Paint it Black, Friday

I wrote earlier about my impressionistic thoughts on bitcoin. I’m still learning as much as I can about bitcoin, currency systems, protocols and platforms. My brain hurts. I feel like Billy Ray Valentine.

In order to be a currency (i.e., money), bitcoin needs to serve three functions: store of value, medium of exchange, unit of account. (I’ve written before about why “bitcoin as a currency” may be a local maximum – a powerful application but only scratching the surface of its potential.) But if you look at this classic “money test”, bitcoin currently succeeds as a store of value but is less successful as a medium of exchange and even less so as a unit of account.

A “store of value” is something that has value, as Randolph Duke might explain to Billy Ray Valentine (go to 0:51 of video above). The classic examples are houses, stock or art. These things have inherent value but may not be freely or easily tradeable for other goods and services.

A “medium of exchange” is simply something that lets you buy stuff and services more efficiently. Without this, we’d have to trade stuff-for-stuff with other people (i.e., barter). This may work among small groups of people. Among larger groups, it’s nearly impossible. For example, let’s say I have 3 mobile phones (which I actually do have). I only use one so I have 2 phones worth about $500 a piece. So theoretically I have $1,000 of purchasing power (2 phones times $500).

Now let’s say I want to buy a bed that’s “worth” $1000. Without a medium of exchange, I need to find someone who not only has that bed but also wants two phones at the same time that I need the bed. Money is the intermediary or medium of exchange that lets me buy the bed – I can sell someone my phones for $1,000 and either now or in the future, and use that $1,000 to buy my bed.

A “unit of account” is just how you measure value. For example, in the example above, how do the parties agree that 2 phones are worth the bed? One way would be to say that my phones are worth 1 trinket of gold and the bed owner thinks that his bed is also worth 1 trinket of gold. Thus that’s a fair trade – we have a common measure of value. And that unit is fungible – my trinket is the same as your trinket. The US would use this system (i.e., the gold standard) up until 1971 when we abandoned it as part of the “Nixon Shock.” (hat tip to Alex Rampell)

The point of any form of money is to give you purchasing power that’s durable and stable over time. And in order to have it, under classic theory, the money needs to have the 3 qualities above. But implicit in this theory is the idea the unit of money will remain relatively stable over time (ignoring inflationary/deflationary effects, which are actually huge). And that’s one issue with bitcoin as money right now – the “value” is extremely volatile, making everyday exchanges harder to do.

One way to increase the stability or decrease the volatility would be to increase the number of times people use bitcoin as a medium of exchange (i.e., increase the transaction volume). This creates [liquidity] which arguably leads to stability of bitcoin’s value over time.

I am oversimplifying all of the above concepts. But the bottom line for me is that if we in the tech community want to see bitcoin thrive as a disruptive technology, one of the ways is to increase the number of times we use bitcoin to buy and sell stuff – and not just a way to hoard it. You need to boost liquidity, which fosters stability and durability of bitcoin as a currency.

Fred Wilson describes all of the above in his post here. I rambled a bit because I don’t fully grasp the concepts and writing them on paper help clarify my thoughts. I want to see bitcoin survive and thrive. It has all the qualities and of massively disruptive technologies. When these technologies emerge, there are great opportunities for founders and more selfishly for me, great opportunities for startup investors.

Therefore we at SV Angel have been involved in Bitcoin Black Friday, an effort spearheaded by Fight for the Future. The idea is to encourage merchants to buy and sell stuff on Black Friday with Bitcoin and to get people to buy stuff using bitcoin. We’ve asked some SV Angel portfolio companies to participate and they have gladly done so. If you want to see Bitcoin succeed, then this is one small way of helping to make that a reality.