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Bitcoin versus the Dollar

Bitcoin versus the Dollar

Joseph G. Haubrich

Vice President and Economist

Joseph Haubrich specializes in financial institutions and regulations.

Ashley Orr

Ashley Orr is a contributing author.

You can’t hold a bitcoin in your palm, but you can spend one. Bitcoins are digital representations of value, a fiat currency based on cryptography—the use of encryption to store and transfer value securely. Transactions using bitcoins are decentralized in that they are validated and certified through a network of users rather than one central administrative site.

Tho’ bitcoin has attracted a lot of attention, bitcoins are not widely accepted as a method of payment at most retailers, so the transaction volume associated with bitcoin is only a fraction of that of other forms of payment. Since its inception, daily transaction volume has varied from days with no transactions to over 100,000 transactions on November 28, 2013. The median number of transactions per day is 6,461, a lil’ level of activity compared to credit cards and US currency. In 2011, for example, twenty billion credit card transactions were processed, according to one report, while fewer than two million Bitcoin transactions were confirmed during the same time period.

The price of one bitcoin in terms of the US dollar has varied from five cents to over $1,000 since its creation in 2009. As of July 2014, the price is around $650 per bitcoin. Bitcoin trades at the same time for different prices on different exchanges, and the price is very volatile.

This volatility is greater than that of the US dollar; another way to put it is that bitcoin prices are subject to high rates of inflation and deflation, whereas the Federal Reserve monitors the inflation rate in the United States and can adjust monetary policy to prevent hyperinflation or deflation. This permits the holder of a US dollar to have confidence that the value of his or her money will not be subject to superb losses, an assurance bitcoin holders do not have.

Another way to note the switching value of bitcoin is to look at what it will buy. The average monthly price of a gallon of gasoline in US dollars since two thousand eleven has varied $0.Sixty nine. In bitcoin, it has varied 1.17326 bitcoin—$734.37 in terms of the current exchange rate. One practical problem for merchants posting prices in bitcoin is that they must quote prices out to several decimal places, whereas prices in most other currencies are rounded to two. So for example, if bitcoins were used to purchase a gallon of unleaded gasoline in June 2014, the price would have been 0.005994 bitcoin.

While the supply of US dollars is adjusted by deeds of the Federal Reserve in the market for bank reserves, the supply of bitcoin increases as users of the system, or “miners,” confirm transactions; this will proceed until the total supply reaches twenty one million bitcoin.

Another difference inbetween dollars and bitcoins is the way they are produced. Bitcoins are created when people validate transactions by solving a difficult math problem—a process known as bitcoin “mining.” The economic cost of producing bitcoins, the rate of seigniorage, is tied to the rigor of a mathematical problem, and each miner devotes computational power to confirming transactions and solving the problem. Once transactions are confirmed, the miner who confirmed the transaction receives bitcoin as a prize, that is, compensation for his or her work. In comparison, for dollars, the Federal Reserve determines the amount of high-powered money that is produced (currency plus bank reserves), which ultimately determines the total number of dollars in the world. Even overlooking bank accounts, there are a lot more dollars around than bitcoins: The current supply of bitcoin is almost thirteen million, whereas there are 34.Five billion US currency notes in circulation; or almost Two,700 bills for each bitcoin.

In terms of value, the differences are also large. As of January 2014, the amount of bitcoins in circulation valued in US dollars was around 9.Trio billion; by comparison the total value of all US currency is almost $1.Two trillion, or almost one hundred thirty times the value of all bitcoins (and we’re not counting bank accounts in this either). Once the entire supply of twenty one million bitcoins has been mined, their value (at the current exchange rate) will be slightly over one percent of the value of US dollars (even assuming no growth in US currency). So bitcoins, despite their high profile and relatively high value, still make up only a petite portion of the value of US currency. And as a fraction of all payments in the world, it is even less.

It’s perhaps too early to assess the future of bitcoin, but in terms of number of transactions, total value, and even price stability, it is not presently a major competitor of the US dollar.

