In the long history of money, there have been essentially two kinds. The first is a tangible commodity — usually, gold. The second is a “fiat currency,” created by a ruler with the power to compel use. The proposition underlying this year’s extraordinary bitcoin surge is that we are about to have a third type of money. It is abstract, not tangible; it is the brainchild of a computer scientist with no power to compel anything. Today’s leading creators of money — the Federal Reserve, the European Central Bank — are at pains to appear transparent and accountable. In contrast, bitcoin’s creator is silent and anonymous.
It is possible, theoretically, that the bitcoin backers are right. Just because something has never existed does not mean it cannot exist. And if enough people believe in bitcoin, their conviction will be self-fulfilling. In a lucid comment, Silicon Valley entrepreneur Auren Hoffman suggests that, if bitcoin comes to be accepted as a safe long-term store of value, demand from savers might drive its price up a hundredfold — on top of the 16-fold price surge witnessed this year. Even if you think the odds of this happening are only around 10 percent, the potential reward is so juicy that you might take the bet — and so help to make the bet come good.
But none of this alters the reality that the bitcoin hype is weird. To succeed as a store of wealth, money usually has to be a transactions medium — after all, wealth is only meaningful if you can use it to buy stuff. But bitcoin is touted as a store of value even though, with a few minor exceptions, you can’t exchange it for items of value. If I stored my wealth in air miles — a privately issued form of money that is significantly more useful than bitcoin — you might suspect that the tedium of airport security lines had addled my judgment.
Bitcoin believers say it can flourish as a pure store of value, without being a medium of exchange. People who think central banks are liable to generate inflation can protect their savings by holding bitcoin, according to this theory; then, when they want to spend some, they can convert the bitcoin into dollars. But this vision ignores the way finance operates. In order for there to be an easy way of swapping bitcoin into dollars, there has to be vigorous flow of trades in both directions — otherwise, the transaction costs will be daunting. A currency that is a long-term store of value and not a transaction medium won’t generate much trading. People will be stashing it in their digital mattresses, not buying and selling.
Besides, the need for bitcoin as a store of value is not at all clear. Despite the enormous shock of the 2008 meltdown and the extraordinary money creation that followed, the dollar has proved itself to be an excellent store of value. The annual rate of core inflation — that is, the change in the dollar’s purchasing power, excluding volatile food and energy prices — has plodded along between 1.2 and 1.9 percent since the crisis; if you add in food and energy, post-crisis inflation has never exceeded 3.2 percent. In contrast, bitcoin’s value swings alarmingly, even if most of the gyrations have been upward. From June through September, it suffered through two periods in which its price fell by a fifth in less than a month. A store of value that fails to store value is a curious idea.
Bitcoin is often described as digital gold. The enduring appeal of gold to a small but fervent cadre of investors does indeed show that there is a hankering for a store of value beyond the reach of governments. But gold’s appeal is built on two advantages. It has a track record going back centuries, and its sheer physicality is psychologically appealing when wealth consists of little more than numbers on screens. In the chaos after 2008, I met a hedge-fund manager who held ingots in Zurich. Come the apocalypse, he would somehow make his way to Switzerland and take solace in riches that you can drop on your foot.
Unlike gold, bitcoin has no pedigree, and it is even more abstract than mainstream currencies. But its appeal is built on something different. It basks in the excitement that surrounds all things technological: Everything from transport to the news business is being disrupted, so why not money? The bitcoin bonanza mirrors the extraordinary run-up in tech stocks more generally, with the difference that the usefulness of Amazon or Google is a lot more obvious. When you cut through all the hype, bitcoin is a technology that invites speculators to bet on the promise of technology. If it sounds a little dicey, that’s because it is.
Sebastian Mallaby is the Paul A. Volcker senior fellow for international economics at the Council on Foreign Relations and a contributing columnist for The Post. He is the author of "The Man Who Knew: The Life & Times of Alan Greenspan.” Follow @scmallaby