The Bitcoin cliff – your house and the mad max currency
In the seminal 1979 Aussie flick, Mad Max, the world was pitched into an oil shortage armageddon. The predictability of shortages and the increasing value of the last major commodity led to social and economic chaos, as well as some interesting leather punk fashion.
While Bitcoin may never change our fashion, it will also never take a realistic foothold as an emerging currency.
Bitcoin (BTC) is a digital currency which was launched in 2009 by an anonymous programmer using the moniker, Satoshi Nakamoto. Bitcoin currency is primarily traded online and can be obtained though bitcoin mining, direct transfers or online trading. It has no central bank, nor is it backed by anything of real value. It is free from government control and its supply only slowly increases to a capped amount of 21 million Bitcoins by the year 2140 (yes, year 2140, that isn't a typo).
The Winklevoss brothers, made famous by their depiction in the Facebook-based movie, The Social Network, have been revealed as some of the largest known holders of a Bitcoin portfolio. Their portfolio is claimed to be as large as 1% of the total digital currency.
Tyler Winkelvoss was quoted in the New York Times saying, "we have elected to put our money and faith in a mathematical framework that is free of politics and human error."
They'd do well to sell the speculative stock before the world realises, as admitted on the Bitcoin community page, that "the monetary base of bitcoins cannot be expanded, the currency would be subject to severe deflation if it becomes widely used."
The predictability of currency shortage inbuilt into Bitcoin's money supply is the fatal flaw in an otherwise highly plausible global digital currency. There may be a similar currency in future which could garner sustainable traction. But Bitcoin, for one, is doomed to catastrophic collapse.
The money supply in the real world rose around 12% in 2011 (unweighted) according to figures from the World Bank. And for 2011, the global inflation rate was 5% according to the C.I.A. World Factbook. But under the fixed framework of Bitcoin, from 2032 onwards, money supply increases by less than 1% every year until 2140.
If the world decided to adopt Bitcoin as a global currency from today, the cummulative deflation by 2032 (using a simple economic model, while ignoring the economic impacts of speculative trading, hoarding from patently deflationary expectations and the impact of the whole world flooding into the currency) would be 66%. That is, a Bitcoin in 2032 would buy more than one and a half times what it does today. That sounds good right? Wrong.
Deflationary expectations crush borrowing and sink investment which relies on businesses borrowing. A Bitcoin world would destroy a global economy faster than you can say 'credit default swap'.
Bitcoining your Home Loan?
Don't believe me? Think this is all snide-nosed hogwash? Well, let's take the example of taking out a home loan in a world where Bitcoin is the sole currency.
|Loan term||Loan amount||Starting household income||Interest rate|
|30 years||4262.67 Bitcoin (A$400,000)||1278.98 Bitcoin (A$120,000)||6% p.a.|
Repayments with a Bitcoin home loan
|Year||Year of mortgage||* Yearly Repayments converted from Bitcoin to AUD||Household annual income in Bitcoin (adjusted for inflation/deflation)||Household annual income converted to AUD||InfIation per year||Mortgage as percentage of pre-tax wage|
*Note: Yearly repayments are calculated at 306.6 Bitcoin units
These calculations are based on an estimated exchange rate as at 15/04/2013 | 1 Bitcoin buys in AUD: 93.84679
In this example, the exchange rate for 1 Bitcoin bought approx AUD: 94 - a Bitcoin home loan would result in the borrower being crushed under the weight of fixed mortgage repayments and a falling household income (which is what happens in a deflationary environment).
So who in their right mind is going to take out a loan which will constitute 89% of their pre-tax income in the final year of the mortgage? Nobody. That's who.
Which is why the premise that Bitcoin will take on an increasing important role as a major currency is wrongheaded and perhaps dire for the many real people who are investing large sums in the currency in anticipation of its rise and eventually increasing real-world usage.
There'd be more intrinsic value in selling all your assets in exchange for Somali shillings, or even Timezone tokens.
Whether by fault or by design, Bitcoin is a ponzi scheme.
True currencies are a means of exchange. Yet the manufactured scarcity of Bitcoin creates vast incentives for early adoption and hence mutes any attempts to exchange for goods and services. The currency itself would be hoarded in order to reap future value out of the currency itself. By definition, it doesn't make for a very useful currency.
And while I'll be ribbed (fair enough) for going through the effort to crunch a very basic economic model to disprove Bitcoin as a currency, which many readers will rightfully think is just a bit of fun, the current market value of the currency is just under one billion Australian dollars. People are taking this thing seriously and big money is flowing in and out.
Yet, failure is hardwired into the Bitcoin currency due to pretty basic economics.
At a conceptual level and from the admiration flowing from programmers, Bitcoin is a brilliant invention. But it is more curiosity than currency. Unless you want your finances to meet a Mad Max fate, keep your paws clear of Bitcoins.