After having been cued in to Bitcoin a few weeks ago, the crypto-currency’s rise has been quite impressive. Its value has quintupled since I began following it, and the amount of goods and services for which people are willing to accept Bitcoin has been consistently expanding. Barring any unexpected catastrophe, then, I feel like it’s reasonable to expect that crypto-currency will be an important part of the economic landscape in the years to come.
That being the case, I think it is important to engage in a meaningful conversation as to the nature of the optimal monetary model for a crypto-currency. After ingeniously solving the double spending problem, the initiators of Bitcoin chose to implement a system in which, for the first few years, a large amount of money is created but, within a decade, the supply of currency will reach a cap of around ~21 million units. This model of a predictable and stable money supply could very well be the optimal one, but it carries certain risks, the largest of which might be some of the pernicious effects of deflation.
The primary concern is that, in a deflationary environment, people will choose to horde rather than spend their money. For instance, why buy a t-shirt today for six Bitcoins today when you’ll be able to get it next week for five? Such incentives might hobble the growth of the Bitcoin economy, meaning more transactions happen in other units of value while people with Bitcoins hang on to them in order to realize potential capital gains.
Different schools of economics hotly debate the legitimacy of such concerns, but, until now, they’ve never really had a chance to engage in a full blown competitive experiment to test the issue. However, since the Bitcoin source-code is open source, it would not be difficult for someone to create a rival currency that, rather than capping off at ~21,000,000 units, is designed to consistently increase the money supply by 1% per year indefinitely after the initial takeoff period. By doing so, it might be possible to learn an enormous amount about monetary economics by comparing the performance of the two economies. Additionally, an environment might emerge in which currencies with innovative elements are regularly introduced to the mix, allowing for the empirically-based semi-organic evolution of an increasingly optimal monetary system. Truly, this is an exciting time to be an econ nerd!