New Technology Plus Old Money Spoil the Broth

THE VIRTUAL CURRENCY HAS PRODUCED A LOT OF SPECULATORS, BUT ULTIMATELY FAILS TO MEET THE NEEDS OF THE REAL ECONOMY

by Massimo Amato and Luca Fantacci, Dept. of Policy Analysis and Public Management, Bocconi
Translated by Richard Greenslade

Bitcoin is an open challenge to the monetary and financial status quo. The stated intent is to create an electronic payments system capable of bypassing any intermediary.

Thanks to the Internet and encryption, transactions are not processed through centralized clearing systems, but by users on the basis of the resolution of a complex mathematical problem. Some users, the "miners", have specialized in the activity of validation accounting, and are remunerated by the issue of new bitcoin.

However, this way of tying together validation accounting and money creation is the Achilles heel of the whole project: Bitcoin as payment system (conventionally written with a capital letter) cannot operate except on the basis of bitcoin as a currency (lowercase).

In its claim to offer a stable currency by subtracting arbitrary central bank monetary creation, bitcoin is  inspired by the nineteenth-century gold standard. Like gold and even moreso, the bitcoin exists in a fixed amount, predetermined by a protocol, which regulates the rhythm of its creation: the bitcoins available will be a maximum of 21 million in 2040. However, to determine in advance the total amount of money excludes any possibility of adjusting supply to demand. The inevitable consequence is extreme volatility of the value of bitcoins.

So far the question of bitcoin was fueled by a desire to obtain capital gains in expectation of a rise in its price. In other words, there was high demand for bitcoins for purely speculative reasons. However, even assuming a prevalence of bitcoins as payment, the offer would remain unchanged. And this would inevitably reduce bitcoin prices. If it can establish itself as a currency, Bitcoin would be a deflationary currency: that is, bad currency. Just ask Mario Draghi, who does everything to avoid the euro becoming like that.

Can you benefit from the advantages of Bitcoin without having to suffer the defects of bitcoin? Yes, but only through intermediaries: which is paradoxical for a project that aims to eliminate the middlemen. And the new brokers are far more numerous, concentrated, unchecked and unreliable than those who populate the traditional system. This pushes up the risks and costs for the transfer of bitcoins, which already now are not insignificant: adding in investments in hardware and energy costs, the average cost per transaction is more than seven dollars.

Bitcoin has aroused and continues to arouse a disproportionate outcry. Perhaps the more you consider it an opportunity, the more it becomes a threat. A threat to the good faith of the users, and to the stability of the payment system and the financial system.
This could, however, become an opportunity for the official financial and monetary systems to rethink their role. Bitcoin is, in fact, the wrong answer to the right question: how to bring money to where it really needed, thus returning money fully to its function as a means of circulation, issued in favor of the actual exchange of goods and services and real economic activity? It would be desirable, in light of the experience of virtual coins, to look for answers as innovative as Bitcoin, but more effective, more meaningful in terms of economic and financial environment, and above all more responsive to the social function of the banking system.