Why Bitcoin Can’t Be Money

from Maudlin Economics,

Everyone is talking about bitcoin, even people who otherwise know little about investing. That’s probably a bad sign for bitcoin. Recently, I had a conversation with my 89-year-old father.

A few weeks ago, he asked the big question: “What is bitcoin?” I told him what I knew: Bitcoin is a digital currency, designed to be scarce, anonymous, and secure, that it’s price has gone vertical, that some people think it will one day replace dollars. He was with me until that last part. A private, digital-only currency didn’t make sense to him. I pondered that conversation driving home… and I think he was right. Bitcoin may be useful and valuable, but it won’t replace fiat currencies anytime soon.

Unless you’ve been hiding under a rock, you know bitcoin prices have gone bananas. I’m not even going to quote any numbers. Anything I say will be laughably wrong by the time you read this. Could some virtual currency that only exists on a computer screen really be worth these crazy prices? Maybe. If you think it will become a major medium of exchange, bitcoin is far underpriced. That’s a big “if”

Bitcoin’s anonymous inventor, who called himself Satoshi Nakamoto, built scarcity into the system. Mining gets more difficult as time passes and the supply increases. No one will ever hit a mother lode and double the bitcoin supply overnight. As the math gets more complicated and the computers have to work harder, bitcoin mining consumes an increasing amount of electricity. And that’s starting to be a problem.

Bitcoin mining and transaction processing consumes a lot of power, and we don’t have infinite amounts of it. A trend that can’t continue, won’t—so something will change it. Here’s a partial list of possibilities: Computers could get faster and more energy efficient We could find new sources of cheap, abundant electricity Bitcoin’s price could fall and make mining unprofitable Another, less energy-consuming cryptocurrency could take bitcoin’s place Governments could try to outlaw bitcoin and shut down the miners Of those, government interference is probably bitcoin’s greatest threat. Governments don’t like the anonymity, because it facilitates tax evasion, money laundering, smuggling, and other illegal acts. But there’s something even more basic to consider...

You can’t talk about bitcoin for long before you get to the “What is money?” question. My favorite answer: Money is simply the most liquid asset in a given place and time. Almost everyone accepts it as payment because they trust it, and they trust it because they know others accept it. Could bitcoin or another cryptocurrency ever reach that status? Maybe, but it will have to cross a very wide moat.

In the modern world, governments define money because they have the raw power to define how you must pay your taxes. They can and will use force to make you pay—and deadly force if you resist too hard. The IRS doesn’t accept cows, chickens, yen, gold, or bitcoin. It demands dollars.

As long as we pay a significant part of our income in taxes, We must all own whatever currency the government accepts as payment, in quantities sufficient to pay our tax obligations. Business accounting must use government-dictated currency as the unit of account. That means most people will default to using the same currency for personal spending and investing. This gives government-issued money an automatic advantage over bitcoin or any other competitor. When national governments start accepting bitcoin for tax payments, you can fairly call it “money.” Until then, it’s simply another risk asset like gold, stocks, or pork bellies. Is bitcoin a risk asset you should own? Probably not, unless you are prepared for some serious pain whenever the price heads south. I don’t know when that will happen. Bubbles get way bigger than anyone thinks possible, but at some point, they all pop. This one will too.

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