Föhrenbergkreis Finanzwirtschaft

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Let’s Be Real: Bitcoin is a Useless Investment

Posted by hkarner - 12. März 2017

Date: 11-03-2017
Source: The Wall Street Journal

The Winklevoss twins are an unlikely source of philosophical musings about the nature of money. But the rejection by U.S. regulators of their plan for an exchange-traded product holding bitcoin is a good time to ask why bitcoin might have any value, and if it does whether it makes sense to hoard it.

Bitcoin as an investment suffers from a basic logic problem formulated at the time of Shakespeare: Gresham’s Law. Only someone who thinks Bitcoin has value would ever hold it. But if a person holds both bitcoin and a government-controlled currency – say dollars – then she would surely choose to spend the dollars. As Sir Thomas Gresham formulated it, “bad money drives out good.” The good currency is hoarded, and the bad money spent.

Exactly this has happened with bitcoin. While the value of transactions has been rising, and the digital currency’s now accepted by a handful of large retailers, the vast bulk of bitcoins are hoarded. Why spend the more valuable money?

In itself this isn’t a problem. Gold coins are never spent in shops, but are valuable both to collectors and for the value of their metal. The problem is that unlike gold, bitcoin only has value because it can be used to buy stuff. (There are deep cultural and historical roots for the widespread acceptance that gold has value, which bitcoin can’t hope to replicate.)

There are lots of theories about why money has value. My favorite explanation for why “fiat” currencies issued by governments have value is that the government forces you to pay tax in that currency. Much as you might wish not to use it, you’ll get sent to prison if you don’t. On top of that, as Prof Christine Desan at Harvard Law School argues, the legal system’s preference for the state currency helps to enforce its use.

Bitcoin doesn’t have this anchor. It relies on widespread acceptance to give it value; if others are willing to take payment in bitcoin, then the electronic currency ultimately has value. If not, it’s just a number on a screen.

For the moment bitcoin hype and an influx of misguided hoarders have sustained the currency, helped recently by a sharp rise in bitcoin-based online gambling. But investors thinking of switching to bitcoin face a lose-lose logic problem. If bitcoins represent an inherently more valuable form of money, they will all be hoarded. Without any spending, bitcoins are worthless. On the other hand, if bitcoins don’t represent a more valuable form of money, why would anyone bother?

This dilemma could be short-circuited if bitcoins had an anchor, a reason to use bitcoin rather than fiat currency. If bitcoins were used as a super-cheap form of money transfer, for example, or if there were sufficient users keen to hide (legal) purchases from the government, that could provide a base of transactions to justify value for hoarders.

For now those don’t exist, and the appeal of bitcoin is almost exclusively as a store of value. That makes no sense.


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