The Bitcoin (BTC/USD) fiasco shows the difference between fiat money, virtual money and the only real money, namely gold. Mt. Gox, the Tokyo private exchange for Bitcoins, filed for bankruptcy last Friday, after the owner shut down its website. Mt Gox account holders, including Mt Gox, lost $425 Million when the virtual exchange went dark. Mr. Gox officials claim over 800,000 Bitcoins went missing from user and company accounts, forcing the company into bankruptcy. Several authorities are investigating the incident.
Mt. Gox is just one of several private exchanges that sprouted up in response to demand for the virtual currency. The value of Bitcoins jumped exponentially since its 2009 start, topping $1200 in December. Bitcoins are trading at $600 or so now.
Bitcoin is virtual, cryptographic money which allows people to transact on a peer-to-peer basis over a network. Bitcoin owners can transact with merchants that have decided to accept Bitcoin cryptocurrency. Bitcoin transactions fall outside traditional banks and banking regulations. Bitcoin.org is the open source foundation that maintains the Bitcoin standard. Private exchanges and application providers allow individuals and corporations and other users to discover the current market price for a Bitcoin in most traditional currencies.
As we know from Aristotle, money is worth precisely what people are willing to exchange for it. Users believe Bitcoins have value, which is why Bitcoins enjoy a higher exchange value now than in 2009. One Bitcoin feature that is attractive is it carries no or low fees for any transaction. As more and more merchants accept Bitcoin payments, demand increases for Bitcoin money, and its exchange value increases. It’s the fundamental law of supply and demand in play.
As we also know from Aristotle, true money is defined by the four characteristics:
1. Money must be durable. Money must stand the test of time and the elements.
2. Money must be portable. Money (coin currency) holds it “worth” relative to it
Weight and size
3. Money must be divisible. Money should be relatively easy to separate and re- combine without affecting its fundamental characteristics.
4. Money must have intrinsic value. The value of money should be independent of any other object and contained in the money itself.
By these measures, it could be argued that Bitcoin meets Aristotle’s divisibility and portability criteria, but fail to meet the durability, and intrinsic value criteria. The Mt Gox fiasco shows Bitcoins to be vulnerable to internet security threats and hacking. Therefore, Bitcoins are not very durable. By their very nature, Bitcoins have zero intrinsic value. A crypto-coin is only as valuable as its security code. Who would assign value to a Bitcoin account that could be accessed by anyone without even a password?
So why are Bitcoins so attractive? A major draw is the freedom to transact without a bank or government regulation. Unlike fiat currencies, Bitcoins are not subject to devaluation by central banks that can add to the money supply. Bitcoins are not subject to the costs and risks of banking regulation. For example, Bitcoins are not subject to factional banking reserve requirements. Bitcoin transactions do not require any traditional bank, or bank fees.
Last week, Fed Chair Janet Yellen, in a response to a Senate Banking committee member’s question about Bitcoin regulation, was happy to say the Fed has no regulatory authority, responsibility or role in any Bitcoin transaction. Her answer seemed to shock Senator Joe Manchin (D-W Va) who apparently wants to slap some new regulation on the virtual currency.
Whatever the fate of Bitcoin, its emergence and recent difficulties demonstrate why gold is the only true money. Gold meets every one of the Aristoltilian requirements for true money, the most important being intrinsic value. Bitcoins and gold share one important feature: neither is directly subject to the whims of the central bank. The Fed can print trillions in new paper money as it attempts (and fails) to stimulate the economy. Each Dollar the Fed prints debases those Dollars that are outstanding.
But Bitcoins and gold behave differently as the Dollar is debased by the Fed’s monetary actions. Bitcoin prices (green line) appear closely correlated to moves in the Dollar (blue line). Gold (candlesticks) tends to move inversely to the Dollar.
This means that gold tends to hold its value better than Bitcoin as the Dollar loses value.
Gold has survived thousands of years as the world’s only true money. While there are costs for its safekeeping, owning gold is the prudent way to protect wealth against the vagaries of fiat currency and government intervention.
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