BitCoins

With the Recession of 2008 still ongoing, governments all over the World are still trying to think about what to do to stimulate the economy. One way to fix the recession of course is to lower interest rate to get people to borrow for cheap. But nowadays, banks charge a lot of fees and the effective interest rate that banks set for deposits are zero or negative. There must be a way to buy things that are less costly and safer ways to keep your money. Now, there is some promise with BitCoins, a new currency which is under circulation.

In 2009, a computer scientist, Satoshi Nakamoto, in Japan created the BitCoin currency. It is intended to be a peer-to-peer currency, which means that it is governed by a community of people who volunteer to maintain the currency system. People can use it to trade goods. So, it is not governed by any central authority. This system has zero transaction costs, if someone gives you BitCoins, you keep all of it. BitCoins are divisible up to 8 decimal places, so you can send very small denominations of BitCoins.

BitCoins is a virtual currency system which allows people to store their money locally, as a file on your computer. The file which contains your money is encrypted so no one can access it. You can back it up to a file for storage elsewhere, and that file is also encrypted. To protect your BitCoins, you can set a password. The money can be used in any places that accept BitCoins and they can also be exchanged for regular currency circulating around the World. Like many currencies, their exchange value is variable over time. But what is keeping it stable is that the money supply will be generated more and more slowly over time, preventing the possibility that people having access to an excessively large money supply and so people cannot buy goods so fast that it creates runaway inflation. At the end, the money supply will taper off at about 21 million BitCoins. Because of the slowing in the creation of new BitCoins over time, the risk of rapid inflation is decreasingly likely over time, and deflation will be the trend after many years, so the value of BitCoins will go up over time, as opposed to currencies in the real world.

Fraud is prevented because transactions and creation of BitCoins are recorded with a secured database stored on a bank of computers. This also means that BitCoins cannot be fraudulently duplicated. So this is another measure which prevents high inflation rendering the money useless.

The money supply can be generated by anyone that has a computer. Once you install the BitCoin software, click on the Options menu and click Generate Coins to start generating BitCoins. They will be generated at a very slow rate because to make new BitCoins, your computer has to make solve cryptographic problems by guessing and testing. Once it is solved, you get 50 BitCoins. This may take a few days or weeks or months, depending on the speed off your computer. Some people are so ambitious that they let a bank of computers solve these problems to generate BitCoins.

Sending BitCoins is easy. Once you know the business or person’s BitCoin address, you can just click the Send button and send money to the BitCoin address you specify.

There is a small economy which trade goods and services with BitCoins in 2011. These businesses are listed in http://bitcoin.org/trade. There, you can also find websites which trades BitCoins for various real world currencies. You can also buy BitCoins with your real money. Currently, examples of online stores which sell tangible goods and accept BitCoins as payment include bookstores, electronics, clothing stores, etc. Services stores include domain name registration services, web design services, etc.

The BitCoin monetary system is still quite simple at the moment. There is no credit system or banks, so you cannot borrow money and there is no place to deposit your money other than as a file on your computer. But the advantage of BitCoins is that you can protect your own stash of cash, so banks are not necessary if you just want to store your cash. Because of the high possibility of deflation from the increasing effort in generating BitCoins, the money you keep will increase; this is effectively like adding interest to your deposits.

There are problems with BitCoins. Its encrypted nature can be exploited by criminals who want to launder money. Also, the economy is very small right now, so it is not an alternative to real currencies like US or Canadian Dollar. If you are not connected to the Internet that can also be a problem if you trade using BitCoins often, because it is the Internet is the only way that BitCoins can be sent or received. Of course, it is also not an alternative to banks because you cannot use it to pay bills directly and perform many kinds of functions that banks can like issue checks and withdraw money via debit cards etc. The lack of a credit system means that you cannot lend or borrow money. The BitCoin system is not a banking service and should not be treated as such. Rather, it is a system for performing transactions and storing wealth safely.

