Ars TechnicaThe last time we wrote about Bitcoin, in October, the currency's future looked grim. A series of security incidents had created an avalanche of bad press, which in turn undermined public confidence in the currency. Its value fell by more than 90 percent against the dollar.

We thought Bitcoin's value would continue to collapse, but so far that hasn't happened. Instead, after hitting a low of $2 (£1.28), it rose back above $3 (£1.91) in early December, and on Monday it rose above $4 (£2.55) for the first time in two months. It's impossible to predict where the currency will go next, but at a minimum it looks like the currency will still be around in 2012.


Of course, the value of Bitcoin could resume falling at any time, but the currency's apparent stability over the last month has inspired us to give it a second look. How can an ephemeral currency without the backing of any large institution be worth $30 million (£19m), as the world's Bitcoins currently are? In the short run, a currency's value can be pumped up by a speculative bubble, but in the long run it must be backed up by "fundamentals"-properties that make holding it objectively valuable.

Dollars are valuable because they're the official medium of exchange for the $14 trillion (£8.9 trillion) US economy; euros and yen are valuable for similar reasons. Bitcoin boosters have traditionally suggested that Bitcoin is an alternative to these currencies. But we'll suggest an alternative explanation: that Bitcoin is not so much an alternative currency as a "metacurrency" that allows low-cost and regulation-free transfer of wealth between nations. In other words, Bitcoin's major competitors aren't national currencies, but wire-transfer services like Western Union.

Bitcoin is a bad currency
The traditional argument for Bitcoins has positioned the peer-to-peer currency as an alternative to conventional currencies like dollars, euros, and yen. Bitcoin boosters point to two major advantages Bitcoins have over dollars: price stability and lower transaction costs. As we'll see, neither of these advantages is compelling for ordinary consumers.

The argument from stability mirrors the traditional argument for a gold standard. The dollar has lost about 95 percent of its value over the last century. The Bitcoin protocol is designed to never allow more than 21 million Bitcoins to enter circulation, and supporters argue that this guarantees the currency maintains its value over time.

The obvious problem with this argument is that Bitcoins have lost more than 90 percent of their value in five months. It would be pretty foolish for someone worried about the dollar's 3 percent inflation rate to put their life savings into a currency with that kind of volatility.

Bitcoin boosters forget that the value of a currency is determined by supply and demand. Demand for dollars is driven by the size of the US economy, which doesn't change very much from year to year. But the demand for Bitcoins is primarily driven by speculative forces, causing its value to fluctuate wildly.

Another oft-touted benefit of Bitcoin is lower transaction fees. Banks make a tidy profit charging merchants to complete credit- and debit-card transactions, and these fees raise the price consumers pay for goods and services. Fans tout Bitcoin payments as a low-cost alternative to traditional credit card transactions.

But this argument ignores the fact that credit cards provide important benefits in exchange for those transaction fees. If you buy something with a credit card and get ripped off, you can dispute the charge and get your money back. In contrast, Bitcoin transactions are irreversible. If you pay a merchant in Bitcoins and he rips you off, (or someone  hacks into your computer and makes a fraudulent payment), you're out of luck.

Of course, third parties may offer Bitcoin-based payment services that offer features such as chargebacks and fraud protection. But such services don't come free; consumers or merchants would have to pay fees to use them. And there's no reason to think Bitcoin-based banking services would be any cheaper than traditional ones in the long run.

Paying with Bitcoins also introduces the inconvenience of fluctuating prices. When people buy things with cash or credit cards, their purchases are denominated in the local currency. Dealing in Bitcoins means customers and businesses must regularly convert between dollars and Bitcoins, and must therefore worry about the fluctuating exchange rate between them. That's a headache few people want.

So Bitcoins are not a compelling alternative to conventional currencies. Although there are a few  isolated examples of traditional businesses accepting Bitcoins as payment, these seem to be driven more by the novelty of the concept than by compelling economic or technical advantages.


Latest on