Wild ride: Bitcoin. Photo: AP
In a world where national currencies are backed by nothing but trust, we now have a form of virtual money designed around a lack of trust.
It's called Bitcoin, and it appeals to folks who don't like the fact that the world's central banks can create dollars and euros and yen at will, seemingly out of thin air. Bitcoin has no central issuing authority; it can be "mined" by anyone with a computer powerful enough to solve increasingly complex mathematical problems.
Based on the events of last week, though, Bitcoin appears unlikely to catch on as a super-currency. At best, it may become an interesting speculative vehicle, a casino where you can bet on the spread of financial chaos.
Money, every first-year economics student learns, serves as a medium of exchange and a store of value. You use money to buy stuff, or you save it so you can buy stuff in the future.
To perform those functions, money must be stable and predictable. You wouldn't like it if your dollar could buy only half as many groceries today as it bought yesterday, or if your savings account fluctuated wildly in value.
Bitcoin is flunking the stability test. Its value rose from about $US15 in January to as high as $US266 last Wednesday, then fell as low as $US54 on Friday.
"One of the desirable qualities of a payment system is that it's relatively stable in its purchasing power," said David Andolfatto, an economist at the US Federal Reserve Bank of St. Louis. "This system's success might work against it."
Bitcoin's creator, a mysterious person or group using the pseudonym Satoshi Nakamoto, is said to have ensured that minting will stop when 21 million bitcoins are in circulation. (The number now stands at about 11 million.)
Such a fixed supply seems sure to cause deflation, or falling prices for goods and services. In theory the Bitcoin economy could adapt, but in practice, periods of deflation have been associated with recessions and financial panics.
Although bitcoins are almost impossible to counterfeit - they're stored as long, encrypted strings of computer code - they may be vulnerable to computer hackers, and if your cyber money gets stolen, there's probably no police force that can help you get it back.
The unregulated exchanges also are vulnerable to the sort of price manipulation that's long been problematic in other markets, such as penny stocks.
To Craig Pirrong, a finance professor at the University of Houston, recent activity in bitcoins looks a lot like a classic pump-and-dump scheme.
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