The Economics of Bitcoin - Econlib - 0 views
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Bitcoin is an ingenious peer-to-peer “virtual” or “digital currency” that challenges the way economists have traditionally thought about money.
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My conclusion is that, in principle, nothing stands in the way of the whole world embracing Bitcoin or some other digital currency. Yet I predict that, even with the alternative of Bitcoin, people would resort to gold if only governments got out of the way.
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According to its official website: “Bitcoin uses peer-to-peer technology to operate with no central authority; managing transactions and the issuing of bitcoins is carried out collectively by the network.”
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To fully understand how Bitcoin operates, one would need to learn the subtleties of public-key cryptography.
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In the real world, when people want to buy something using Bitcoin, they transfer their ownership of a certain number of bitcoins to other people, in exchange for goods and services.
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This transfer is effected by the network of computers performing computations and thereby changing the “public key” to which the “sold” bitcoins are assigned.
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The encryption involved in Bitcoin concerns the identification of the legitimate owner of a particular bitcoin.
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Without delving into the mathematics, suffice it to say: There is a way that the legitimate owner of a bitcoin can publicly demonstrate to the computers in the network that he or she really is the owner of that bitcoin.
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Only someone with the possession of the “private key” will be able to produce a valid “signature” that convinces the computers in the network to update the public ledger to reflect the transfer of the bitcoin to another party.
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When Bitcoin was first implemented in early 2009, computers in the network—dubbed “miners”—received 50 new bitcoins when performing the computations necessary to add a “block” of transactions to the public ledger.
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In principle, the developers of Bitcoin could have released all 21 million units of the currency immediately with the software.
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With the current arrangement—where the “mining” operations needed to keep the system running simultaneously yield new bitcoins to the machines performing the calculations—there is an incentive for owners to devote their machines’ processing power to the network.
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Here, the danger is that the issuing institution—once it had gotten the world to accept its notes or electronic deposits as money—would face an irresistible temptation to issue massive quantities.6
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Bitcoin has no such vulnerability. No external technological or physical event could cause Bitcoin inflation, and since no one is in charge of Bitcoin, there is no one tempted to inflate “from within.”
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Some critics argue that Bitcoin’s fixed quantity would imply constant price deflation. Although this is true, everyone will have seen this coming with more than a century’s notice, and so long-term contracts would have been designed accordingly.
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Whether to call Bitcoin a “fiat” currency depends on the definition. If “fiat” means a currency that is not legally redeemable in some other commodity, then yes, Bitcoin is a fiat currency. But if “fiat” means a currency relying on government fiat to define what will count as legal money, then Bitcoin is not.
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Bitcoin is an ingenious concept that challenges the way economists have traditionally thought about money. Its inbuilt scarcity provides an assurance of purchasing power arguably safer than any other system yet conceived.