Bitcoin’s Roadmap to Relevance

My brother sent me the following video, as part of our ongoing discussion regarding the future and place of bitcoin. Working at an excellent startup, he is very in touch with and opinionated about the tech world (all in all a solid follow on twitter). I started to reply, but after passing the 500 word mark, I decided to post my thoughts here instead. Here’s the video:

As of now, the general public has yet to embrace bitcoin. In order to build a niche in the modern payment network, it is difficult to foresee any alternative to bitcoin taking on more characteristics of a traditional currency. To its credit, the video immediately states that bitcoin is a “crappy currency.” The reason that the modern financial world runs primarily on credit and debits is that it is backed by the US Dollar, an entity with several crucial characteristics that give the public the requisite confidence to electronically send/receive money.

To start, bitcoin’s value relative to the USD has been remarkably unstable. In the past year, the value of 1 bitcoin has ranged from $100 to over $1100, and is not sitting around $450. In the time since I started writing this piece, it has fallen all the way from $500! You can see the movements on this chart:

5.1.14 Bitcoin

 

One of the main characteristics people look for in money is its “store of value,” namely an entity’s ability to be set aside for a time and not drastically lose its value when that entity is retrieved. I’m reasonable confident, for example, that if I stash $100 in my bedroom for a year, its purchasing power will not drastically fall. Given bitcoin’s wild swings in exchange rates, it currently fails this test.

Secondly, bitcoin isn’t accepted in most places. People use money as a “medium of exchange” rather than bartering for goods. If you can’t spend or receive bitcoins in the places you’d like to, however, then it is unable to serve as that medium.

I recently started using Venmo, an app that allows mobile payments to be transmitted simply and safely between friends. First of all, Venmo is great, and I can see the parallels between what it does and how people would like Bitcoin to function. The other night, I was sent some payments on Venmo as a reimbursement for dinner. Rather than deposit the $12 to my bank account, I’ve let the money sit in my Venmo account, so that I can use it down the road when the need arises to pay back my friends. Notably, there are no fees for any of these actions.

It’s not hard to envision bitcoin functioning like Venmo, but on a broader scale: people buying and selling goods, both online and off, using an entity that sidesteps some of the issues we have with the modern payment network. It would be great not to need banks or credit agencies to send money digitally! Before we can cut out the middleman, however, there are several steps that must come to pass to permit a more substantial proliferation of bitcoin:

  1. The primary notoriety of bitcoin must shift from a mechanism for speculation to an electronic form of money. It’s easy to discount the media’s reporting on bitcoin as overly sensational, but as history shows us, a currency is only as good as the public’s faith in it (which often takes it cues from the media). For more information on the consequences of discounting public faith in a currency, see here, here, or feel free to read my thesis on hyperinflation, which is at the bottom of this page.
  2. Relatedly, our individual views towards bitcoin must change. If we played a word association game and I said “Euros” or “Dollars,” most people would reply “money.” Try that same game with “bitcoin,” and the responses include “Silk Road,” “Winklevoss twins,” and “Huh? What the f%$# is that??” Most of bitcoin’s fame thus far has come from speculation; while useful in bringing attention to its existence, this is the anathema to fostering stability. As we’ve witnessed time and time again, the financial system is held up by the trust that people have in it. If the public loses confidence in a bank, a currency, or an economy, it can plummet in value, shattering the public’s trust in a way that is hard to rebuild.
  3. The exchange rates to established currencies must be more stable. Nobody is going to care about Mastercard’s 2% cut when they’re worried about a 50% slide in the convertible value of bitcoin. Before we enter a hypothetical world where bitcoins are traded around with ease, it must be seen as safe by the bulk of the population – I’m talking Middle America, not just highly educated tech geeks living in San Francisco.
  4. Make it as close to free as possible! Nobody will fret over Mastercard’s 2% cut when Mt. Gox’s successors are taking 1%. Analogously, individuals wouldn’t leave the comfort of Facebook for a social network that’s marginally better. Facebook may not be quite as good as this hypothetical competitor, but unless the alternative is markedly superior, the consumer will value the comfort and security they’ve built with Facebook over the past decade. The same goes with the current payment network.

As my thesis verifies, I’ve been fascinated by the concept of money and currency for some time. If nothing else, bitcoin is an intriguing mix of economics, technology, and innovative thought. Money has been around for thousands of years, and marked improvements come around infrequently. I’m looking forward to seeing where bitcoin is headed, and if it can fulfill its potential as a decentralized form of widespread digital payments.

 

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