Economics of Bitcoins

Introduction

In 2009, an individual by the pseudonym Satoshi Nakamoto created a crypto-currency commonly referred to as Bitcoin. Its creation is founded on cryptography, distributed systems and databases as subsets of computer science as well as contracting and currency as taught in economics. This essay seeks to outline the function of money, the role of the Federal Reserve in the management of money supply within the US economy, functions served by Bitcoin, associated risks and its usefulness to the US economy.

Federal Reserve: Management of Money Supply

According to Krugman (2013), normative economics serves to offer explanations on ‘how things should be’ while positive economics is concerned with ‘how things work’. The functions of money are to basically serve as a store of value while also acting as an enabling medium for exchange. Money also serves as a unit of account such as determining amount of taxes owed to the government or other similar transactions. The US Federal Reserve is a critical component of the nation’s economic system that not only places value on the dollar but also acts as a dollar sink for curtailing money supply and by extension, deflation. This directly implies that the Federal Reserve is not only the source of the dollar’s value but also functions to ensure such value is not compromised by determining supply of the currency.

Bitcoin Functions

Goldstein and Kestenbaum (2011) posit that Bitcoin is essentially some cash like option of the virtual world. It is nonexistent in the real world and only present on computers. Bitcoin is dependent on peer to peer computer designated systems managed by its users. This implies that there is no central depository system that plays a role in regulating flow of the currency. Bitcoin derives its value from it applicability through computer technology. With little control over supply of Bitcoin, its prices fluctuate very quickly as a result of speculation and negative media coverage making it an unstable store of value. However, it is employed as a unit of account on the virtual market through an exchange rate that values dollars in terms of Bitcoins. It is a notable fact that Bitcoins are mainly used as a medium of exchange and unit of account with users expressing little dissatisfaction with its poor functionality as a store of value.

Risks and Benefits of Bitcoin to the US Society

According to Goldstein and Kestenbaum (2011), the most potent risk associated with the adoption of Bitcoin as a currency is that it volatile. For instance, the reports that its exchange rate website had suffered a cyber-attack led to its unavailability. Another risk is that it is highly regarded by people conducting legal activity which government agencies are keen on eradicating such as the war on drugs. However, as Goldstein and Kestenbaum (2011) provide, it is possible to use it as a respectable medium of exchange. This is notable only acceptable in institutions that have embraced its functionality as a currency. To date, it is still considered as a legal currency within the US economy.

Conclusion

Proponents of a Bitcoin run economy subscribe to positive economics while its critiques are keen on normative economics. As this paper has provided, it is an unstable currency mainly appreciated by people seeking to progress illegal activity. Its volatility makes it a poor store value as well as an inept account of value making it a very risky currency with the potential to throw the economy into significant economic problems if fully acknowledged as a currency.

References

Goldstein, J. & Kestenbaum. (2011). What Is Bitcoin? NPR. Retrieved from http://www.npr.org/sections/money/2011/08/24/138673630/what-is-bitcoin

Krugman, P. (2013). The conscience of a liberal: Bitcoin is evil. The New York Times. Retrieved from https://krugman.blogs.nytimes.com/2013/12/28/bitcoin-is-evil/?_r=0