If a small city state had adopted Bitcoin as its national currency, it would now be in the grip of deflation as foreign speculators siphoned away its supply of the virtual currency. Money would be scarce, and prices would fall dramatically. Authorities might try to lift prices but they would lack one of their most powerful tools. Central bankers can create money at will, by printing notes or creating deposits. Bitcoin is based on digital tokens, which are generated at an unalterable rate by cryptographic algorithms running on the computers of volunteers, making it impossible to match supply to demand.
This is an improbable fantasy. But Bitcoin’s undulating value makes it unsuitable for all but the most limited purposes. Speculators are the keenest acquirers of the currency. For some, it is a way of stashing wealth where authorities cannot find it. Others want to make purchases without leaving an obvious trace. Silk Road, the online contraband emporium that was closed by authorities last month, was one of the few businesses to insist on payment in Bitcoin. But many prices were pegged to the dollar; the virtual money served merely as a way of disguising the flow of hard currency.
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Still, if Bitcoin’s applications are limited, its emergence as a workable means of exchange nonetheless reveals something surprising. Friedrich Hayek argued that the government should cede its monopoly over the money supply, leaving consumers free to choose between competing currencies. It turns out that they were already freer than they thought. Authorities have so far tolerated the virtual currency. Yet the product of the state-owned incumbent has proved more attractive than Hayek expected.
The experiment is an indication of how monetary systems might change in future. Many believed it impossible to create a form of electronic cash that did not rely on a bank to keep tabs on account balances. Bitcoin proved them wrong. But many are uneasy about reversing the technological accident that has made financial transactions more traceable in the era of electronic banking.
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