Bitcoin or Bitcon?

The Potential Influence of a Virtual Currency on the Real Economy

Patty Foxall
PSC 502
Dr. Lewis
April 24, 2014

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Bitcoin is the virtual world's best known crypto-currency. Its creation and use is leading
to a paradigmatic shift within fiscal and monetary policy today. In order to consider where
Bitcoin may be headed, there are questions about the currency that must be addressed. This paper
will discuss what is needed to define money as a unit of exchange; the potential for Bitcoin to
fulfill the requirements of what money is; the pros and cons of a virtual, non-tangible unit of
exchange; the extent of impact a solely virtual currency may have on specific segments of
population; and the likelihood of Bitcoin surviving as a virtual, unregulated monetary device.
In order for a currency to be considered money it must be able to fulfill three main
functions1. First, the currency - whether coinage or paper - must serve as a medium of exchange
between groups who agree to the currency's value. It must maintain a stable store of value.
Finally, it must be measurable as a unit of account against which an economy's value can be
determined. The US dollar and the Euro, for example, meet the classifications to be considered
currency. As they each have the backing of a government, both the dollar and the Euro are
accepted worldwide as fiat currency.
Fiat currency is currency that a government decrees to be legal tender2. Bitcoin's defenders,
however, would prefer to see currency backed by a tangible commodity (such as gold) instead of
'only' by government promises. Because of this desire for a different definition of "currency",
these defenders feel the notion of fiat currency itself needs to change or be replaced. They
consider Bitcoin and other virtual currencies as a potential evolutionary step for interacting
1 The Economist "Money From Nothing" Mar. 15, 2014
2 Hern, Alex. "Bitcoin should not be seen as a currency, warns Ernst & Young" December 11,
2013

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within the global economy. In spite of these considerations regarding fiat currency, it is not an
unstable system waiting to be replaced; as long as a government has the ability to back its
currency, currency will maintain its value. Currency can be described somewhat tongue-in-cheek
as "an asset with an army".3 The value of actual currency in recent history is drawn from the
perception of the stability of the government backing the currency. As an example, during the
early years of the Civil War, the Confederate dollar had a reasonable value; once the
Confederacy lost the war, that money was deemed worthless everywhere.4
Using the above definitions, does Bitcoin meet the criteria to be considered money? Bitcoin can
be used as a medium of exchange for virtual products in some corners of the virtual world. Aside
from its use in the illegal drug trade,5 it is very rare to see Bitcoin transactions for real world
goods.6 One of the eventual aims of Bitcoin is to be considered currency without the need for a
physical representation, using computer files to show value in place of a piece of currency.7 At
this time, Bitcoin cannot be considered a stable store of value. The volatility of the currency is
extremely high. In 2013, the exchange rate for Bitcoin was 142%; during other volatile periods,
such as the Asian financial crisis of 1997-8 and the default in Argentina in 2002, volatility
reached levels topping 50% in Asia and 120% in Argentina. However, unlike Bitcoin, these
3 Greeley, Brendan. "The Dollar Will Never Fall to Bitcoin" December 24, 2013
4 Colabella, Patrick and Michael Shoff. "Virtual Currencies: the Challenge to Global Fiat
Paradigms" February, 2014
5 Yermack, David. "Is Bitcoin a Real Currency? An Economic Appraisal" December, 2013
6 Hern, 2
7 Verne, Francois R. "Chicago Fed Letter", December, 2013

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volatility levels only lasted a few weeks.8 Bitcoin may become more stable in the future, due to
the maximum limit placed on the currency by the system's creators. The system is set to reach a
total value of 21 million Bitcoins in 2140.9
However, because of the novelty of the online world, there are separate considerations regarding
virtual currencies and how they work. Virtual currency systems have three different
classifications: closed, hybrid, and open. The closed systems are limited to virtual communities
where the real-world fiat currency is used to purchase virtual currency for use within the virtual
world. This is seen most often on websites such as World of Warcraft or Second Life, where
people may choose to exchange real money for virtual currency that can be spent on in-game
commodities which will improve their virtual experience. Hybrid systems are found in websites
where users have the ability to purchase virtual money to use within a virtual game or
community, but where tasks can also be completed for points to exchange for goods or services
which have a real world monetary value. Finally, open systems exist where virtual currency can
be used to purchase both real and virtual goods. In these cases, the real world purchase occurs
after the currency has been exchanged from its virtual form into a fiat currency.10 Bitcoin has the
capability to be spent on real goods; however, in most of the exchanges a third party chooses to
accept the Bitcoin currency and then pays the seller in the fiat currency, set at the moment's
exchange rate.11 Because of the volatility, the Bitcoin market behaves as a speculative market.12

