September 2, 2013 | by Martin Vlachynsky Print

Western governments resorted to unprecedented monetary interventions during the financial crisis. Quantitative easing, decreased privacy, capital controls, and criminalization of cash transactions have forced people to search for better money. Fortunately, they have potential alternatives.

Many are looking to Bitcoin or similar cryptocurrencies. Bitcoin permits anonymous transactions through PCs and mobile phones without a financial intermediary. It is not real money – yet. So far it is mostly a club game for computer geeks, parts of the libertarian community, and a small number of dealers in illegal goods. But it could grow to something bigger because it serves the demand for a sound money that is beyond the manipulations of politicians and central banks.

Bitcoin indeed has two characteristics that no single currency has had before. It is neither based on a commodity nor backed by central authority. This has advantages. A commodity can be confiscated, and a central authority can exercise debilitating control.

What Bitcoin offers is this: You can convert all your possessions into Bitcoins, create a password (called the private key in the Bitcoin world), and store your wealth in your head. No software files need to be carried around. You can imagine the Bitcoin network as a gigantic information chain consisting of paired public and private codes. All you need to do is find a computer with Internet access, download one of many Bitcoin clients, match your public key with your private key, and you can do transactions with your Bitcoins.

Bitcoin potentially offers solutions to the problems posed by fiat money, but it is still far from being real money. Money is a medium of exchange, a unit of account, and a store of value. A good may have the potential to be money, but if it is not universally accepted in trade in a particular geographic area, we cannot consider it money.

Here is a simple rule of thumb: If you can use something to buy both the latest tech gadget in your mall and a Doner kebab on a street corner, it is money. Today, only fiat currencies issued by central banks function as real money.

However, history shows us that goods can gain monetary value overnight under the right circumstances.

Inhabitants of the Pacific island Yap fell in love with a certain type of limestone rock. The imported rare rocks were cut into circles and became the medium of exchange. As the miners imported larger and larger pieces, the stones became too heavy to carry around. So islanders engaging in exchange stopped moving the stones themselves and transferred only ownership to them. There are known cases in which stones sunk in ocean yet the titles to them remained in circulation.

People desire money – it overcomes the inconveniences of barter – and they transform goods into media of exchange swiftly when need arises. In almost all German POW camps during World War II, prisoners spontaneously created cigarette-based money, and even experienced inflation, deflation, and Grisham’s Law (according to which artificially overvalued “bad money” drives out “good money”).

The Internet gave rise to a new form of goods that gained some monetary traction, including such virtual currencies as Linden Dollars and World of Warcraft gold, which can be quite easily turned into dollars or euros.

These “currencies,” however, were money only in the worlds of Yap, POW camps, Second Life, or World of Warcraft. You can’t use them to buy a Doner kebab on street corner or gadgets in your local mall.

What keeps Bitcoin from being a full-fledged money? It requires more technical skills than traditional cash and banking transactions do. It requires even more knowledge when it comes to keeping transactions truly anonymous. This represents a cost to potential users and keeps their number low.

Nevertheless, Bitcoin is finding users among even the poor and uneducated, and is becoming popular in number of African countries. With growing restrictions on remittances to blacklisted countries like Somalia, Bitcoin offers a solution to those who need to send resources to desperate relatives back home.

Recent harsh actions against Bitcoin exchanges by U.S. agencies (for example, the seizing of several million dollars from the biggest exchange, MT.Gox, which temporary ceased operations in U.S. dollars) and more gentle German efforts to bring Bitcoin into the official financial realm are the initial steps in the upcoming tug of war between governments and Bitcoin users. Authorities will likely try to control or suppress it by imposing more indirect costs on users. Some will accept the costs and play by the rules. But we can expect a pushback in the form of innovations that improve anonymity and user-friendliness.

It is difficult to predict if Bitcoin will grow or fade away as a boring regulated virtual currency. But the project is already a success. It is a pioneering experiment demonstrating that a crowd (a techy synonym for “people”) is able to create and so far maintain high-tech decentralized private information channels. Bitcoin is only one example of this new phenomenon; others are decentralized peer-to-peer networking (P2P), TOR (for online anonymity), and 3D printing. All offer modern tools to counter Big Brother, who is equipped with some modern tools himself.

It is too soon to predict that these tools will guarantee the spread of freedom throughout the world. But they will definitely help to give the liberal effort a boost.

Martin Vlachynsky graduated from the Faculty of Economics and Administration Masaryk University in Brno, then completed his master studies at the University of Aberdeen. For several years he worked as a specialist in web marketing and social networking. His areas of focus at INESS include economic policy, energy and natural resources Learn More about Martin Vlachynsky >