Tuesday, November 26, 2013

Bitcoins Have Company

Bitcoins Have Company

The early success of Bitcoins has spawned imitators, according an article in The New York Times by Nathaniel Popper[1].  They go by names such as PeerCoin, Litcoin, and Ripple.  They use different algorithms and have yet to outpace Bitcoins, but they all have the same purpose.  They intend to supplant, or at least supplement, government issued currency. 
Asian Efforts (1999)
Digital money is based on the premise that a well-constructed and secure algorithm can’t succumb to the inflationary practices of deeply indebted governments.  While this premise is true, I believe it is probably an insufficient basis for establishing a viable digital currency.  There are a virtually infinite number of algorithms that can produce a slowly growing supply of alternative currency.  Thus there’s no limit to the number of these forms of money.  While widespread acceptance may give one type of digital money a form of first mover advantage, my guess is that it will be hard to maintain.  Instead of government firing up the printing press, I suspect that computer programmers will fire up their laptops and create a form of inflation by flooding the market with competing digital specie.

Although lax monetary policies are a risk to conventional currencies, traditional money maintains one advantage that digital currency cannot match.  Currency is not only a means of exchange, but also a rough measure of the wealth of a country.  In my view, the status of the dollar as the world’s default currency stems from America’s inherent wealth.  Investors not only want to hold US dollars, they also want to invest a portion of their wealth in American assets.  Our political system may be dysfunctional, and our economy may be operating at less than peak capacity, but the United States is still the richest and most diverse economy on the planet.  Digital currency can never make that claim.

Someday America’s wealth may be sapped and our politicians and central bankers may succumb to the printing press in order to pay off the country’s IOUs.  However, we’re a long way from this situation. Digital currencies will develop as a form of accepted payment.    It’s hard to say which algorithms will win.  However, if I had to bet, I’d wager that the winning digital currencies will be pegged to or backed by the US dollar.

[1] http://dealbook.nytimes.com/2013/11/24/in-bitcoins-orbit-rival-virtual-currencies-vie-for-acceptance/?_r=0

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