Why Bitcoin doesn’t have what it takes

This column originally appeared in The Globe and Mail on June 6 2013.

People love to peer into the future, and one of the hottest topics these days is the future of money. Bitcoin – an electronic cash system used predominantly for online transactions – is sending tingles of excitement down the spines of some folks. But for all its potential advantages, Bitcoin is not going to replace the U.S. dollar or other major national currencies any time soon.

An illustration of Bitcoins. (NEAL CRESSWELL FOR THE GLOBE AND MAIL).

The fact that Bitcoin is made up of binary code and has no physical presence isn’t what makes it unique. After all, electronic purchases made with a regular bank debit card are essentially the same thing. What makes Bitcoin unique – and perhaps more interesting – is that it isn’t issued by a national central bank and can be transferred without a financial institution acting as intermediary. Because some online vendors accept it as payment, it’s starting to resemble what we normally call money.

Monetary theory taught in economic text books outlines the basic roles of money as a medium of exchange, a way to store wealth, a means to determine value, et cetera. At least potentially, Bitcoin can check off some of those boxes. But at least two conditions would have to fall into place before it goes from fad curiosity to serious contender as a global currency.

First, people would have to be commonly paid in Bitcoins. While it’s not difficult to find online vendors willing to sell in Bitcoins, few workers (if any) receive their wages that way. There may be the odd programmer or Web designer willing to do a specific task for a Bitcoin payment, but it would be a rare exception for someone to receive a regular Bitcoin wage.

The second condition poses a bigger hurdle. For Bitcoin to become a serious global currency, you’d need people willing to lend them. Borrowing and lending is the traditional role of banks and as imperfect as they can sometimes be, banks are one of the foundations on which the modern economy is built. A quick Google search turns up all sorts of groups willing to lend in Bitcoins, so at least the early stages of a Bitcoin banking system seems to be taking root. But would it work?

Smart lenders are willing to lend only because there is a reasonable expectation that they’ll get their money back with interest. If the borrower is risky, interest rates will be higher. And if the borrower skips town or refuses to pay, the lender has legal recourse. But if a loan were made in Bitcoin, what legal recourse would there be?

Legal contracts can be drawn up between two parties to cover everything from borrowing money to renting a car to setting out conditions of employment. It would be simple to write a contract, enforceable in a court of law, to lend and borrow Bitcoins. But much of Bitcoin’s appeal is that it exists outside the view, or reach, of any government’s legal system. And without a legal way to enforce contracts, Bitcoin doesn’t stand a chance of replacing national currencies

Free-market libertarians are distrustful of government and get quite cross when the taxman comes calling. The extremists among them hole up in bunkers with guns and bars of gold, spinning extravagant conspiracy theories about the U.S. Federal Reserve. For these paranoid folks, Bitcoin seems a dream come true – a way to conduct their finances totally outside the peering eyes of Uncle Sam. Drug dealers and criminals love Bitcoin for the same reason.

And U.S. authorities are already cracking down. The Federal Bureau of Investigation, the Department of Homeland Security and the Treasury Department’s anti-money laundering arm are monitoring Bitcoin users very carefully. At a Bitcoin conference last month in San Jose, Calif., the big topic was regulatory compliance.

Bitcoin may still play a role as an online barter currency, or maybe even a limited form of wages. But criminals and libertarians shouldn’t get too excited. Our current monetary system works precisely because of, not in spite of, those peering eyes of government.

Todd Hirsch is the Calgary-based chief economist of ATB Financial and author of The Boiling Frog Dilemma: Saving Canada from Economic Decline.