Bitcoin appears to be gaining traction

Bitcoin is touted as a virtual currency controlled by a peer-to-peer network that apparently places it out of the reach of traditional monetary authorities. I have to admit that when I first heard about Bitcoin I couldn’t see the point.

What BitCoin is — near as I can make out — is a token that you earn by lending your computer’s processing power to some function — I think processing transactions. As you do this you earn more tokens and the idea is that you can exchange those tokens for stuff on the Internet.

Is this crazy? It turns out that it isn’t necessarily crazy. BitCoin is structured to have a fixed supply of tokens and so at some point it will become harder to earn them through your computer. But the quantity theory of money will hold and so the rate of exchange of computer power to goods earned should stay constant in equilibrium (unless something happens to velocity). As Eugene Fama pointed out years ago what you need to have money take off is some scarcity of supply. The people behind BitCoin have thought through that.

So the next question is: what function will it serve? The return in terms of goods acquired for processing power given is something that can be priced now; in existing currency. There is no reason to suppose that BitCoin will change this rate of exchange fundamentally. It may unlock some computer power (liquifying it) but it could do that without launching a new currency. I can’t see the market here.

Now the processing tasks being done are apparently useful but it is the function that Bitcoin is providing that I wasn’t sure about.

Yesterday, something happened that got my attention: WordPress made it possible to pay for some of its services with Bitcoins. WordPress is perhaps the biggest website platform in the world and so this is a big deal. Here is their announcement:

PayPal alone blocks access from over 60 countries, and many credit card companies have similar restrictions. Some are blocked for political reasons, some because of higher fraud rates, and some for other financial reasons. Whatever the reason, we don’t think an individual blogger from Haiti, Ethiopia, or Kenya should have diminished access to the blogosphere because of payment issues they can’t control. Our goal is to enable people, not block them.

Bitcoin is a digital currency that enables instant payments over the internet. Unlike credit cards and PayPal, Bitcoin has no central authority and no way to lock entire countries out of the network. Merchants who accept Bitcoin payments can do business with anyone.

So what this is about is providing access to global payments in for people in countries without such access. That is a good function.

But what we shouldn’t mistake is that this is anything other than a payments platform. A little while ago when exploring eCurrencies I used the following 2×2 classification to understand them.

The classifications depended upon whether you could exchange the currency for dollars (no for monopoly money although my children did expand the money supply using another set and yes for casino chips) or whether you could use dollars to buy in to the currency (no, for frequent flyer programs — typically at least — and yes, for the Canadian dollar). When you look at it this way, Bitcoin has more in common with computer chips than Farmville credits. But it is also not unprecedented.

Where this will all go is hard to say. Bitcoin is like the private currencies of old or the ones that emerge in prisons. It has found a niche and also enough stability that WordPress is willing to have Bitcoins on its books. But why do we need a separate unit of account and store of value to serve these purposes? Could a national currency coupled with more efficient payments substitute for this or is it the unique way you can earn Bitcoins that generates its distinctiveness? Time will tell.