oralloy wrote: Thomas wrote:
The technology of Bitcoin is nifty, but the monetary economics of it never made sense to me.
It's the same concept that is behind paper currency. People trade currency for goods, and trade goods for currency.
That's not where the monetary economics fail. To understand where they do fail, lets go back to basics. Let's recall that money is whatever serves people as their medium of exchange, store of value, and unit of account. Bitcoin has proven functional as a medium of exchange, but highly volatile as a store of value and a unit of account. That makes it dysfunctional in its role as money.
And there's a reason for that: Nothing in the Bitcoin system puts an upper or lower limit on the price of Bitcoin.
This is not true with other monetary systems. With gold, for example, you have a lower bound for its price because gold is useful for things like making jewelry, filling teeth, and galvanizing electrical contacts. On the other side, you have an upper limit on its price that is set by mining technology. When the gold price rises above a certain level, mining operations find it profitable to dig out more of it, increasing its supply, and decreasing its prices in turn.
Dollars function differently than gold, but they, too, have upper and lower limits on their value. The lower limit on their value is that you can pay taxes to your local, state, and federal governments with them. (If and when that changes, I will agree that dollars are just as flaky as Bitcoin.) Putting an upper limit on the value of the dollar is monetary policy. As long as the federal government wants to maximize its tax revenue, the Fed will contribute to this goal with a suitable monetary policy. That policy involves stimulating the economy to take the tax base high, while avoiding to devalue tax revenue with excessive inflation. That's why dollars have low and fairly predictable inflation.
Bitcoin, by contrast, has none of that. There's no lower limit on its price because it's useless. And there's no upper limit either because the total quantity of bitcoins is arbitrarily capped at 21 million. Once supply hits this limit, nobody can mine more of them, no matter how much that would benefit its users.
Summing up, the recent Bitcoin debacle was predictable by anyone who has read the monetary-economics chapter of an econ-101 textbook. Those who find the debacle surprising, I suspect, were either taken in by the nifty technology or blinded by libertarian ideology.