Economics of BitCoins

Introduction

Money is used to perform numerous functions in the modern economy. People use money in their daily transactions, for instance, the purchase and sale of goods and services, the creation and settlement of contracts. However, there is no universal agreement on what constitutes money; for instance, the introduction of Bit Coins has caused significant controversy. Böhme and colleagues (2015) define Bit Coin as an online communication protocol that allows the use of a virtual currency and electronic payments to make transactions. The use of BitCoins is decentralized as it does not require a central authority to issue and regulate the supply of money. Economists support different views on the practicality of replacing money with BitCoins. A critical analysis of the economies of BitCoins shows that they cannot be a perfect replacement of money in the modern economy.  

The Functions of Money

Money performs various functions in the economy, including its use as a medium of exchange. People hold money because they would want to swap it for goods or services. Thus, individuals do not seek to possess money because they want it, but because they can use it to get other things. Different objects have served the role of medium of exchange before, for example, during the Second World War, cigarettes became the medium of exchange in some war prisons in the absence of money (McLeay, Radia, & Thomas, 2014). Non-smokers were willing to hold cigarettes; not because they planned to smoke, but because they could exchange them for other things they wanted. Money can only be taken in exchange, but cannot create utility by its own because it is never consumed by the receiver or utilized in production. However, it can be exchanged for goods or services. Therefore, money is a means of payment that is taken by anybody in exchange for any commodity habitually and without hesitation.

Money is a unit of account in the modern economy and is used to price items. Items on menus, contracts, and price labels are valued in monetary terms. However, it should be noted that the unit of account is usually a currency (McLeay, Radia, & Thomas, 2014). For example, the US Dollar is used to denote the monetary value of goods and services in the United States. Therefore, a unit of account provides a common measurement of the relative value of goods and services. In the absence of money, there is no common denominator against which goods and services can be measured. Individuals would be forced to decide the value of goods and services on the basis of other goods and services. For instance, one bale of wheat flour can be assigned the value of twenty liters of cooking oil. However, with money, the price of a bale of wheat flour can be compared with the price of twenty liters of cooking oil.   

Money plays a significant role in the economy as a store of value in exchange for some item in future because it holds value over time (Tucker, 2010). For instance, it is difficult for a farmer to store his tomatoes for five months and then exchange them for oranges. However, the farmer can sell his tomatoes and keep the money for five months to buy oranges when they are in season. There are instances when money has failed to maintain value over time. For example, money loses some value during inflationary periods. However, money maintains value better than goods and services. Therefore, money can be used to transform current income into future purchases.    

Objectives of the Federal Reserve

The Federal Reserve performs various functions in managing the US money supply. Therefore, there are set objectives that should be achieved to enhance proper management of money supply in the United States. First, the Federal Reserve should ensure stable prices for commodities and services in the economy. Secondly, the institution seeks maximum employment in the economy. It should also ensure that there are moderate long-term interest rates in the economy.

The Federal Reserve creates and implements monetary policies to achieve its objectives. For instance, it adjusts the money supply by utilizing monetary policies such as interest rate regulation and government spending. The Federal Reserve influences money and credit conditions within the country. Moreover, it supervises and regulates banks and other financial institutions. It is the role of the Federal Reserve to maintain financial system stability by mitigating any systematic risk that may arise in the financial markets (Federal Reserve, 2014).

Provision of financial services to the US government and overseeing the country’s payment systems enables the Federal Reserve to achieve its objectives.

The Federal Reserve ensures the stability of prices in the economy. Maximum and sustainable output growth, employment, and moderate long-term interest rates can only be achieved when prices are stable. Prices of goods, labor, services and materials remain undistorted by inflation because of stable prices (Federal Reserve, n.d). Consequently, there is an efficient allocation of resources, which contribute to higher standards of living. The culture of saving and capital formation is fostered by stable prices because they eliminate the risk of loss of asset value due to inflation. Households and businesses are encouraged to save and invest more respectively. Additionally, the Federal Reserve contains financial disruptions such as stock price fluctuations and prevents them from spreading outside the financial sector (Federal Reserve, n.d). For instance, the Federal Reserve mitigates the impact of threatening disturbances on financial markets and the economy by providing liquidity, using open market operations or discount window lending.

Clear explanation of monetary policy decisions enables the Federal Reserve to ensure well-informed economic decisions by households and business. It reduces uncertainty in the economy, leading to effective financial commitments. For instance, the annual inflation rate has been determined as 2% and is expected to be consistent for a long time (Federal Reserve, 2016). Consequently, citizens and businesses are well-informed about the long-term inflation expectations. Price stability and moderate long-term interest rates will be ensured, leading to the promotion of maximum employment. The Federal Reserve also reduces deviations of inflation and employment between the longer-run goal and its assessment of maximum level. It also enhances a balanced promotion of the two objectives, in case they are not complementary. Thus, the Federal Reserve uses monetary policies to achieve its objectives.

Functions of Money served by BitCoins 

BitCoins can serve some of the functions of money. For instance, transfer of value can be enhanced by BitCoins because miners can use them to purchase commodities or services. BitCoins can also be used to buy shares in the stock market. Therefore, a BitCoin holder transfer or remit them, through the network system, to another person in a different location. However, the recipient should accept BitCoins as a medium of value that can be used to purchase goods and services and make payments. Secondly, BitCoins can be used as a common measure of value. However, senders and receivers of BitCoins should accept them a measure of the value of their goods and services. Therefore, a commodity or service provider who accepts BitCoins can value and measure them in BitCoins terms. BitCoins act as a medium of exchange because they can be accepted by some people as a means of payment. However, there has to be a common acceptance of BitCoins by transacting parties in exchange for goods and services.        

Drawbacks of BitCoins

BitCoins cannot make perfect equivalents of money as they are characterized by some economic drawbacks and risks. Money is a medium of exchange and a stable store of value. However, BitCoins cannot be a stable store of value because they are expected to increase in value over time (Krugman, 2013). Therefore, they cannot be regulated to prevent deflation and inflation in the economy. Secondly, the use of BitCoins lacks trust and accountability because there is a possibility of anonymous financial networks without third party arbiters developing. Moreover, there is no long-term material and social consequences associated with BitCoins. It involves taxation of untraceable money as there are no actual financial holdings in a BitCoin economy.

There is no central control in the use of BitCoins. Therefore, undetected double spending is most likely as there is no way of establishing the time of the transaction to note past transactions. The existing method of proof of works is too complex to be used by ordinary investors. The creation of BitCoins is constant. Therefore, they can be hoarded to be sold at higher prices. Mining is the creation of new BitCoins (Karlstrøm, n.d). They are produced in one of six or seven gigantic server farms and miners receive BitCoins for free. They then distribute them by using them in purchasing goods or services or selling them in a BitCoin exchange. BitCoin transactions have to be verified by the other nodes of the peer-to-network (Karlstrøm, n.d).  Transaction information is then updated in a shared record known as a blockchain. With the use of BitCoins, the need to seek reserves will be eliminated, and transactions cannot be regulated. 

Use of BitCoins in an Economy

BitCoins cannot be a useful medium of exchange, store of value, and unit of account in an economy because their use is decentralized. Therefore, control of their creation and distribution is unattainable. The need for reserves by banks from the Federal Reserve creates a control and verification of transactions because banks require real currency to make payments. However, with the BitCoin technology, there is no real currency required even in making payments. Therefore, falsification of transactions is possible. Secondly, BitCoins are not a standard of deferred payment because they cannot facilitate future transactions. Therefore, BitCoins cannot be used in the place of money in a modern economy.

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