Sometimes Bitcoin soars in value and it might have been a good investment for you. But it has lots of problems and instead of thinking about it as an investment you should think about what a currency is supposed to accomplish - what is its purpose?
Making Transactions Happen
If we didn't have money/currency we'd be back to bartering, which is a clunky way to do business. Therefore, one simple conclusion is that money facilitates transactions. This doesn't make you rich but it makes the entire economy rich. A good currency is just like infrastructure or a rising tide which lifts all boats.
I think people subconsciously equate Bitcoin's price appreciation with its success, which would be a mistake. A currency is a "numeraire", the denominator upon which everything else is valued - it isn't itself a precious Google Stock or something else on which you should speculate, because those things, like investments are claims on future income and dividends.
Bitcoin could facilitate transactions like any good currency, but its supply is relatively fixed. While you can "mine" bitcoins and grow the monetary base, it gets harder to do as time goes on. This makes it a lot like gold or any other scarce resource where the more you mine the less you can extract.
Hoarding and Inequality
Like gold and other fixed resources, people tend to hoard Bitcoins. According to one loose indication it is possible that 1 percent of Bitcoin users control 50% of all Bitcoins in circulation [1]. In other words, there is massive inequality.
When people hoard the currency, they are afraid to spend it, and when they are afraid to spend it, the number of transactions in the economy plummets, which in everyday parlance we recognize as a "recession". Note that if our criteria for a good currency is to improve and facilitate transactions then this is indeed not a very good way to go. And with no way for more Bitcoins to circulate the economy through mining it can be very difficult if not impossible for the economy to get unstuck.
People hoard Bitcoins either because
- Their speculative positions increased and they hope to make even more money by holding their Bitcoins or
- They notice that since no one is spending Bitcoins the price of everything is going down ("deflation") so it makes sense to hold the currency so that you can buy what you need later when it is cheaper (causing the system to spiral out of control).
The Capitol Hill Co-Op
I have a specific story in mind about how currencies work and it is called the "Capital Hill Co-op" and I highly recommend anyone interested in understanding what Central Banking and Monetary Policy is all about. It is just a simple analogy about a Baby Sitting co-op - a bunch of parents who got together to take turns babysitting for each other using coupons not too unlike Bitcoins and it will tell you more about things that can go wrong with an economic system than reading the WSJ for a year. As Paul Krugman put it, it is the story that could save the world.
Central Banking
Note however, that this doesn't mean that I think that monetary policy, the way we are doing it, is the way that we should be doing it. It just means that in theory, a good currency should be thinking about what do do when hoarding takes place, gini coefficients spike, inequality becomes rampant, and recession sets in. To be honest, I can't in clear conscience advocate the Fed or Centrla Banking as the one and only means of dynamically altering the amount of currency in an economy as a means to stimulate the economy during recessions.
The limitations of Bitcoin is too bad because I think that digital currencies belong in our future. I am and continue to be excited about its alternatives as well as the underlying technology.
