thus prevents it from serving as a reputable form of currency.
The function of a unit of account is also flawed, as bitcoin’s volatility leads it to be an ineffective standard for comparison in making payments between businesses and consumers. There are numerous costs which arise from a fluctuation in value. Merchants that accept bitcoin are forced to repeatedly recalculate and record prices to fit the current bitcoin exchange rate. In addition, the frequent change in value prevents both retailers and consumers from acquiring a good idea of how equitable a price is when stated in U.S. dollars and bitcoins. There are also discrepancies between “current market prices” on various bitcoin exchanges (Yermack 12). Widely-ranging prices invite the possibility of arbitrage, as the currency could easily be purchased at one price and instantly traded around the globe for a higher value.
Another barrier to being a successful unit of account is bitcoin’s relatively high price per unit compared to the price of most goods being purchased. For example, the price of one bitcoin at the time of this writing is $235.93. This means that if a consumer wanted to buy a gallon of milk for $5, the equivalent would be 0.0212 bitcoins. This very small number makes transacting with the virtual currency more complex and creates confusion for both merchants and consumers. As a consequence of bitcoin’s price disparity and inconvenient exchange mechanism, it fails to serve as a reliable unit of account.
Bitcoin’s inherent basis on technology also creates issues with becoming more widely accepted within society. One of the primary obstacles is protecting its user anonymity. The bitcoin system is designed to be completely anonymous; all transactions are recorded in a public register, but specific transfers cannot be traced to a single user’s identity. However, it is always possible that this anonymity could be breached through computer hackers (Grinberg 179). Accidental user errors or negligent use of personal information could easily expose a customer’s identification. A second caveat is the potential for theft. Just as keeping large amounts of cash on hand can be a dangerous invitation for thieves, bitcoins can only have so much technological protection. As with any digital file, a bad virus or computer hacker can cause the complete loss of a bitcoin supply.
In addition to issues with anonymity and theft, bitcoin could also fail by way of a denial of service. Because there does not exist a central entity that controls bitcoin, the production of the currency is left to the individual “mining” computers. Essentially, these miners have the ability to block any given bitcoin transaction. In an extreme case, and with the necessary hi-tech computer equipment, a single individual could cause the destruction of the entire bitcoin system. Although seemingly unlikely, this scenario is plausible given governments who wish to implement regulation, or people attempting to blackmail bitcoin-accepting merchants (Grinberg 181).
The unique thing about bitcoin is that it lacks a governing body. Without a company to oversee it, bitcoin operates solely through users and their computers, and value is based on demand and how often bitcoins are being “mined.” The question which arises with this system is whether or not bitcoin will be sustainable without a central organization to monitor and guide it. Langdon Winner, in his work The Whale and the Reactor: A Search for Limits in an Age of High Technology, offers insight into the political aspects of such advanced technologies, and the necessity for either an authoritative power or government regulation.
In Winner’s writing, he analyzes how new forms of technology serve as “political artifacts.” Many advanced technological forms serve as a way to build order in our current society. Winner explains that “Consciously or unconsciously . . . societies choose structures for technologies that influence how people are going to work, communicate . . . and so forth over a very long time” (Winner 28). Bitcoin as a virtual currency can similarly be analyzed. Because currency is traditionally maintained by the government in order to ensure security and stability, there is debate over whether bitcoin should be federally regulated. In fact, some users have confidence in bitcoin specifically for its separation from the government. It offers an alternative for those who mistrust the money supply stability and fear an abrupt and purposeful inflationary period. If bitcoin continues to grow in popularity, it could signal general dissatisfaction with the management of U.S. currency.
The social form of many technological systems can be a major determinant in its effective function. In The Whale and the Reactor, Winner discusses a specific study in which it was found that routine operation of many systems requires “a large-scale centralized, hierarchical organization administered by highly skilled managers” (Winner 34). This hierarchy specifically relies on executives to keep track of and coordinate responsibilities. Bitcoin, however, does not have a central authority and is therefore run by no single person or organization. This also means that there is not a “contractual relationship” between the people mining bitcoins and the initial creator of the system (Kaplanov 130). According to the previously stated theory, bitcoin would consequently not serve as an efficiently-working system with a proper social organization.
Numerous advancements in banking technology have created a system of unprecedented reliance on mere “digital” money. Swiping a credit card, writing a check, or simply paying with bitcoins over the Internet can make currency seem like a virtual concept. Since the first “mining” of bitcoins in 2009, their use and value have increased significantly, although the currency is still mostly used among computer engineers and those who mistrust government-regulated money. After nearly five years in circulation, bitcoin continues to have a very volatile value and consequently fails to fulfill the three main functions of money. A lack of central authority and potential technological downfalls also make it difficult to implement government regulation of bitcoins. Despite these barriers, the virtual currency has shown growth and may be an accurate glimpse of what is in store for the global economy.
“Bitcoin and Beyond: The Possibilities and Pitfalls of Virtual Currencies.” Central Banker, Federal Reserve Bank of St. Louis. Fall (2014): 6-7.
Grinberg, Reuben. “Bitcoin: An Innovative Alternative Digital Currency.” Hastings Science & Technology Law Journal 159 (2012): 175-81. Web. 25 Mar. 2015.
Kaplanov, Nikolei M. “Nerdy Money: Bitcoin, the Private Digital Currency, and the Case Against its Regulation.” Loyola Consumer Law Review 25:1 (2013). Web.
Yermack, David. “Is Bitcoin a Real Currency? An Economic Appraisal.” National Bureau of Economic Research Working Paper Series. (2013): 2-17. Web.
Winner, Langdon. The Whale and the Reactor: A Search for Limits in an Age of High Technology. Chicago: The University of Chicago Press, 1986.