8 Conway, Brendan. "Like an Emerging Currency, Bitcoin is 'Vastly Inferior' to Fiat Money"
February 11, 2014
9 The Economist, 2
10 Colabella, 174

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There are positive features to the Bitcoin system. While the implications of the system are just
beginning to be considered, one of the most appealing features of the arrangement is that there is
no ownership of the Bitcoin network.13 The network appears to be a loose group of software
engineers and coders who are creating the network to run with Bitcoin protocol. In order for this
to be effective, the software features must adhere to complete consensus with the users of the
network.14 Without complete consensus there is a danger of competing software and, more
importantly, competing data arising that can cause difficulty regarding how the issued Bitcoins
have been spent. For this reason, consensus of all users is a vital requirement for the successful
use of the Bitcoin platform.15 Because of the decentralized system and the competition of
software used in the management of Bitcoin, there appears to be no need for a central server to
maintain a full record of what is being done, as this record becomes part of all of the blocks
which maintain a cumulative record of all the Bitcoin transactions as they have been
authorized.16
Unlike most currencies where there is a potential of unlimited currency creation within a system,
the founders of Bitcoin have already announced that the creation of Bitcoin currency (called

11 Yermack, 6
12 Id., 10
13 www.bitcoin.org/about-us
14 Id.
15 Id.
16 Hobson, Dominic. "What is Bitcoin?" Fall, 2013

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mining by the workers who are in the business of creating the currency)17 will be capped at 21
million Bitcoins. There is a complex algorithmic function that has been created to monitor the
creation of Bitcoins, which will be used to slow the creation process down based on firm volume
points created in time, with the last Bitcoins expected to be mined in 2140.18 This may lead to
deflationary trouble in the future, since each Bitcoin will become "comparatively more
competitive over time".19
One main feature of Bitcoin is its ability to lower transaction costs associated with sending
money worldwide. While the major banks charge large percentages to transfer money between
one world region and another, Bitcoin has managed to reduce these transaction costs to a much
smaller amount. This makes Bitcoin very appealing for those wishing to send money overseas.20
It also has appeal to small businesses. Surprisingly, a street in Cleveland is set to become the first
"Bitcoin Boulevard" - eight businesses have agreed to accept the currency mainly because of the
cheaper transaction fees offered by Bitcoin. Bitcoin charges 1% in transaction fees over the 2-3%
charged by the major credit card companies.21 If this continues, we could see an impact to the
traditional market as major credit card systems may have to reconsider their higher fees in order
to maintain their competitive edge. Bitcoin is also very popular in countries where the national
17 Id.
18 Id.
19 Hern, 2
20 Rosenblum, Paula. "Bitcoin: The Currency of the Future?" January 27, 2014
21 Sheeter, Justin. "Cleveland Ohio to Be the Home of the Nation's First 'Bitcoin Boulevard'"
April 18, 2014

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currency may be unstable or problematic due to political reasons. Bitcoin has been used by some
in Argentina where it is seen as more successful than the inflation-riddled national currency; it
has also been used in Iran to work around internationally-imposed currency sanctions.22
Anonymity of transactions is one of Bitcoin's most important features,23 along with the freedom
from state power and control that the network enjoys at least for now.24 The popularity of the
black-market Silk Road one of the first organizations that accepted only Bitcoins as payment
cemented the assumption of anonymity of the Bitcoin system.25
Bitcoin works best as a form of payment in industries with a low profit margins as the low
transaction costs make Bitcoin a more attractive option than traditional credit card companies.26
It presents an intriguing new way to pay for online services27 and offers a veneer of privacy
around what is being purchased and by whom. This privacy is one reason it is currently
considered the Gold Standard of crypto-currencies.28 It is also the most widely-circulated
virtual currency.29 However, Bitcoin does have some accepted value beyond its role as a virtual
22 Colabella, 175-6
23 Rosenblum, 2
24 Velde, 2
25 Yermack, 6
26 Rosenblum, 3
27 Cohan, Peter. "Bitcoin or Gold: Which is More Fiat-Proof?" April 11, 2013
28 Id.
29 Colabella, 175

