Yesterday, I posted an update on Twitter about how I’d bought some bitcoin. A friend of mine responded, saying,
“Really? I have to admit the idea of bitcoin freaks me out a bit.”
I asked why and she said,
“The fact that the currency doesn’t actually exist is a bit freaky to me.”
I think she’s not alone in this discomfort. I’d bet lot of people think because bitcoins are a digital currency that therefore, somehow, they don’t really exist. We’re used to thinking of “real” money as dollars or coins you can hold in your hand. But bitcoins are every bit as real as the email messages or tweets that you send and, while it might be a surprise many, no less real than US dollars.
Nowadays most money is pure information. The dollars you have in your bank account and that you write checks against are merely entries in a ledger. Bills and coins are minted and dispensed only as needed for cash transactions in the economy. Yes, those electronic dollars can be exchanged for hard cash, but cash transactions are diminishing rapidly as online bill paying, credit and debit cards and other forms of electronic transfers are becoming more commonplace. In other words, the digital dollars in accounts represent the “real” money and physical bills and coins are merely tokens for it.
I’ve also seen comments in forums saying bitcoins “aren’t worth anything.” Well, dollars have not been tied to a physical commodity like gold or silver since the Nixon Administration. As anyone my age might remember, US bills used to have the words, “Silver Certificate” printed on them. That meant you could exchange them for the equivalent value in silver dollars. Not anymore. The dollar is what’s known as a “fiat currency”, meaning it derives its value from government decree, not from a backing commodity.
Dollars are “worth something” only because people believe they are. They accept them for payment, and measure the value of things using them. But in 2012, dollars are just as vaporous an abstraction as bitcoins. The Federal Reserve creates dollars out of thin air (i.e., “by fiat”) when it deems the money supply needs inflating. In this respect dollars are even more vaporous than bitcoins, which require a certain amount of proven computational work to make as we’ll see below.
The fact is, value is a human perception. Some things have intrinsic value, like food because we can eat it or titanium because you can build very strong but very lightweight things with it. We also value things that are beautiful, scarce or hard to come by, like gold, diamonds, truffles, 1961 Corvettes and van Gogh paintings. We value money because of its utility as a medium of commerce. We can trade it for things which have real intrinsic, artistic or collectible value.
Bitcoins fall into the categories of scarcity, difficulty to make and utility. They’re scarce like diamonds or gold because they’re difficult to make. Even a very, very fast, specially designed computer takes some days to make a batch of bitcoins. The production rate and total number of coins is strictly controlled by the software and protocol and actually adjusts itself to the number of participating servers on the network. And you can’t cheat at it because the other servers in the network have to validate your work before you get awarded the coins.
Now, you might say, “Big whoop. It’s just computer time.” But running a computer costs money for electricity or capital investment to build a solar array to power it, or a wind turbine or water wheel. And the electrical energy required to create a batch of bitcoins is not insignificant. It’s on the order of the energy required to run air conditioning, which is a lot!
In fact, the servers that do these intense calculations are called “miners”, because they’re analogous to gold or diamond mines that expend great amounts of energy to recover very small amounts of the precious materials.
So bitcoins possess all the necessary attributes of value and in addition have some attributes that make them much easier to use. But that’s a subject for the next post.