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Inside the Bitcoin economy
Apr 11th 2013, 19:48 by R.A. | WASHINGTON
BITCOIN (http://www-economist.com /news/finance-and-economics/21576149-even-if-it-
crashes-bitcoin-may-make-dent-financial-world-mining-digital) , a "eryptocurrency" that has
all the financial world talking, has had a crazy few days. Bitcoins have always been volatile, but
over the past week the currency went on a tear, rising to close to $300 dollars, before plunging,
losing some 60% of their value in the space of a few hours. Felix Salmon considers
(http://blogs.reuters.com /felix-salmon/2013/04/11/the-promise-of-ripple/) the carnage and
writes:
Bitcoin is clearly not an effective store of wealth — just look at how quickly that
wealth can be evaporated. Neither is it a useful payments mechanism, given how
fast its value can fluctuate. Currently, it ean take an hour for a bitcoin transaction
to clear, which means that the value of the transaction when it clears ean be
radically different from its value at inception. Biteoin only works for payments if
you can be reasonably sure that its value will remain reasonably steady for at least
the next hour or s
I'm going to play the pedant and note that this isn’t quite right. The dollar is one of history's
most successful currencies, I think it's fair to say, and yet it, like virtually every floating
currency, is prone to wild volatility. In the late 1990s, the trade-weighted dollar soared nearly
50%. It then turned on a dime, dropping 30%. Then, in a matter of weeks in late 2008 it jumped
nearly 20%. Once again, that's the trade-weighted dollar, not an individual currency pair
(which can be much more crazily volatile).
Now over long time horizons those
vings can have substantial macroeconomic impacts. But
ona scale of weeks or months or even a year or two the average American has almost no idea
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that such movements are occurring nor does he care. And that's because America is a massive
economy, in which trade is a relatively small share of GDP, in which everyone is paid in dollars
and in which everything is priced in dollars. Foreign exchange volatility matters only to the
extent that the exchanges you care about have a foreign component.
Now in Bitcoinia (as we might call the Bitcoin economy) that means volatility currently
matters very much, Almost every good one ean purchase with Bitcoins is actually priced in
dollars and sold at a Biteoin price reflecting the prevailing exchange rate. So there is almost no
Bitcoin frame of reference independent of the Bitcoin-dollar exchange rate. Bitcoinia mostly
lacks internal supply chains, in which contracts for intermediate goods are denominated and
settled in Bitcoins. People aren't taking home Bitcoin paycheques. To put things simply: every
good in Bitcoinia is an import and every job must be offshored. In that kind of economy,
exchange-rate volatility matters a very great deal indeed.
But just because that's how Bitcoinia operates now doesn't mean that's how it will operate
always and forever. The more purchasing power there is in Bitcoinia, the greater the incentive
there is to cater to Bitcoinian demand. The more transactions there are in Bitcoinia, the more
entrepreneurs will want to hedge their exposure to foreign exchange volatility by paying
suppliers or employees in the same currency they're accepting as payment. And Bitcoin wage
payments reinforce the demand for goods and services that can be purchased with Bitcoins. The
greater the ability one has to buy and sell what one needs exclusively within Bitcoinia, the less
foreign-exchange volatility matters.
Whether Bitcoinia actually attains that critical mass is very much an open question, and I
certainly have my doubts. In early days volatility does matter a great deal, and huge swings
against other currencies may Kill the Biteoin economy in its cradle. One might recommend a bit
of macroeconomic management to create enough to stability to allow the critical mass to build,
but centralised management is very much what Bitcoin is not about. Sceptical as Bitcoinistas
may be of the value of central banking, it has developed as it has for a very, very good reason.
And if the Bitcoin economy manages to come up with a completely decentralised way to
stabilise itself without that top-down maintenance, well, that would be something very
interesting indeed. More probable: either Bitcoinia will remain a small, fringe economy thanks
to inherent instability, or a stabilising financial structure will somehow grow within it. And then
one day we just might see a Bitcoinian J.P. Morgan gathering Bitcoinia's financial eminences
into a virtual office to cooperate in an effort to stave on looming financial pani
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