![]() “No one wants to use a money that no one else is using. “Media of exchange are subject to what economists call network effects,” he explained. It is more volatile than other media of exchange because it lacks a core, reliable source of demand.” “Bitcoin is more volatile than many other assets because it is a medium of exchange. “Since bitcoin’s supply is essentially fixed, its price fluctuates due to changes in demand,” Luther says. This is what makes it an attractive speculative asset for some, but also is a barrier to its adoption as a widespread currency used for exchange. ![]() Hence, even those interested in bitcoin as an investment should understand its role as a currency.” Why Is Bitcoin’s Price So Volatile?īitcoin is infamous for its volatility, meaning that its valuation, or price, often swings drastically up and down over relatively short periods of time. Indeed, bitcoin’s price will only rise if (1) it becomes more useful as a currency today or (2) is expected to be more widely used as a currency in the future. For this reason, some people think of bitcoin as an investment. However, “all currencies are assets,” Luther offers. “Bitcoin is, first and foremost, a currency (or, potential currency),” the economist says. At first glance, it seems more similar to an asset like a stock one buys on the stock market than a currency, defined as a medium of exchange. Much of the news around bitcoin involves people making (or losing) money by purchasing it and then selling it when its highly-volatile price shifts. However, “since bitcoin can be transferred without relying on a trusted third party, it tends to offer more financial privacy than traditional digital payment mechanisms,” Luther explains. (This opens up an opportunity for privacy violations). While exchanges using the dollar can be very private if done in-person with cash, digital exchanges using the dollar that are not done in person must involve a trusted third-party that records the transaction-like Venmo or your bank. One other key difference, Luther says, is that “bitcoin tends to provide more financial privacy in digital transactions.” No one can inflate bitcoin because the supply of the currency is not centrally controlled or subject to manipulation. One consequence of this difference is that the government can inflate the US dollar if it wishes, by printing money. The supply of dollars, in contrast, depends on the discretion of the Federal Reserve.” “There will never be more than 21 million bitcoin in circulation and the supply will follow a predetermined trajectory until it reaches the maximum. “Bitcoin’s supply is preprogrammed,” Luther said. Bitcoin is decentralized, meaning there’s no central authority controlling it. However, the two differ in important ways.įor one, the US government has centralized control over the dollar and its supply. ![]() (Bitcoin is fully digital, while the dollar is only 99.96% digital-close enough.)” Both are irredeemable, meaning they are not backed by some underlying asset. “Both are intrinsically worthless, meaning they have no use apart from their role as a medium of exchange. “Bitcoin is similar to the dollar in many respects,” Luther explained. One easy way to understand bitcoin is to compare it to the US dollar. What Makes Bitcoin Different From the US Dollar? So, to help readers better understand the novel technological trend, FEE interviewed Will Luther, an economics professor, director of the American Institute for Economic Research’s Sound Money Project, and an adjunct scholar with the Cato Institute’s Center for Monetary and Financial Alternatives. Many Americans may not have followed the trend closely, and are seeking to understand it. ![]() But in recent months it has surged to the forefront of the national conversation as major figures like Elon Musk have bought in and bitcoin has hit record valuation levels. Of course, the rise of non-government, decentralized, encrypted electronic currencies like bitcoin has been going on for years. Bitcoin and other cryptocurrencies are all the rage right now.
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