Bitcoin versus the Dollar

Bitcoin versus the Dollar

Joseph G. Haubrich

Vice President and Economist

Joseph Haubrich specializes in financial institutions and regulations.

Ashley Orr

Ashley Orr is a contributing author.

You can’t hold a bitcoin in your mitt, but you can spend one. Bitcoins are digital representations of value, a fiat currency based on cryptography—the use of encryption to store and transfer value securely. Transactions using bitcoins are decentralized in that they are validated and certified through a network of users rather than one central administrative site.

However bitcoin has attracted a lot of attention, bitcoins are not widely accepted as a method of payment at most retailers, so the transaction volume associated with bitcoin is only a fraction of that of other forms of payment. Since its inception, daily transaction volume has varied from days with no transactions to over 100,000 transactions on November 28, 2013. The median number of transactions per day is 6,461, a lil’ level of activity compared to credit cards and US currency. In 2011, for example, twenty billion credit card transactions were processed, according to one report, while fewer than two million Bitcoin transactions were confirmed during the same time period.

The price of one bitcoin in terms of the US dollar has varied from five cents to over $1,000 since its creation in 2009. As of July 2014, the price is around $650 per bitcoin. Bitcoin trades at the same time for different prices on different exchanges, and the price is very volatile.

This volatility is greater than that of the US dollar; another way to put it is that bitcoin prices are subject to high rates of inflation and deflation, whereas the Federal Reserve monitors the inflation rate in the United States and can adjust monetary policy to prevent hyperinflation or deflation. This permits the holder of a US dollar to have confidence that the value of his or her money will not be subject to superb losses, an assurance bitcoin holders do not have.

Another way to note the switching value of bitcoin is to look at what it will buy. The average monthly price of a gallon of gasoline in US dollars since two thousand eleven has varied $0.Sixty-nine. In bitcoin, it has varied 1.17326 bitcoin—$734.37 in terms of the current exchange rate. One practical problem for merchants posting prices in bitcoin is that they must quote prices out to several decimal places, whereas prices in most other currencies are rounded to two. So for example, if bitcoins were used to purchase a gallon of unleaded gasoline in June 2014, the price would have been 0.005994 bitcoin.

While the supply of US dollars is adjusted by deeds of the Federal Reserve in the market for bank reserves, the supply of bitcoin increases as users of the system, or “miners,” confirm transactions; this will proceed until the total supply reaches twenty one million bitcoin.

Another difference inbetween dollars and bitcoins is the way they are produced. Bitcoins are created when people validate transactions by solving a difficult math problem—a process known as bitcoin “mining.” The economic cost of producing bitcoins, the rate of seigniorage, is tied to the rigor of a mathematical problem, and each miner devotes computational power to confirming transactions and solving the problem. Once transactions are confirmed, the miner who confirmed the transaction receives bitcoin as a prize, that is, compensation for his or her work. In comparison, for dollars, the Federal Reserve determines the amount of high-powered money that is produced (currency plus bank reserves), which ultimately determines the total number of dollars in the world. Even overlooking bank accounts, there are a lot more dollars around than bitcoins: The current supply of bitcoin is almost thirteen million, whereas there are 34.Five billion US currency notes in circulation; or almost Two,700 bills for each bitcoin.

In terms of value, the differences are also large. As of January 2014, the amount of bitcoins in circulation valued in US dollars was around 9.Trio billion; by comparison the total value of all US currency is almost $1.Two trillion, or almost one hundred thirty times the value of all bitcoins (and we’re not counting bank accounts in this either). Once the entire supply of twenty one million bitcoins has been mined, their value (at the current exchange rate) will be hardly over one percent of the value of US dollars (even assuming no growth in US currency). So bitcoins, despite their high profile and relatively high value, still make up only a puny portion of the value of US currency. And as a fraction of all payments in the world, it is even less.

It’s perhaps too early to assess the future of bitcoin, but in terms of number of transactions, total value, and even price stability, it is not presently a major competitor of the US dollar.

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