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Bitcoin appears unlikely to catch on as super currency

In a world where national currencies are backed by nothing but trust, we now have a form of virtual money designed around a lack of trust.

It's called Bitcoin, and it appeals to folks who don't like the fact that the world's central banks can create dollars and euros and yen at will, seemingly out of thin air. Bitcoin has no central issuing authority; it can be "mined" by anyone with a computer powerful enough to solve increasingly complex mathematical problems.

Based on the events of last week, though, Bitcoin appears unlikely to catch on as a super currency. At best, it may become an interesting speculative vehicle, a casino where you can bet on the spread of financial chaos.

Money, every first-year economics student learns, serves as a medium of exchange and a store of value. You use money to buy stuff, or you save it so you can buy stuff in the future.

To perform those functions, money must be stable and predictable. You wouldn't like it if your dollar could buy only half as many groceries today as it bought yesterday, or if your savings account fluctuated wildly in value.

Bitcoin is flunking the stability test. Its value rose from about $15 in January to as high as $266 last Wednesday, then fell as low as $54 on Friday.

"One of the desirable qualities of a payment system is that it's relatively stable in its purchasing power," said David Andolfatto, an economist at the Federal Reserve Bank of St. Louis. "This system's success might work against it."

Bitcoin's creator, a mysterious person or group using the pseudonym Satoshi Nakamoto, is said to have ensured that minting will stop when 21 million bitcoins are in circulation. (The number now stands at about 11 million.)

Such a fixed supply seems sure to cause deflation, or falling prices for goods and services. In theory, the Bitcoin economy could adapt, but in practice, periods of deflation have been associated with recessions and financial panics.

Although bitcoins are almost impossible to counterfeit — they're stored as long, encrypted strings of computer code — they may be vulnerable to computer hackers, and if your cybermoney gets stolen, there's probably no police force that can help you get it back.

The unregulated exchanges also are vulnerable to the sort of price manipulation that's long been problematic in other markets, such as penny stocks.

To Craig Pirrong, a finance professor at the University of Houston, recent activity in bitcoins looks a lot like a classic pump-and-dump scheme.

"Episodes like last week will lead to some sort of scrutiny," he said. "There are foreign-exchange boiler room aspects to this, and that's something the CFTC has been very aggressive about."

The Commodity Futures Trading Commission hasn't taken any action against Bitcoin traders, but another government agency, the Financial Crimes Enforcement Network, said last month that dealers in virtual currency are required to comply with its money-laundering and record-keeping rules.

Of course, Bitcoin's whole appeal is based on being beyond the reach of government. If regulators succeed in applying national laws to this anarchist currency, pessimists may have to find some other way to bet against the end of the financial world as we know it.

Bitcoin appears unlikely to catch on as super currency 04/17/13 [Last modified: Wednesday, April 17, 2013 9:02pm]
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