Bitcoin became a sensation in 2013, when the value of a single unit of the virtual currency rose from $13 to more than $1,000 and people began to use it for daily commerce (see chart on page 18). Travelers toured the world subsisting on bitcoins. A Bitcoin ATM appeared in a Vancouver coffee shop. And a U.S. Senate committee held hearings at which regulators commented favorably on Bitcoin and other virtual currencies.
Bitcoin is not issued by a government or a business but by computer code that runs on a decentralized, voluntary network. It has found users among computer enthusiasts and opponents of the banking system (see “Marginally Useful”). However, economists remain skeptical of Bitcoin’s staying power because it lacks many attributes of a useful currency. Money is supposed to serve three purposes: it functions as a medium of exchange, a unit of account, and a store of value. Bitcoin arguably satisfies the first criterion, because a growing number of merchants accept it as payment. But it performs poorly as a unit of account and a store of value.
Bitcoin’s extreme fluctuations undermine any useful function for it in these roles. During 2013 its volatility was three to four times higher than that of a typical stock, and its exchange rate with the dollar was about 10 times more volatile than those of the euro, yen, and other major currencies. Bitcoin’s dollar price exhibits no correlation with the dollar’s exchange rates against other currencies. Nor does it correlate with the value of gold. With a currency whose value is so untethered, it is nearly impossible to hedge against risk.
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