Anthony J. Pennings, PhD

WRITINGS ON DIGITAL ECONOMICS, ENERGY STRATEGIES, AND GLOBAL COMMUNICATIONS

Bitcoins and the Properties of Money

Posted on | January 27, 2014 | No Comments

“Money is a matter of functions four, a medium, a measure, a standard, a store.” – Lyrical couplet used to memorize the roles of money.

Bitcoin emerged during the Great Recession to challenge the notion of official money and particularly its political and symbolic connection to a national system. While the US and much of the rest of the world teetered on financial ruin, it emerged as the great geek hope for an ultra-national currency.

Bitcoin is a complex computer-based type of digital money proposed by the mythical Satoshi Nakamoto that utilized the principles of cryptography and peer-to-peer networking. This “cryptocurrency” emerged from the calculative and recording abilities of modern processing technologies and the transactional capabilities of highly encrypted networks spanning the globe. It has been both embraced and vilified for its capacity to act as money, to transcend national regulation, and for the volatility it offers speculators.

Bitcoin’s value spiked in 2013 when it traded at around $1000. A striking example of its appreciation was a pizza purchased in 2010 by one of the Winklevoss twins for 10,000 bitcoins. The value of those coins at the end of 2013 would be worth around $10 million. One of the most intriguing aspects of this innovation is that this bitcoin money supply is “mined” by computers doing complex calculations.

But can Bitcoin conduct the activities that are required of a currency: the facilitation of exchange; the capacity to price, the ability to compare value, and the storage of wealth.

An analysis of Bitcoin or any other cryptocurrency or even an electronic payment system like Paypal should start with an examination of money and how our current system works. Economists give a wide berth to the question of what is money. The standard agreement is that money is anything that can be used to buy goods and services or anything that is accepted by both sellers and buyers as payment. They also generally agree that money has the following functions that can used as criteria to evaluate the utility of a type of money:

1) Medium of Exchange – Money facilitates the exchange of goods and services. It operates as a “symbolic third”, a separate entity that helps to reconcile the value of other goods and services. It is much more efficient than barter, which requires a “double coincidence of wants” (I want your cow, you want my chickens). Money reduces the transactions costs associated with a purchase primarily by reducing the problems associated with bargaining. Can you imagine trying to negotiate for all the products and services you use? How about standing in line when four people in front of you need to negotiate for their milk and bread? Virtual currencies like Bitcoin are seen to reduce transaction costs, especially if they can be used to avoid the billions in fees paid to companies such as Visa Inc. and Citibank for the use of credit and debit cards.

2) Unit of Accounting/Measure of Value – Money is used to price products and services and to express those prices in terms of a common unit of account. It is a measure by which prices and values are expressed. By making nearly everything price-able and exchangeable, a system of comparison is created. When the prices of goods are stated in terms of the monetary unit, the relative price-value of all items become comprehensible. This function also allows for prices to be displayed – crucial for a market environment. In the US we have the dollar, in Japan the yen, and in Brazil, the real. In each case, money provides a common “nominator” – a way to use numbers to value products. It can be used to add up the wealth of a person, a company, or a nation in monetary values.

Economists use the term “nominal indicator” to refer to this process of naming a price-value in terms of monetary numbers. Indo-Arabic numerals (0,1,2,3) have been nearly universally adopted as the major money nominator around the world. The power of zero and its place-value system of writing helped displace Roman numerals and provide the vehicle for new calculative innovations. Spreadsheets have given the nominal function of money extraordinary new power by creating enhanced capabilities for budgeting and other types of financial analysis at any one point in time, or over time, or projected into the future.

3) A Store of Value – Money should have the ability to hold its value over time. Although currencies do deflate and inflate in value, it needs to be able to transfer most of its value (wealth) into the future. Granted, most people would actually like to see it increase in value. This capability of money allows it to act as a standard of deferred payment in a credit process where money is lent out with the expectation that it will be returned, with interest, at a future date. Because of its volatility, countries like Sweden have classified Bitcoin as as an asset like art or jewelry that can be taxed – and not as a currency.

Surprisingly popular, Bitcoins are accepted by a wide number of merchants and companies such as Zynga. It would seem network effects are in play as the currency becomes more popular with each additional site that accepts it. Bitcoins offer companies a new option for accepting payments and announcing your willingness can be a PR event in itself. Companies should monitor the value of the cybercurrency and convert their Bitcoins to official currencies often to avoid major fluctuations in value. Bitcoins have been subject to hacking as well and thefts have occurred. A company should also be prepared to pay taxes on any transaction as if they were dealing just with dollars.

Bitcoins suggest the possibilities of a secure, decentralized, and distributed currency system outside of control of national governance, but they also raise additional concerns and issues about the role of money in an globalized digital economy. Bitcoins promise a monetary system where its value and amounts produced are determined by it’s cryptocurrency parameters and not the influences of any individual or organization, including central banks. But how will nations control their money supply? What will it mean for organized crime? Will it create new inequalities? Will its value vary too much to be useful for anything but asset speculation or a temporary hedge?

It is likely that the international system of nation-states will continue to block Bitcoin’s growth. The Bank of Finland recently denied Bitcoin status as an official currency or even a payment instrument because Finnish law states that “a payment instrument must have an issuer responsible for its operation” according to Paeivi Heikkinen, head of oversight at the Bank of Finland. They have joined China and Germany in taking action in slowing the adoption of the virtual currency. The US on the other hand has taken a cautious approach to the issue with Fed chair Bernanke acknowledging the Fed doesn’t have the authority to supervise bitcoin and other virtual currencies. However, Bitcoin broke $1000 when Bernanke suggested that they “may hold long-term promise.”

While the future of Bitcoins is uncertain, what we should be looking at is the platform it runs on called a blockchain. This is a distributed electronic ledger shared among the nodes in a participating network and suggests a new era of online services.

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AnthonybwAnthony J. Pennings, PhD is Professor and Associate Chair of the Department of Technology and Society, State University of New York, Korea. Before joining SUNY, he taught at Hannam University in South Korea and from 2002-2012 was on the faculty of New York University. Previously, he taught at St. Edwards University in Austin, Texas, Marist College in New York, and Victoria University in New Zealand. He has also spent time as a Fellow at the East-West Center in Honolulu, Hawaii.

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    Professor at State University of New York (SUNY) Korea since 2016. Moved to Austin, Texas in August 2012 to join the Digital Media Management program at St. Edwards University. Spent the previous decade on the faculty at New York University teaching and researching information systems, digital economics, and strategic communications.

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