3 reasons why Bitcoin is an economic dud

Posted on March 16, 2014 · Posted in Blog

A bet about the future of Bitcoin recently took place on the the podcast, Planet Money. The bet took place between Ben Horowitz, a venture capitalist backing Bitcoin ventures, and Felix Salmon, a finance blogger at Reuters. The bet was made in response to a blog post by Felix in which he said we’re in the middle of a Bitcoin bubble.

Not surprisingly, as an economist I tend to side with Felix’s take on things. There are good reasons why Bitcoin is an economic disaster waiting to happen. Here are three reasons why Bitcoin will never replace traditional means of financial exchange, and why it’s highly likely we’ll see more “MtGox“s.

1. Bitcoin is not backed by anything tangible

People often lament the good old days when currency was backed by things of ‘real’ value like gold. But they forget that currency is still backed by something tangible and ultimately more valuable than gold.  Currency is backed by the ability of governments to tax their citizens.

Bitcoin on the other hand is entirely lacking in any kind of tangible backing. No real assets and no government stands behind Bitcoin. The latter is in-fact part of the appeal to technological utopians, though as an economist I think this is just silly.

2. It would be easier to hack Bitcoin than to print fake currency

I’m not a programmer and I don’t know how Bitcoin mining and encryption works. But security weaknesses will be exploited and each time it happens, confidence in Bitcoin will erode. In-fact, a quick Google shows that a Polish Bitcoin exchange was recently the target of hackers.

And the bigger the market for Bitcoins gets, the greater the incentive for fraud and hacking.

Compare this to trying to print forged US Dollars or any other currency printed with modern facilities. You need the expertise, the facility and machinery, the raw materials and the ability to launder the money. This is very very hard. Supposedly the best fake USD came out of North Korea.

Hacking Bitcoin on the otherhand would pretty much just require a computer and Internet access.

3. Bitcoin doesn’t solve any really big problem

The final reason (in this post) why I think Bitcoin isn’t such a big deal is that it doesn’t solve any big problem in the World. It just isn’t a significant enough improvement on existing mediums for transaction. The global economy has been doing just fine with traditional (and slightly disruptive) products for international trade and online payment.

The Bitcoin website lists several advantages of Bitcoin but I’m not convinced any of these are worth the potential disadvantages. One day when you eventually want to buy something requiring hard currency, you better hope the Bitcoin exchange rate is on your side.

So, prove me wrong technological utopians, because I’m a bit dismal about Bitcoin.