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currency. Some companies have agreed to accept Bitcoin for real (physical) goods that exist
outside of the virtual world. TigerDirect, a low-cost computer peripheral company, began
accepting Bitcoins for payment in January, 2014; Overstock.com, one of the largest online retail
sellers, began to accept Bitcoins for payment in January 2013.30
Lastly, there is money to be made in the creation of the Bitcoin currency. Bitcoins are
mined via a complicated system of algorithmic math equations that originally were done by
regular people with regular processing equipment; however, as the value of the currency has
increased, so has the number of people investing in more-powerful equipment to mine Bitcoins
more efficiently. Like most gold rushes, the money can be made, but only if one is in a position
both to understand how the system works and to afford the equipment necessary to mine
effectively.31 Like the gold rush of a prior century, those who were able to have the best
equipment and the best information on possible gold veins were much more likely to strike gold
than those who went out into the wilderness armed with only their wits and a dream. The true
believers in the system see Bitcoin as a potential savior of economic policy, and believe that one
possible outcome of Bitcoin adoption will include a viable challenge to the fiat paradigms of
today.32
While most of the above positive considerations of Bitcoin make the system sound like an
exciting new platform for the world to adopt, there are many cautions that have to be considered
before jumping completely onto the Bitcoin bandwagon. Foremost at this time is the concern of
30 Stock Market Watch. "What Companies Accept Bitcoin?" February 3, 2014
31 Yermack, 10
32 Colabella, 172

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Bitcoins extreme market volatility. Nearly every article makes strong mention of volatility as an
inherent danger to the system, with fluctuations in value during the four-month period from
January-April 2013 from a low of $20 to a high of over $250.33 While some choose to consider
this volatility as an acceptable feature of a new system, others see the volatility as a sign of the
need for regulation.
This lack of regulation is touted by the users of Bitcoin as a design feature; however, when the
lack of tangible value is added to a lack of regulation over the system,34 it becomes difficult to
accept financial transactions that do not have a governing body.35 Because the term used for
creating new Bitcoins is 'mining' there is an illusion of an actual product being brought into
existence. Still, it is nothing more than data on a terminal with nothing to base value on but an
arbitrary value. If one is spending large amounts of money on a potential currency, this lack of
oversight will become more difficult to rationalize.36 Even if someone is interested in using
Bitcoin for transactions, it is a stumbling block when a purchase takes up to an hour for a
transaction to be verified on the network.37
Bitcoin has attempted to work around the need for regulation by placing a firm threshold on the
eventual total value of Bitcoins in the virtual world. The currency will be capped at 21 million

33 Hobson, 43
34 Rosenblum, 2
35 Twomey, Peter. "Halting a Shift in the Paradigm: The Need for Bitcoin Regulation" 2013
36 Conway, 2
37 Hern, 2

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units. According to their calculations, this amount will be reached in 2140.38 If Bitcoin were to
become an international currency, "it is hard to imagine a world where the major currency is
based on an extremely complex code understood by only a few and controlled by even fewer,
without accountability, arbitration, or recourse."39 Because of its creation by the computer elite,
the system itself is not a product that is likely to be adopted by the average person in a developed
economy.40 People may choose to work for Bitcoins, but because of the technological
requirements to run software to engage in the 'mining' process, the ability for users to make
money on Bitcoin will be limited to the understanding of a few technocrats.41 The same systems
that are used to create Bitcoins can also be used against the system via hacking and other
mechanisms designed to manipulate the design protocols. These attacks can only be mounted by
the same high-powered processors used for creating Bitcoins.42 The Bitcoin system is not an
intuitive one. There will be difficulties promoting potential uses of Bitcoin beyond some of the
black market uses (such as the Silk Road) for which Bitcoin has become known. The biggest
meltdown of the Bitcoin system to date is the Mt. Gox bankruptcy. Mt. Gox grew from humble
beginnings as a Magic the Gathering card exchange to become the leader in Bitcoin trading

