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What Is Bitcoin, Anyway?

Bitcoin has been much in the news recently, particularly because of the meteoric increase in the price of a bitcoin — from less than a dollar in 2009 to (at this moment as I type on 10 December 2017) about $15,440, up from $10,012 as I typed the first draft on 30 November 2017. This has, not unreasonably, gotten a lot of attention in the financial markets, with mixed opinions among financial pundits. Jamie Dimon of JPMorgan-Chase Bank says it’s a fraud; others aren't so sure. But while it seems everyone in the financial world is talking about it, the rest of the world is looking puzzled and saying: “What is a ‘Bitcoin’, anyway?”

To answer that question, let’s start with a more basic question: What is “money”?

Economists say money has three attributes:

  • it's a medium of exchange: you can use it to buy things
  • it's a unit of accounting: you can use it to keep your books
  • it's a store of value: you can hold on to it in place of other goods or services of value.

The obvious historical meaning of money has been specie: physical coins, gold, silver, copper, along with less common physical objects like cowrie shells and wampum — beads made from quahog shells. Of course, exchanging specie in large amounts is difficult, so other representations came into use, largely paper notes that originally were supposed to represent a fixed amount of some valuable item like gold and silver, but — governments being what they are — those are usually replaced by fiat money, notes that are given their value simply by the issuing government announcing their value, and the willingness of people to exchange real goods or services for that stated value. Sometimes this works, sometimes it doesn’t, as for example the hyperinflation of the Weimar Republic in the 1930s or in Venezuela right now.

There’s a whole ECON 101 course to explain all the ramifications of how this works, but Milton Friedman and others restated a clean, simple model called the quantity theory of money. The super-simplified version of this theory says that money represents the value of the real economic assets available to the entity who issues the money.

As a model for this, let's say that all our stuff, the whole gross domestic product (GDP), is bundled up in a basket (a very large basket) and balanced under an equally ridiculously large helium balloon. Next to the balloon in a yardstick. If the balloon is perfectly balancing the weight, the basket floats steadily at the exact same level on the yardstick.

The thing is, we keep making new stuff — ideally, the GDP is growing. So we need to keep adding helium to the balloon to keep it balanced.