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The first was as a sober engineer, touting the benefits of his new invention for internet merchants. His original technical paper introduced Bitcoin as the solution to a practical problem. Why accept this weird new currency? The problem, as Nakamoto described it, seems curiously modest: But Bitcoin does it for electronic transactions. Money is a social device. The things that make it work are not to be found inside the coins and notes, but in a network of connections between the people who use it.

At worst, the properties coded into Bitcoin will make it unsuitable for a viable social infrastructure, and it will implode and remain niche — a disruptive technology that mainly disrupts its own users. That is what Bitcoin is offering, so if it is to be the future of money, that answer better be pretty good.

The technical problem that Bitcoin solves is to simulate a physical coin electronically, without relying on centralized administration. Simulating this electronically is nothing new. Most of what we use as money is not physical cash — coins or notes — but electronic money in the form of bank deposits. The regular electronic-payments system is a complex network, and hierarchical in nature: The whole system is administered: The blockchain technology Bitcoin introduced also simulates coin transfer, but in a different way — without centralized, hierarchical administration.

It does this by creating public records of transactions, with copies of the blockchain existing on many computers, thus creating a hard-to-falsify record of who has title to each coin.

The blockchain does solve a problem: But this merely solves the most basic monetary problem. True, any means of payment, at a minimum, needs to have solved this problem: But that is just a minimum. That can be coded into Bitcoin just as traditional currencies are stamped at the mint. What cannot be coded is:. Acceptability in payment generally depends on the other two things: Unlike goldbugs, they are not recommending we adopt something like gold with nonmonetary uses or a long tradition as a safe haven, which might put a floor under the value of their alternative.

Their claim rests on the idea that central banks are prone to manage currency badly, due to either ineptitude or depravity. Bitcoin, on the other hand, has no manager at all.

It is coded so that mining will release new coins at a predictable and declining rate, with peak supply of 21 million Bitcoins. So, the argument goes, value has been coded into it. So far, though, Bitcoin has fared worse in terms of value stability than almost every fiat currency in history.

But Nakamoto never promised value stability. Instead, he predicted that Bitcoin would steadily rise in value: As the number of users grows, the value per coin increases. It has the potential for a positive feedback loop; as users increase, the value goes up, which could attract more users to take advantage of the increasing value. That worked as a third pitch for Bitcoin — to appeal, beyond the nerds and techno-libertarians, to shoeshine-boy speculators.

And this argument would ultimately prove a very important one. Its value in terms of national currencies, and in terms of things priced in those currencies, kept rising. Since total Bitcoin supply is capped, even a fairly modest share would support a much higher Bitcoin price than even the stratospheric valuations of late Speculators were getting in early, and over the long run would be able to offload their holdings to new users as Bitcoin moved towards mass adoption. A rapid, self-perpetuating rise in value can undermine a currency as easily as rapid inflation: Now its trajectory is uncertain from day to day, even from hour to hour.

Sellers do not usually price things in Bitcoin independently. They set their price in terms of some national currency, like the dollar, and let the Bitcoin price automatically adjust according to the current exchange rate — just as they do with foreign currencies when they sell to buyers around the world.

Bitcoin is only a vehicle, a means of payment not intended to be held any longer than it takes to convert it into some other currency. It is true that something does not need to be a good long-term store of value to succeed as a means of payment. But instability of a unit of account, on the other hand, can undermine a monetary system, because contracts are drawn up in terms of units of account.

For contracts to do what they are meant to — lock-in aspects of the future — the parties must have some confidence in the future meaning of the numbers written into them.

Imagine what would have happened to anyone contracting for a wage set in terms of Bitcoin, fixed last February for a year in advance. Or, imagine an annual wage struck in terms of Bitcoin in December: Clearly a currency subject to so much volatility will not be adopted as a unit of account.

