I wrote this article years ago when Bitcoin was virtually unknown. A lot has changed since then, but not everything.
I doubt there’s a single person alive in North America who is unaware of the financial mess the United States is in. Jumping from Fiscal Cliff to Sequestering, it’s quite obvious to all of us that the “money” in question does not exist. Greece is in a no better state half-way across the world so it’s pretty easy to make the argument that money is broken. When your country has over-leveraged its financial resources so terribly that you know, deep down inside, that your money and property can become worthless overnight with the flick of a pen in government house, what do you do?
Get new money, of course.
All Money Is “New”
Humans were trading stuff long before there was any concept of money. If I had an extra side of beef and I needed a bag of flour, I would take my side of beef and go wandering around looking for someone with a bag of flour they didn’t want. The basic barter system is how modern commerce started and it still exists in a much smaller form today. Money, however, requires a third party – an issuer. Money issuers are always governments in some form or another; kings, regents, democratics and dictatorships are the central issuers of money. Commerce as we know it today stemmed from the relatively recent concept of this third party issued money. Money Has Always Been Worthless
Bartering involved the trading of intrinsically valuable goods. My side of beef has value because a side of beef has value. Your bag of flour has value because a bag of flour is worth something. Money, on the other hand, has no intrinsic value. That \$10 bill in your pocket is simply a worthless piece of paper with no actual value. It is worthless in itself.
Money’s value is in what it represents, not in what it is. Money was created specifically to be a worthless third party that can be traded in for something of value. You can either trade it in for actual thing of value it represents (originally gold in the issuer’s coffers) or you can trade it for something else of value with someone else who wants the money (like buying something in a store).
The reason money works is because we all agree on its value therefore we all want it. That’s the foundation of an economy – trust in the value of the issuer’s money. If we have that trust then we use money as a temporary repository of worth until we find something we want to trade it for.
Bartering Does Not Scale
The main problem with bartering is what is known as the “coincidence of wants”. If all I have to trade is a side of beef and what I really need is a bag of flour, I may have to travel far and wide before I find the coincidence of someone with a bag of flour who also wants a side of beef.
The likelihood of the incidence of the coincidence (see what I did , there?) can be increased by things like marketplaces. If I take my side of beef down to a market where other people have things they are trying to trade, I have a better chance of finding my flour wielding trading partner among a bunch of people looking to trade than I do just wandering around aimlessly.
The reason bartering does not scale well is because it would require literally thousands of people with everything under the sun in order for a society to function completely on bartering. If there is no intermediate thing we can use to temporarily hold our value, then we’re left with a one-on-one trading scenario which has long odds.
Bitcoin: The New Money
Bitcoin is an alternative currency used primarily by geeky Internet folk.
Bitcoins are generated and distributed by the general public. Bitcoins are not generated by a central issuer such as a government’s mint and are therefore argued to be more stable because they are not at the whim of government shenanigans.
Bitcoin is a cyber currency; it does not exist in physical form and is therefore used solely for purchasing goods and services online. People can buy Bitcoins at any number of Bitcoin exchanges such at Mt Gox by using government issued money (currently a Bitcoin is worth about \$23 USD) and then use those Bitcoins to purchase things from vendors who accept Bitcoin as a currency.
That, however, is silly. Everyone accepts real money, so why would you trade your widely accepted government issued money for Bitcoins which are accepted relatively nowhere? The smarter thing to do is generate Bitcoins for free.
There is only one way to put a new Bitcoin into circulation and that is by mining it. Remember there is no central issuer so someone can’t just mint a new Bitcoin and put it into circulation. It has to be mined from the depths of cyberspace by computers working to further the Bitcoin economy.
When someone purchases something with Bitcoins, the transaction is recorded as a cryptographic hash in a log that is shared among everyone who is running the Bitcoin software. To prevent people from entering fraudulent transactions into this log, each transaction is verified by arbitrary Bitcoin nodes along the way. If you elect to mine Bitcoins, you will have to install a Bitcoin miner on your system it will get the latest copy of this log. It will then attempt to reverse the hashes that represents those transactions and if it succeeds, you will then be rewarded with Bitcoins. The more nodes that successfully reverse these hashes, the more confident the Bitcoin economy is that the transaction is valid and it becomes irreversible.
Bitcoin Is Bartering
In the 1990’s there was a rash of Barter Networks. These were groups of companies and people that got together and agreed to accept some barter network currency for part or all of their sales. For example, if I was a web designer, I might be willing to accept 50% of my wage in “Barter Bucks” for work done for other members of the barter network and 50% in my country’s currency. As I build more web sites for my fellow barter members, I would accrue more barter bucks which I can then use to purchase things from other members of the barter network. This is another example of an attempt to eliminate the need for a coincidence of wants by introducing some trusted third party thing of value to replace government money. However, since the barter bucks are only accepted by the relatively small number of members of the barter network, it mostly fails in any significant way.
It is my opinion that there is no difference between barter bucks and Bitcoins from a vendor’s perspective. The vendor is agreeing to accept some portion of the transaction’s value in some form other than government issued currency which can only be used within a closed economy of other vendors.
Bitcoin Income Is Taxable
If you agree with my assessment that Bitcoin == Bartering, then your country may tax that income. Canada’s CRA and the United States IRS certainly do.
Bitcoin Is Only a Curiousity
Let’s wrap this up. Bitcoins are only usable in a closed economy and they are taxable as income. You can only get Bitcoins by throwing stupid amounts of computing power at it to verify the work, or by exchanging actual money for Bitcoins. Further, since Bitcoins are computationally generated it is known that the maximum number of Bitcoins that will ever be put into circulation is 21 million and that won’t be until the year 2040. So the question is: why would you exchange real money for something else of equally worthless intrinsic value that can only be exchanged for goods or services at about 150 places on the entire planet, has a very low amount of total money to begin with and has to tax advantages? You wouldn’t.
Bitcoin is merely a curiosity. While the method of generating Bitcoins is unique, the philosophies and ramifications of a limited circulation currency are old and have been tried and discarded over and over throughout history.
Until some currency comes along that I can spend at my local gas station, the pub, my utilities and my house mortgage, anything other than “real” money is going to fail.