Sometimes I get really surprised by commentaries.

Having just casually written about bitcoins – and having just been caught up in the crash of the MtGox bitcoin exchange myself – I have been keeping my ears out about this topic.

Personally I thought that many with an interest in economics, particularly free markets and Austrian economics, would appreciate having an alternate currency around, but somehow it seems that many of them are just stuck on gold, and really don’t get it.

This Bitcoin ‘hack crash’ at www.MtGox.com has brought all this ‘Told you so’ out of the woodwork.

In reality, a collapse in Bitcoins – in this case from an exchange rate of $17 all the way down to 1c and back up – was a forseeable and pretty much inevitable blip in the growth and development of literally the biggest innovation in money I can think of since the paper currency was developed in China.

Will bitcoins catch on? Maybe, maybe not, but there is quite a bit of commentary going around that doesn’t dig deep enough.

Take this one from Casey Research, a usually well-considered source, from Jeff Kopocis, Junior Analyst and was the first to surprise me:

When I sent around a note a couple weeks ago to some folks at Casey alerting them of Bitcoin’s existence, our own David Galland responded simply, “I kind of get Bitcoin… but give me something tangible I can lay my hands on any day.”

Now this makes lots of sense to me so far, but the piece went on to say…

Referring back to how Aristotle characterized money, David’s comment makes all the more sense. Approximately 2,000 years ago, Aristotle said good money must be:

• Durable
• Portable
• Divisible and consistent
• Have intrinsic value

The astute reader will immediately realize that Bitcoin does not possess any of those characteristics and was subject to trouble from the get-go – not to mention the security issues that immediately arise with anything computer- and Internet-related. A computer-generated currency is not durable, as the recent hack demonstrates. And it’s certainly not portable. Can you imagine bringing your computer to the door to pay for your next Chinese food delivery? You get the idea for the remaining characteristics.

Well I think of myself as somewhat of an ‘astute reader’ and I for one don’t get the idea.

Why did the analysis stop before divisible? Seems like an electronic number like bitcoin could be infinitely divisible, whereas gold has a final limit when you start dealing in one atom of gold at a time (don’t laugh it really has been proposed.)

Certainly bitcoins fail at ‘have intrinsic value’ but really, if gold for some reason looked ugly and was useless for jewelery tomorrow and we stopped using it in teeth and in industrial uses, we would still use gold for transactions because of its other properties.

Heck one of the biggest problems stopping gold’s rival, silver, from making a big come back as everyday money like it has been in so many countries for so many centuries, is because of its intrinsic value. Silver is being used up in tiny amounts in computers, solar panels, bandaids etc that it’s supply has become severely limited and reducing, just while money is best when it is a stable supply.

But getting back to … “Chinese food delivery paid by bringing your computer to the door”?

That is like saying you’d pay with gold by dragging your safe to the front door. No, you’d use some type of debit card like they will do in Utah for gold, and you could do this even more easily for bitcoins.

Durable – well bitcoins will be around as long as electronic storage and computers will last, which will sure do for any forseeable future that I think is worth living in.

And Portable – heck there can’t be anything much more portable than electronic digits. Carry it in a USB, hidden in a microchip, or send it anywhere in the world in an instant. Seems almost the ultimate definition of portable to me.

Another libertarian and Austrian school of economics point of view on Bitcoins comes from David Kramer writing at www.LewRockwell.com an article with the title Bitcoin: Just Another Bogus Medium of Exchange

While many people who are touting it on Facebook are enamored with the fact that it was voluntarily created by the marketplace (i.e., is not forced down our throats by a private central bank), I’m afraid that those people are losing sight of how a real medium of exchange arises in a free market. A medium of exchange arises from something that had a material use/value in the market prior to becoming a medium of exchange, i.e., it was also a good being bartered for other goods and services. Over the centuries, the commodities gold and silver won out as the two most preferred mediums of exchange—with gold holding the number one position due to its being more scarce than silver.

What was Bitcoin’s prior material use/value? Zero. It is just bits in a computer. And what’s with the “fixed” amount of Bitcoins? Who/what determined the “proper” amount of 21 million for Bitcoins to top out at? A computer program?

To work through the two main points from this…

A medium of exchange arises from something that had a material use/value in the market prior to becoming a medium of exchange.

This is a good description of historically how money has formed, HOWEVER it is not a fundamental requirement a medium of exchange, just history. As I said before, having a material use can actually interfere with the use as money.

The real problem before bitcoins was that anything not backed by something tangible like gold or silver or cigarettes or land, was not scarce enough. With paper money or digits in a bank account there is no intrinsic limit to how much you can make. Bitcoins however are limited – just like gold!

And so to…

Who/what determined the “proper” amount of 21 million for Bitcoins to top out at?

This is as much a non-problem as if you counted up all the gold existing on earth or in the universe and complained about that.

Bitcoins are divisible into part bitcoins so you have 21 million as single bitcoins but pretty much as many as you like when you go into fractions. How small will the fractions be? Well that is where the free market will decide.

The one thing bitcoins need to become useful is for it to become easily recognized and widely accepted. And until this happens the market will be unstable and Wild West territory.

And finally back to Casey Research, but this time to Vedran Vuk who at least gives some space for Bitcoins…

In my opinion, Bitcoins – or “sh*tcoins,” [Editor: someone must also be saying 'bitcons'] as some are calling them after the crash – are a really bad idea. I’m not basing this opinion on some theoretical construct. Rather as a consumer, I find the product completely unattractive.

Nonetheless, Bitcoin is free-market money. Quality isn’t a prerequisite of freedom; it is simply the outcome of competition. Entrepreneurs come to the market with their ideas and compete. The weak ideas will eventually die out, and the better products will succeed. A truly excellent product often stands on the ashes of dozens of failed products.

Look, I can print my own paper money, call the bills “Vuks,” and sell them to willing customers. Yes, it’s completely fiat, worthless money, but it’s just as free-market as gold bullion.

And here is revealed the missing piece that separates all other un-backed money from bitcoins – their intrinsic scarcity.

His imaginary ‘Vuks’ could be printed endlessly, however bitcoins have an inbuilt limit on how many there will be. No one can suddenly flood the market with new ones and wash away their ‘value’.

In the end, will bitcoins work? Will the system be hacked at the core, not just at an exchange? Will the cryptography that protects bitcoin security and privacy prove to have holes? Will the entire internet disappear and wipe out all bitcoins? The creators and participants in this open source project have considered all these questions and have answers for them all, but in the end it comes down to what happens in the real world.

Bitcoins are indeed at an innovation stage rather than maturity.

So for now the public acceptance is the true growth curve in bitcoins. And with articles like these around it shows the awareness is growing, but understanding and legitimacy still has a long way to go.

Leave your comments below.

“Nothing is more dangerous than an idea when it is the only one we have.”
–Emile Chartier.