The difference between Bitcoin and Tulip

The difference between Bitcoin and Tulip

During the holiday season, the conversation in my family inevitably turned to the dramatic rise – and fall – in the price of the US dollar (exchange rate). For Bitcoin During December (Figure 1). The rollercoaster ride of the blockchain-based currency has been front-page news for the mainstream media, where it has been both Looks like And Separate from Boom and bust of the famous Dutch tulip craze of 1637.

Figure 1. Bitcoin vs. US Dollar, December 2017

It is undeniable that December 2017 marked the point at which the terms “bitcoin” and “cryptocurrency” became mainstream. But whereas in 1637 the average participant in the Dutch tulip market had a fairly good idea about what was promised, as 2018 dawns, confusion abounds about what Bitcoin and other cryptocurrencies like Ethereum (Figure 2), Litecoin, and Dash are. How they differ from other currencies or commodities, and whether their trading warrants any special policy attention.

Figure 2. Ethereum price against the US dollar, December 2017

Currency concerns

The starting point is to understand the similarities and differences between Bitcoin and Tulip William Stanley Jevons. His 1875 work Money and the Mechanism of Exchange defines the four functions of currency: Medium of exchange, a Value scale (or arithmetic unit), a Deferred payment standard, and Store of value.

Comparing Bitcoin with tulips reveals that tulips only perform the function of storing value. To qualify as a currency, Bitcoin and other cryptocurrencies (which arguably include digital balances like Airpoints) must fulfill each of these four functions. Clearly, a group of merchants are willing to price and accept Bitcoin (and Airpoints) in exchange for goods and services, and it can be used to transfer value from one person to another (although the transferability of Airpoints is somewhat limited), thus settling debts. An amount of Bitcoins (or Airpoints) may be held for a period of time as a store of value to be converted or redeemed in the future, although the terms of exchange may be different from those prevailing when the unit of currency is first acquired. . Their status as currencies seems assured.

However, comparing Bitcoin with tulips reveals that tulips only perform the function of storing value. Tulips are commodities, like stocks and shares, not currencies like the US dollar. Tulips (and stocks) were not commonly used to price and conclude trades for other commodities or to settle debts. Nor was it used primarily as a means of transferring wealth from one place or person to another. However, both tulips and stocks are purchased with the expectation that they will retain or increase their value to a greater extent than the buyer could expect to hold the amount used to purchase them in a currency (or substitutes that can be purchased with the currency). He. She).

Coin or something else?

If there is a similarity between the Bitcoin boom of 2017 and the tulip mania of 1637, it is that the vast majority of people who bought Bitcoin in December were buying (and selling) a store of value seen as offering better (worse) returns than those of the alternatives on offer. They’re not buying a currency they can actually transact with – like when I convert my US dollar-denominated salary into NZD, for example. One function of currency – the store of value – appears to be crowding out the other three.

In fact, the bitcoin buying frenzy arguably more closely resembles the speculative buying of shares in digital companies like Google and Amazon than the tulip frenzy. Ironically, one important difference between cryptocurrency and nation-state currencies issued and supervised by central banks appears to have made this situation possible in the first place.

Cryptocurrencies like Bitcoin are hybrid currencies. The difference here is that since August 15, 1971, when the United States unilaterally ended the convertibility of the US dollar into gold, the dollar and most other national currencies have become fiat currencies. Fiat currency only has value by government order (Airpoints are corporate fiat currencies because their value is determined by corporate orders). The price (in another currency) that individuals are willing to pay for a dollar (or Airpoint) is a function of those individuals’ belief in the actions of a government (or legal entity) to preserve the value of the Dollar (or Airpoint) relative to the alternative currency in which that value can be held. Actions such as quantitative easing – increasing the supply of dollars/airport points – lower the price of the dollar relative to other currencies as no change is made by changing the balance of supply and demand.

In contrast, digital currencies like Bitcoin are hybrid currencies. In addition to displaying some aspects of paper currencies, it retains some elements of commodity currencies and representative money. Commodity currencies derive their value from the value of the underlying commodity (for example, the gold used in coins). Representative money consists of tokens that can be exchanged for a fixed amount of a commodity (for example, gold). The value of representative money is a function of the value of the underlying good. If the supply of that good is limited (for example, no more gold can be extracted to make coins), there will be the ability to manipulate the price of the currency (exchange rate) downward by changing the quantity in circulation (as happens with quantitative easing in fiat currencies ). ) is no longer an option.

Share of work

The price of Bitcoin has been very volatile, with speculation rife. In the case of Bitcoin, by design, the total supply that will be available is 21 million (the current number in circulation is just under 17 million). By the simple laws of supply and demand, the more people want to buy a share of the known, fixed amount of bitcoins, the higher the expected price will be, all else being equal. In this way, bitcoins act more like the limited amount of shares available in an initial public offering (IPO) than a unit of currency like the US dollar, the total number of which is constantly changing. In contrast, the quantity of tulips was not constant, as some bulbs could be used to propagate more bulbs rather than growing them to provide flowers.

While the organization that oversees Bitcoin is not traded, the “coins” themselves act as a substitute for shares if they are traded, reflecting the amount of individuals willing to buy a stock and their collective expectations about the value of the company. As is the case for most IP offices, this price can be affected by the quantity and quality of information available in the public domain. Hence the price of Bitcoin has been very volatile, with much speculation in the media about whether the current price path is reasonable or sustainable.

Although Bitcoin has been the most widely traded cryptocurrency, it is not the only one “on the market.” Bitcoin ended December about 25% higher (relative to the US dollar) than it started, but the lesser-known (and unspecified) cryptocurrency Ethereum rose 75%.

This discussion suggests that the first question we have to resolve before we can form any policies is whether the objects of interest are currencies or something else, and if they are currencies, what kind have they adopted? As with the debate over whether Uber is an online matching platform or a taxi service, this may take some time, as the practice is far from clear.

Reprinted from the American Enterprise Institute

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