Bitcoin (BTCUSD)

[Dutch1]

Here's what Paul Krugman doesn't get about Bitcoin

http://www.washingtonpost.com/blogs/the-switch/wp/2013/12/23/heres-what-paul-krugman-doesnt-get-about-bitcoin/

By Timothy B. Lee
December 23 at 12:04 pm

Paul Krugman doesn't like Bitcoin. He's taken several swipes at the technology on his blog over the last couple of years. And yesterday he devoted a full column to denigrating the cryptocurrency. He argues that Bitcoin mining, the process where new bitcoins are created by repetitive mathematical calculations, is socially wasteful. And, he argues, that's reflective of the pointlessness of Bitcoin more generally.

There's just one problem: Mining isn't just a process by which new bitcoins are created. Those newly created bitcoins are a clever mechanism for rewarding miners for participating in the mining process. The point of the mining process is to process Bitcoin transactions. Without it, the Bitcoin network wouldn't function at all. By neglecting to mention this fact, Krugman misleads readers more than he informs them.

Unfortunately, that's par for the course in public discussions of Bitcoin. Bitcoin has a dual character as a currency and a payment network. The latter is what makes Bitcoin useful and potentially important. Yet the former is what has gotten all the media attention.

That's partly because gyrations in Bitcoin's value has generated most of the press. It's easy to report that the value of the currency has risen by a factor of 10 in a matter of weeks. It's much harder to explain how the payment network works and why it might be useful.

But Bitcoin advocates themselves also deserve much of the blame for the press's myopic focus on Bitcoin's character as a currency. Bitcoin fans overlap heavily with critics of the Federal Reserve who favor tighter monetary policy. They love the fact that the supply of bitcoins are permanently capped at 21 million, and they've touted it as an alternative to the inflationary policies of central banks.

Naturally, that has caused people with more conventional monetary policy views to approach the technology with skepticism. They've argued that replacing the dollar with Bitcoin as a national currency could easily lead to a Great Depression or worse.

The skeptics are probably right about that. But the smart case for Bitcoin isn't as a replacement for the dollar. Rather, Bitcoin is best seen as an alternative, or complement, to conventional payment networks like Visa, PayPal and Western Union.

Leading Bitcoin payment processors such as BitPay and Coinbase already give merchants the ability to price their goods in conventional currency. The dollar or euro price is automatically converted to the corresponding number of bitcoins (or fractions of a bitcoin) at the time of purchase. That makes Bitcoin's price fluctuations almost irrelevant for the thousands of merchants who now accept payment in Bitcoin.

Will the Bitcoin payment network carve out a significant niche for itself alongside today's mainstream payment technologies? That's a hard question to answer. Bitcoin is a technological platform with sophisticated capabilities not available on older payment networks, so it could prove to be a big deal. But the Bitcoin community will need to overcome a number of technical and regulatory obstacles to make paying with Bitcoin convenient for ordinary consumers.

But Bitcoin's long-term prospects have almost nothing to do with Bitcoin's unorthodox monetary policy. And the technical and regulatory issues that will determine whether Bitcoin succeeds or fails has received very little attention in mainstream coverage of the currency. In the mainstream imagination, Bitcoin is either the second coming of the gold standard or a repeat of the Dutch tulip craze. That debate obscures everything that makes Bitcoin interesting and potentially important.