Boston Fed Paper Gives Bitcoin-as-Payment-System a Thumbs-Up

by Patrick Brennan

In this space, I’ve been following the evolution of the digital currency bitcoin, which has gotten big enough to merit an academic paper on it from two economists affiliated with the Federal Reserve Bank of Boston, essentially asking whether bitcoin has viability or usefulness as a currency. 

In order to answer that question, they lay out what it means to be a viable form of money. There are three purposes of money, as economists generally see it: as a medium of exchange, as a unit of account, and as a store of value.

Bitcoin essentially fails on the last two of these: For one, its price has been and probably will continue to be so volatile that it’s not a good way to hold value (“store of value”) or measure how much value you have (“unit of account”). That’s partly because, as the paper notes, currencies have generally not been viable over very large areas (bitcoin being accepted globally, if only in limited places) and when they depend on some external factors to determine their value (in bitcoin’s example, the actions of digital “miners”), rather than the actions of a central bank. The last objection might be taken by a lot of libertarians and the Paulites who’ve enthused over bitcoin as begging the question — they like bitcoin because it’s not tied to a central bank. But as the Fed economists point out, in both theory and practice, there are good economic reasons, in the modern wealthy world, to prefer central-bank currencies rather than deregulated currencies that have to be tied to some other value. (Rand Paul went so far as to say bitcoin would be better if it were indeed tied to some kind of other asset, which, as I explained, is a bad practical idea whatever the merits are of tying currencies to the value of other assets, since it would have invited much more regulation.)

The good news is that bitcoin is still a nice development for liberty-loving people, because it’s an innovative medium of exchange. It’s already surprisingly widely accepted as payment on a number of e-commerce sites, where customer and vendor get to avoid the non-negligible fees associated with traditional payment systems like credit cards, and transactions can be made so quickly that that bitcoin’s volatile value doesn’t matter. The Fed economists do point out a few problems: For instance, you can’t cancel bitcoin payments like you can, say, a credit-card payment or a wire transfer, so it’s harder to do returns on merchandise.

Yet bitcoin is still useful in this respect, because payment systems, particularly in America, are overregulated and expensive. One of the areas where they impose the highest tariffs is remittances, where the Fed paper is a little skeptical in what I think is kind of a nonsensical way:

Another plausible area of application, because of Bitcoin’s clear cost advantage (at least in terms  of the explicit cost), is remittances, especially across borders. A likely serious impediment to Bitcoin’s  adoption in this case is that the bulk of remittances are to developing countries. One could imagine that the potential users in these markets have neither the specific knowledge nor the digital devices necessary to utilize Bitcoin. This would explain why, to date, Bitcoin has no presence in this market. On the other hand, there is the mitigating factor that most such users have cell phones and many are comfortable with mobile applications. To the extent that a mobile application for international remittances using the Bitcoin network can be developed and accepted by a broad range of providers around the world, it can be possible for Bitcoin to capture a nontrivial share of this market. The crucial, yet difficult to assess, element is whether enough providers in different countries will be willing to adopt the Bitcoin technology, or some variant.

In other words, they’re worried developing economies won’t be tech-savvy enough to take advantage of bitcoin . . . but wait, developing economies are already pretty tech-savvy. As the authors note, there will have to be investment in apps (and wireless networks in these places) for something like bitcoin to become a good way to do remittances, but the potential there is real.

In the end, though, it’s important to qualify that the potential probably lies with “something like bitcoin,” and not bitcoin itself. That’s because, while bitcoin has some interesting innovations that has made it a basically free secure payment system, it has weaknesses, too. (Which are too technical to explain.) But both the technical weaknesses of bitcoin and the deeper problems with this kind of decentralized payment system can probably be overcome — assuming that there isn’t, as the Fed paper worries, a flurry of regulation for digital currencies.

Thanks to Jim Pethokoukis for the pointer.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.