I've written extensively defending monetary policy, the Federal Reserve and Ben Bernanke. I do so because even with all its flaws, the existing system is far better than all the rest. The Bitcoin pretty much proves my point, and will ultimately do nothing but re-enforce the credibility of the U.S. dollar and bolster the reputation of the Federal Reserve and Ben Bernanke.
The Bitcoin is a product of the libertarian "End the Fed" movement that believes in a concept called "competing currencies." This movement has also given rise to using gold and silver as legal tender. Supporters of these concepts tend to see things as how they want things to be, not as how things really are, and they tend to overlook extremely obvious flaws in their theories.
1) The first flaw in the Bitcoin is that it really isn't a "currency." Yes a Bitcoin can be used as a means of exchange, but so can a chicken in a barter system. At best Bitcoin can be considered an electronic commodity that can be used in a barter economy. Functioning currencies must meet more qualifications than just being a means of exchange.
2) Currencies must also be good for settling debts. The Bitcoin is a highly deflationary and inflationary currency, just like gold and silver are when they trade as commodities. The Bitcoin started trading at $0.05 and increased to over $250. Yes, that was a great investment when the bubble was forming, just like gold, but it would have made an awful currency. Why? Imagine writing a contract in Bitcoins back when it started trading at $0.05. You buy a $10,000 car and agree to pay 200,000 Bitcoins for it. When you sign the contract you owe $10,000 for the car, but today a Bitcoin trades at $100, meaning the loan now must be paid off with $20,000,000. At the Bitcoin's peak of about $260, the loan amount would have been 2.6 x that value, or over $50 million dollars. The impact would have been completely opposite had the contract been signed at the Bitcoins peak instead of its low, the point being, the volatility of freely trading commodities make them impractical for use as a currency.
3) Currencies must act as a store of value. Yes, I've heard Ron Paul rant about the U.S. dollar losing 98% of its value since the creation of the Federal Reserve, and I've seen the charts, but those chart and comments as misleading as they are, cover a 100 year time period. That works out to be an annual compounded rate of inflation of approximately 3.75%, or about 0.98% if you use a simple average of losing 98 out of 100 over 100 years. The point being, under the Federal Reserve inflation has been very moderate and relatively consistent and predictable. The Bitcoin dropped from about $260 to below $30 in a day, and closed at under $90. At its low the Bitcoin had lost a almost 90% of its value in a day. Even today at $100, the Bitcoin is still off over 60% from its peak value of less than 2 months ago. Sorry, but I'll take losing 98% over 100 years where I can plan and adjust for the inflation over randomly losing 60% in 2 months any day.
4) Currencies must be a unit of value. Yes a Bitcoin can be a unit of value, but not a very functional one. The Bitcoin is deliberately designed to be a highly deflationary perfectly inelastic currency. The Bitcoin went from $0.05 to $260 in a few short years. Imagine the "menu costs" involved with using the Bitcoin? The Bohemian Weed Shop down the street would go bankrupt simply re-printing price labels and menus to accurately reflect the ever changing price of their "medical" marijuana.
5) Most importantly, viable currencies must be legal and accepted as payment of taxes. The Bitcoin alternative "Liberty Reserve" was just raided for money laundering, and California's financial regulatory body is currently filing cease and desist orders against the Bitcoin Foundation. The irony of the State where Silicon Valley resides being the one to file charges should not be ignored. If California has a problem with Bitcoin, I'm pretty sure almost any other state that bother to take a look at it will too, let alone the Feds who have Article 1 Section 8 Clause 6 of the US Constitution making counterfeiting and competing currencies illegal.
"The Congress shall have Power To...provide for the Punishment of counterfeiting the Securities and current Coin of the United States....
Article I, Section 8, Clause 6
In conclusion, the theories that hold up the Bitcoin and concepts like "competing currencies" and "gold and silver as legal tender" are pillars made of sand. The facts are while they are alternatives to the US dollar or other currencies, their medicine is far worse than the illness. Our economics would be severely damaged if these alternative currencies every truly get accepted. The chaos and instability they would inject into our banking system would make 2008 look like amateur night at the Karaoke Bar. Worst yet, they give a false sense of hope to those that believe these theories. Just like gold was supposedly going to the moon, all bubbles eventually pop, and both gold and the Bitcoins are on the back side of a bubble. Bitcoin however has the added risk of having the Federal Government step in and shut them down, and with every new lawsuit filed, that likelihood becomes more and more probable. I know that isn't the popular opinion, nor was warning people about the pending gold collapse, but the analysis is what it is, and in my opinion both Bitcoin and gold are being supported by pillars made of sand.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.