Sunday, November 24, 2013

Energy Currency vs. Bitcoin Currency vs. Fiat Currency vs. Gold Currency vs. Google Currency

Currency is a means to an end. The end is growth, happiness, knowledge, complexity, diversity, etc...
Currency is a mean to those ends because it allows people to collectively trade goods, i.e. through the use of currency I don't need to trade my engineering services directly with farmers in order to eat breakfast, lunch and dinner everyday. I can trade my engineering services with companies, who pay me in $dollars, and somewhere down the line, farmers trade their food for $dollars.
This is the most important purpose of a currency: a respected Medium of Exchange.

The other major purpose of a currency is not really a function of the currency as it is really a function of the investor. The question is: can the currency be invested into companies and/or banks so that one's investment in terms of real goods increases with time. In order words, the money invested into companies and banks should not have rapid fluctuations and it should increase with time, i.e. it should be a stable Storage of Wealth. This means that all sorts of growing companies need to accept payment of the currency. This also means that the currency must be safe from theft and that you can purchase stocks/bonds/homes using the currency with near-zero transaction fees.

As of the end of 2013, Bitcoin appears to satisfy only one of the two purposes of a currency: Medium of Exchange. (For more details on Bitcoin, check out the following YouTube video. It's the best summary of Bitcoin I've seen so far.) As far as a stable Storage of Wealth, Bitcoin has failed miserably...due to theft, price fluctuations, and arbitrary rules for increasing the number of Bitcoins in circulation. But this is not a complete problem, as long as you realize that you shouldn't be holding onto Bitcoins, but rather you should be investing your savings into projects with real, positive rates of return on investment, such as stocks and bonds. Where are the stable and growing Bitcoin-friendly banks, stocks and bonds?

I think that there are some novel aspects to Bitcoin as a currency, such as the innovative way of having all of the currency transactions recorded by the public and without a central organizing agency. I would like to see a currency like Bitcoin take off and become a global medium of exchange with near-zero friction (i.e. with near zero transaction fees.)

However, people who purchase Bitcoins should realize that there are some underlying problems with Bitcoin:
(1) There is currently an arbitrary limit to the number of Bitcoins. This expected limit is around 21 Million Bitcoins. (See graph below) The problem is that it's not clear what will be the incentive to secure the transactions (i.e. to mine Bitcoins) if there are no more Bitcoins available to be generated.

(2) To continue along point 1, the amount of currency should track the growth in the capability to generate useful work. New currency should be generated when self-replicating power plants are built, and not due to some arbitrary limit and not when gold/silver are mined out of the ground. I'd like to see an alternative to Bitcoin in which new currency is generated only when new power plants are built and only when people democratically vote to allow more currency (i.e. not just when Ben Bernanke says so.)

(3) Right now, new Bitcoins are instead generated when transactions occur, but there is no connection between the amount traded in transactions and the growth rate in useful work.