Krugman takes on Bitcoin

Back in June, I wrote a piece on Bitcoin, the much ballyhooed virtual currency, which depending on who you ask, is either the future of money, a tool for money-laundering, or a massive ponzi scheme. The piece is being reposted today as part of a larger "Deep Dive" package on the future of currency in partnership with the Brookings Institution. 

As it happens Bitcoin is getting some extra attention today thanks to a post from Paul Krugman, which essentially characterizes its users as higher-tech gold bugs:

Bitcoin, rather than fixing the value of the virtual currency in terms of those green pieces of paper, fixes the total quantity of cybercurrency instead, and lets its dollar value float. In effect, Bitcoin has created its own private gold standard world, in which the money supply is fixed rather than subject to increase via the printing press.[…]

Bear in mind that dollar prices have been relatively stable over the past few years – yes, some deflation in 2008-2009, then some inflation as commodity prices rebounded, but overall consumer prices are only slightly higher than they were three years ago. What that means is that if you measure prices in Bitcoins, they have plunged; the Bitcoin economy has in effect experienced massive deflation.

And because of that, there has been an incentive to hoard the virtual currency rather than spending it. The actual value of transactions in Bitcoins has fallen rather than rising. In effect, real gross Bitcoin product has fallen sharply.

So to the extent that the experiment tells us anything about monetary regimes, it reinforces the case against anything like a new gold standard – because it shows just how vulnerable such a standard would be to money-hoarding, deflation, and depression.

Pirate Party founder Rick Falkvinge, who I interviewed for the piece and who emerged as Bitcoin’s most prominent evangelist after putting his entire savings into the currency, took some questions from Reddit users today, and continued to make the case for it: 

To be honest, though, it took me about two months to realize that the real money in Bitcoin isn’t in hoarding, but in learning to ride the wild swings.

But that’s in the intermediate term.

Bitcoin has only two endgames: a wildly successful payment system or a marginalized experiment used by niche groups like PGP-encrypted email. Much work remains to realize the former, but if it happens, the value of a single bitcoin is going to be two to three magnitudes over today’s value.

Bitcoins are currently hovering around $7. 

As even its strongest boosters admit, Bitcoin’s future relies on it finding acceptance beyond its core group of radical libertarians and hackers. It’s still has a long way to go on that front, even if you can use it to buy crepes in Brooklyn now.