38 Cohan, 1
39 Velde, 3
40 Hobson, 43
41 Bradbury, 2
42 Id.

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worldwide before it "imploded in a spectacular bankruptcy. Hundreds of millions of dollars
worth of Bitcoins went missing."43
Anonymity is a large potential benefit of Bitcoin; however, the system is not able to ensure total
secrecy of its users. This can be seen in the eventual shutdown of the Silk Road black market
online storefront. When a government chooses to do the work, the Bitcoins can be traced with
enough effort. Once enough data was discovered, the government was able to arrest the main
operator of the Silk Road using the NSA's internet data monitoring.44 Bitcoin is volatile enough
to be compared to the risky internet stocks of the 1990s,45 which could explain why the IRS has
chosen to tax Bitcoin not as currency, but as an investment.46 This volatility makes it nearly
impossible to hedge risk because there is no correlation either with other conventional currencies
or with gold.47 Because of these risks, it is likely that regulation will be necessary to protect the
users of the system.48 However, due to the nature of the individuals who are looking for a nongovernment currency, the early adopters may not stay with a system that is eventually regulated.
This catch-22 is one of Bitcoin's largest issues with a possible transition to a commonly accepted

43 Yermack, 2-6
44 Id., 8
45 Id., 2
46 Wood, Robert W. "IRS Says Bitcoin Is Property, Not Currency, And Forms 1099 Are
Required" March 25, 2014
47 Yermack, 3
48 Velde, 3

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currency.49 Even as Bitcoins are accepted more places, most Bitcoins are still being exchanged
between investors - 80% of activity on the leading digital wallet service was related to
speculation.50
There are two types of users who are embracing the Bitcoin system. The first type are the
technocrats who are more comfortable within a virtual world. These are also the individuals most
likely to understand the 'mining' system and how money can be made within the Bitcoin
universe. This is analogous to the other financial technocrats who were created CDOs and other
money-making vehicles. Other early adopters have been the 'pseudo-libertarians' who are
concerned about the influence of an overarching State on every aspect of society.51 However, the
first time a enough value is lost to impact the real economy, there will be a demand for regulation
if not by the people who have lost money then by the states who may be impacted by another
financial crisis. Once regulations start to become an aspect of the Bitcoin currency, it will begin
to lose appeal.
Bitcoin could also become a victim of its own success. If the Bitcoin platform is shown to be as
successful and as safe as traditional currencies, there is a potential for the various governments
around the world to move into the creation and tracking of their own virtual currency. The
difference would be that this currency would be backed by the strength of a government,
becoming a fiat virtual currency.52 Once there are alternative currencies backed by a stable
49 Yermack, 10
50 Id, 7
51 Id., 8
52 Colabella, 176

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government, the likelihood of Bitcoin maintaining dominance in the virtual world without either
regulatory controls or government backing is unlikely.
As long as Bitcoin is both anonymous and unregulated , it will attract people interested in
spending their money on illegal activities. When this combines, it is not surprising that the black
market finds a home selling real goods for virtual money. Middlemen facilitate most transactions
by agreeing to purchase Bitcoins from a client, then purchasing the requested real good on behalf
of the client with his own fiat currency. The middleman has the expectation that by facilitating
the transaction and in essence purchasing the Bitcoin being used, Bitcoin will increase
dramatically in value and he will be able to make money off of the investment.53
One aspect of Bitcoin's creation is the consideration of an entirely new way of considering who
gets to create a society's money. A debate is ongoing as to whether money should be a state
monopoly, or if it should be another commodity controlled by the private sector.54 People who
are afraid of government regulation in general would rather see private industry control every
aspect of a society. However, experiences from the early years of the Industrial age are replete
with stories of disadvantaged workers who lived in homes owned by their employer, shopped in
'company stores', and earned wages in company chits that could not be spent outside of their
employer's domain. When nobody else is willing to accept a currency, declaring a currency's
value is suspect. Because of the inherent dangers of abuse of a private financial system,
governments must maintain the creation of money. Otherwise an unfavorable playing field will
tilt permanently to the advantage of those who create the money and everything purchased with
it.
53 Yermack, 6
54 Velde, 2-3