If the BitCoin system catches on, you would not need banks to transfer and deposit money. Essentially, everyone has their own virtual safe or wallet in which people can hold their own money. The encrypted file that you back up has all your money in it. Because it has strong encryption, it is just as safe as banks, and no authorities can access to your BitCoin file or the network of computers with BitCoin software installed, so people can transfer as much BitCoins around as they want. Whereas if you transfer money in banks, there are upper limits to how much you can transfer to prevent fraud and money laundering. If this catches on and criminal use it, then it would be a great problem for the authorities to track it. It is completely impossible to regulate or control the flow of money. Capital can flow freely between countries instantly. So, if BitCoin becomes prevalent, then the international finance system will change dramatically. Economists’ ideal of freely money flow would be met because of its encrypted and unregulated nature and the fact that no central bank can issue BitCoins, only the BitCoin system controlled by computers all over the World can. This implies that prices all over the World would be dictated by the flow of BitCoins. From an economic perspective, this would be optimal for everyone compared to banks because people can choose the optimal flow of money. In other words, if BitCoins becomes the prevailing medium of exchange, people would prefer it over banks because of its free nature. It is also an optimal medium for exchanging goods internationally because it has zero transaction costs, this means that from simple theories of international trade would hold. For instance, wage will adjust to their optimal level because BitCoins are transferred instantly, and it is subject to capital flow controls imposed by governments. Adjustment in wages in this fashion means that the price of goods will adjust to a level where production is optimized, because flows of capital and adjustment in wages will change to their optimal levels since transactions cost nothing and are instant. 

The implications of then free flows also mean that the World as a whole would become an Optimum Currency Area, that is, the World would become one big market where flow of currencies are free, and so it is optimal because producers and consumers would agree on prices they like. This big market will reach efficiency because of the free flows of money that is made possible by the BitCoin system. This has great implications for the World economy because production would not be bounded by any region. Globalization would be even more prevalent than it is now because of this completely friction-free flow of financial capital, in addition to the relatively free flow of the labor market which we have now.

All in all, the broad circulation of BitCoins means that people have the authority to generate their own supply of money. Regulation would also be decentralized. If the World uses it, then the World would be much more globalized than it is now. People would not have to worry about differing prices in different places or exchanging money. They would just spend it. There would not be any control of flow of money because of its decentralized nature. Countries would not need central banks, and other banks are much more limited in their function if BitCoin catches on. All tradable goods would have the same prices everywhere, and if labor can move anywhere, wages would be adjusted so that it will be the same everywhere. With BitCoins, the global financial system is controlled by the people. No one can gain it or control it because of it decentralized nature and clear record keeping and encryption capabilities. Every transaction is recorded in a separate entry. Counterfeiting would also be almost impossible because it tracks every BitCoin generated, so there would be one less kind of fraud. This is a dream come true for economists, producers, and consumers alike. If Bankers change to BitCoins, they benefit as well because of its security and anti-counterfeiting features.

Until more people know about BitCoins, it is unlikely that BitCoins will be in broad circulation. Because of this, there is not yet much regulation on BitCoins or similar kinds of currency. Because the system is well thought out to prevent fraud and inflation destroying the usefulness of the currency, it does not need much regulation in terms of monetary policy and counterfeit prevention. There is also no BitCoin based financial instruments, so there is no need for laws in that regard either.

BitCoins is a new system of exchange. The supply of money is tightly controlled, so it will remain stable. BitCoins’ value will be maintained because they have low inflation or deflation, so the purchasing power of BitCoins will be hard to wipe out. There is already a small economy which uses BitCoins for exchange. It has the advantage of no transaction cost so people receiving payments receive the full payment. It is not subject to the whim of any person or bank, so its maintenance is a community effort. The money is stored as a file on your computer which you can back up and password-protect, so you can be sure that it is safe. If BitCoin catches on as a medium of exchange in the World, would trade and finance would be a lot freer. Economic ideals as we know it today would come true. That is, equilibrium in wages and prices would be reached. However, the community is small. It is an interesting currency.