Platt Perspective on Business and Technology

Considering the nature and qualities of money 12: thinking ahead to the next peer-to-peer currency generation 2

Posted in macroeconomics by Timothy Platt on July 8, 2014

This is my twelfth posting to a series on money and on what monetary value functionally means (see Macroeconomics and Business, postings 142 and loosely following for Parts 1-11.) Over the course of the first 10 installments of this series, I have discussed the nature of money as a medium of value exchange and representation, and how peer-to-peer currencies do and do not fit into that larger ongoing paradigm. And I largely focused in that discussion on bitcoin as a best known example of a peer-to-peer currency offering, at least as of this writing.

I have at least briefly noted through this series of postings, a set of potential challenges that peer-to-peer currencies such as bitcoin face, and certainly as they have been implemented and brought to market as of now. And then in Part 11 I started addressing peer-to-peer currencies in general, and bitcoin in particular from a very specific perspective:

• The very same qualities and features that would be seen as defining strengths for such a currency by one viewing constituency, can be seen as its defining weaknesses and flaws by another.
• I focused on the favorable, and on the unfavorable ways that bitcoin’s built in user anonymity are viewed as a primary working example of that in Part 10, where consumers and users value and appreciate the anonymity offered by this currency form when making online transactions but where governments and their agencies hold a very different opinion on that.

And I ended that series installment by noting that I would “consider what might be considered bitcoin’s more overtly consumer and marketplace-perspective weaknesses” next. I will do that here, focusing on a single core source of weakness that essentially all observing constituencies would see as representing significant vulnerability: bitcoin’s valuation volatility.

• An increasing number of businesses have started accepting bitcoin in payment of products and services purchased.
• On the face of it, this makes it sound like the business side of active marketplaces has concluded through their due diligence evaluations that bitcoin’s valuation is sound and reliable enough so that perceived benefits from accepting it exceed any risks from doing so.
• Here, the primary risk is that the value that a bitcoin holds might drop from what it was pegged at when a business acquired it, to an unacceptably lower value before that business can use it, passing it on to others.
• And the basic benchmark for evaluating that, and certainly as of now is in stability or fluctuation in the exchange rate available that this bitcoin would be valued at when it is converted to a stable and economically reliable nationally based currency; bitcoin or I add any other peer-to-peer currency would fail this test if it were considered excessively likely that it might drop in this exchange rate valuation and significantly enough to reduce what would have been a profit from a sales transaction into a break-even or even an overt cash flow loss.

That is all very basic and fundamental. Now let’s question it, and starting with that second bullet point where I allow for a tacit assumption that if businesses accept bitcoin, they must feel confident in its currency unit’s valuation stability.

• Volatility is a function of timing, and particularly of delay between receipt of bitcoin currency and its use or conversion to other currencies.
• If more and more businesses accept bitcoin, and more and more are doing so, that is not necessarily because their managers and owners feel anything like long-term confidence in the valuation of the bitcoins that they acquire. It is because they have developed a level of trust in the reliability of the peer-to-peer currency exchanges that they deal with in swapping out any bitcoins that they do take in for more standard currencies, and rapidly enough so that even when bitcoins themselves are volatile, they do not have time to change much before they are unloaded again.

This is why direct legally based challenges to currency exchanges such as Mt. Gox represents so serious a threat to bitcoin’s reliable stability as an acceptable, valid form of currency in the first place (see Part 8: the due diligence and risk management issues of bitcoin wealth and how they might be addressed and Part 9: some further thoughts on online peer-to-peer currency exchanges as a weakest link.)

• Tightening up bitcoin’s underlying code and improving its system for limiting if not preventing counterfeiting and the production and effective distribution of bogus bitcoin currency is not going to significantly improve its stability and reliability as perceived in the marketplace. It is already quite secure in that regard, even if no software system can be considered absolutely immune from hacking. So improvements there would at most offer a minor incremental increase in perceived stability.
• Improving its system for maintaining user anonymity, as valuable and important as that is for its users, will not significantly improve its overall marketplace stability or its overall viability as a trusted currency either. As discussed in Part 11 of this series, that is a two edged sword as it is viewed as a fundamental source of threat and therefore as a weakness by government agencies.
• The one aspect of bitcoin and its usage cycle that I would offer as a place where direct improvement would significantly enhance its currency stability and help reduce its perception-created volatility is in the currency exchanges that market in this peer-to-peer currency and that convert between it and more standard currencies. And this brings me to the point that I have been leading up to throughout this series installment:
• Bitcoin and its peer-to-peer counterparts are often understood all but exclusively in terms of what could be considered their internal structures. That means in the specific case of bitcoin, its underlying currency unit generating algorithm, and its crowdsourced network of computers that collectively mine (generate) its currency units according to that algorithm. But ultimately, money has value as accepted currency because of its marketplace context and as an emergent result of its acceptance there. This holds for any form of currency, nationally-based included. So in a fundamental sense, the currency exchanges that have been set up and run from outside of the bitcoin community, but that serve as conduits for its exchange and for setting its valuation are part of the bitcoin system too, and integral parts of it. And when they prove to be weak links for a peer-to-peer currency they render that currency itself weak and unreliable too and because of that.

I am going to turn in my next series installment to directly consider the challenges and requirements of building a more stable and secure trading exchange that would trade in peer-to-peer currencies. Meanwhile, you can find this and related postings at Macroeconomics and Business.


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