With the price of Bitcoin sky-rocketing over the last few months (making millionaires out of some very young people), the world’s attention is suddenly focused on Bitcoin (and other crypto-currencies). Economists and financial ‘experts’ are talking about how Bitcoin really isn’t a currency and is a bubble, and boosters are talking about how Bitcoin will change everything and drain power away from governments allowing transactions to take place beyond the regulatory reach of the state.

So, what is the truth? It would be tough to claim that anyone currently really understands what Bitcoin is. Saying that Bitcoin isn’t really a currency is ludicrous. Anything that anyone will take in exchange for something else is a currency, whether that be dollars, Swiss francs, or a stack of baseball cards. The criticism that Bitcoin isn’t backed by anything really runs into a similar problem that afflicts other conventional currencies; namely that they aren’t really backed by anything either beyond faith that someone else will take them (dollars, euros, etc.) in exchange for something else. True, the faith in these currencies is underpinned by fact that certain governments will accept their own currencies to satisfy tax obligations, as well as the widely shared experience that many establishments will accept the local currency as payment for goods or services rendered. However, if the government issuing the currency is overthrown, the faith in the currency (and its value as a medium of exchange) tends to disappear too (see German Reichsmarks, East German Marks, etc.). So, what is really meant by the assertion that Bitcoin is not a real currency is that its ability to be exchanged for tangible goods and services has not yet been adequately established. Admittedly, at this time Bitcoin does seem to be the Esparanto of currencies: some people use it, but the use of it has not been adopted widely enough to make it a truly useful currency.

One of the more apparent criticisms of Bitcoin is that it is currently in a bubble phase. Any item that increases its price in dollars by 5 or 10 times over during a few months is a legitimate target for a bubble accusation. This is especially true when there is no obvious reason for such a move. The rapid increase in the value of Bitcoin bears a lot of the hallmarks of a bubble move. Specifically, you have a new, potentially transformative, technology that nobody really understands. It moves from the fringes into the popular consciousness. People get excited and the price skyrockets beyond all rational expectations. We have seen this historically in the legendary tulip craze a few centuries ago, and more recently in the “tronics boom” of the 1960’s and the tech bubble of the late 90’s. The rise in price was due largely to sentiment and expectations. If (when) these fail to be met and people lose faith in the idea that they will ever be met, the price of the asset crashes hard, leaving financial (and possibly economic) wreckage in its wake. Having said this, if Bitcoin suddenly entered popular use (and with the internet, something can enter popular use rather suddenly from out of nowhere), see the price of the coins increase rapidly would not be something unexpected. For now, as I haven’t seen signs sprouting up touting that my local grocery store now accepts Bitcoin in payment, count me in the bubble category (although as Bitcoin is a global currency, its possible that the price increase could be justified just from online use).

Finally, the question about the use of Bitcoin also must include questions regarding how one can obtain Bitcoin (it’s essentially inaccessible for most people) as well as the alleged limit on its supply. While this limit is viewed as a limit against Bitcoin losing its value through inflation (a VERY important concern when one is dealing with a medium of exchange that has no governing structure), its limited supply could result in it limiting economic growth and prosperity if it were ever widely adopted in the way that gold (another faith-based medium of exchange) does. As for being inaccessible for most people, this is going to make it less likely that your average person will have experience with it, less likely that he/she will be comfortable with it, and this will hinder its overall adoption by the general public.

What we could end up seeing, however, is the emergence of a global economic segment (a sort of sub-economy, if you will) where people/firms who do business with each other but are also weakly linked with the greater global economy use Bitcoin in transactions. There are many potential ways this could come about, but illustrating them would be an exercise in pure speculation. Perhaps over time, Bitcoin will be gradually adopted as more and more people begin to have experience with it and the faith in the currency grows and allows it to achieve critical mass. However, at this time, it is too new, and the value too unstable, for this to be considered a candidate for mass adoption any time soon.