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Bitcoin has definite potential to remain a niche currency in the facilitation of online exchanges.
Within the last week a Texas gubernatorial candidate announced his willingness to accept
Bitcoins as campaign donations.55 It would be interesting to follow his campaign if only to see
how many donations come to his campaign in that format, as well as to determine how many
individuals chose to donate with Bitcoins. It also opens a new concern in the murky area of
campaign finance; while the caps to how many individuals a donor may give to have eroded, the
amount allowed to be given to any one candidate are still in place. This could be yet another
attempt at a run-around of the maximum donations allowed to individual candidates by those
who can afford to do so. However, Bitcoin must become less volatile before it can reliably serve
as a unit of value for commercial markets. As long as it is only available as a virtual commodity,
with no easy avenue of confirmation or proof of ownership, it will always be in danger of having
a system failure destroy large chunks of data. Because there is no central storage facility, if
anything were to happen to one major area, data would inevitably be destroyed. Since currently
there are also issues with being able to double-spend the same value if the network is
compromised, and because those who know how to hack the system can do so with ease, there is
as of yet no way to maintain the system's integrity.
Fiat currency is the measure of the strength and stability of an issuing institution, typically a
government. Regulations give the value stability because there is recourse if something happens
to the currency while it is in storage, held by banks. Bitcoins will never be stable because the
system lacks regulation. The only strength behind Bitcoin comes from faith in the Bitcoin
system, and faith in the internet itself. Unfortunately, the Bitcoin network has already shown
55 Starr, Hugh. "Texas Attorney General Greg Abbott to Accept Bitcoin in His Run For
Governor" April 17, 2014

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itself to be vulnerable to both cyber attack and software malfunction. At best, Bitcoin will
become a tool of the technocrats, those who can understand and manipulate the market to make
money off of those who choose to use the system for political ideology's sake. At worst, it could
become politically disruptive, with its anonymity and grey legal definition enabling corruption of
the campaign donor system. Allowing Bitcoins to be used in campaign donations - with its
international access and the effort needed to trace the currency trail - has the potential to open
our democratic process up to foreign investment. However, this is a new step in financial
evolution and while it may not have a future as a fiat currency, it may end up as the next Wall
Street CDO/CDS system, where the few who are able to understand the mechanism that drives
the system forward will be able to extract real world value from the people who may choose to
opt into Bitcoins for the illusion of privacy offered by the network. Overall, Bitcoin is likely to
be another exploitative tool that will take money from those who would choose to risk a
deregulated financial market in order to avoid the evils of 'guvvermint'.

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Works Cited
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Bradbury, Danny. "The Problem with Bitcoin". Computer Fraud & Security Volume 2013, Issue
11, November 2013, Pages 58.
Cohan, Peter. "Bitcoin or Gold: Which is More Fiat-Proof?" The Guardian April 11, 2013.
Retrieved from http://www.forbes.com/sites/petercohan/2013/04/11/bitcoin-or-goldwhich-is-more-fiat-proof/
Colabella, Patrick and Michael Schoff. "Virtual Currencies: The Challenge to Global Fiat
Paradigms". ASBBS Annual Conference: Las Vegas. February 2014, Vol. 21, No. 1. Pp
171-186.
Conway, Brendan. "Like an Emerging Currency, Bitcoin is 'Vastly Inferior' to Fiat Money"
Barron's February 11, 2014. Retrieved from
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Greeley, Brendan. "The Dollar Will Never Fall to Bitcoin" Bloomberg Businessweek December
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Sheeter, Justin. "Cleveland Ohio To Be the Home of the Nation's First 'Bitcoin Boulevard'".
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