Bitcoin is, in that case, not an alternative to state-issued currencies, but parasitic on them. It leaves the stability of units of account to the dastardly central banks. But even this is doubtful. To the extent that Bitcoin — miraculously — were to become a popular alternative means of payment, it would undermine the unit-of-account stability it depends on.

But, as parasites go, Bitcoin is not likely to be terribly successful at reproducing, and so will not kill its host. To be a good means of payment, something needs to be widely accepted in payment, and usable with a minimum of transaction costs. That raises a chicken-and-egg problem: There is an out: Convertibility has helped support the acceptance of most of what we now use as money: The acceptability of bank deposits still depends on convertibility at par, not least because we want to be able to pay the customers of other banks.

Bitcoin has no one guaranteeing convertibility at any particular rate, so at best it fits into the category of liquid assets, like bonds and shares. But unlike them, it is intended as a means of payment. Can such a thing achieve wide acceptance? Bitbugs used to claim low transaction cost as an advantage of Bitcoin, because no overhead needs to be paid to a managing institution like a bank. That now looks foolish.

There are two parts to the cost of using Bitcoin. Then there is also the cost of shifting out of Bitcoin. Most retailers that do accept Bitcoin cannot themselves make most of their payments in Bitcoin, so the ease of its convertibility into national currencies is vital. The internal Bitcoin transaction fee is an odd thing. The spender chooses how much to pay, but of course the miners are interested in including the transactions with the highest payoff for the space they take up on the block.

The weightier the transaction, the higher the fee. Instead of paying a set fee to some dinosaur of a bank, Bitcoin users make bids on a free market to get their payments processed. You must monitor the going rate, which depends on how many other transactions are out there competing for blocks, and then trade off how much you are willing to pay against how long you are willing to wait for your transaction to clear.

For a long time, this was basically invisible to people, because the going fee was tiny — typically a few US cents, for processing within an hour. That changed in for the simple reason that a lot more Bitcoin transactions started happening as the bubble took off. This, remember, was the cost of executing a single Bitcoin payment. Sample Reddit comment from last September: But these fees internal to the Bitcoin system are only part of the transaction cost. Because Bitcoin is not widely accepted, retailers who do accept it need to turn it into their regular domestic currency.

Because its value is so volatile, they generally do not want to take the risk of holding it any longer than they have to. No institution has taken on the responsibility of converting Bitcoin into currency at a fixed rate — and it would be insane to do so.

That alone makes Bitcoin, or any cryptocurrency, far less liquid than the competition — that is, electronic bank money denominated in a national currency. At best, this would be not so far from the situation internet retailers face in accepting foreign currency. In any international transaction someone — whether the buyer, the retailer, or a financial institution in the middle — has to change currencies in the foreign-exchange market, and that adds a small cost to the purchase around 3 percent , usually borne by the purchaser.

For one thing, Bitcoin adds such a cost even to domestic purchases, when buyer and seller share a currency and the transaction could have happened without any need for money-changing. In fact, the cost is doubled: But it gets worse, because Bitcoin is not just another currency. It is much more volatile: The time it takes for transactions to be recorded in the blockchain is uncertain but often around an hour, and much longer in high-transaction periods.

But it can be substantial for some currencies. This opens yet another wedge between what the buyer pays and the seller receives, on top of the transaction fee and any institutional fees. And there is no cryptographic protection from a liquidity seizure on the markets, should people suddenly become wary of Bitcoin for some reason or another. In fact, most retailers accepting Bitcoin do not do it directly. They use institutions to handle the backend, making it relatively painless and mostly risk-free.

Of course, they charge for the service, one way or another: That is, they cut costs by avoiding actually using the Bitcoin infrastructure. Can fractional reserve banking be far behind? The lesson here is that institutions spring up in response to problems because money cannot manage itself, even with all the cryptographic innovation in the world. Perhaps this emergence of an infrastructure of cryptocurrency middlemen shows a certain maturation of the currency, just as banks inevitably grew up around currencies.

Most casual users of Bitcoin engage through an online service, and so get the worst of both worlds.