Digital money: store of value or illusion?

Digital coinage like Bitcoin can't do everything a physical coin can do, but that's not stopping people from giving up real money for them. Or are they trading one fake currency for another?

Digital currency as a store of value?

Today the value of Bitcoin and other digital currencies is more volatile than Americans are used to. But with Amazon and eBay looking at accepting them, that could change.

If that seems unlikely, recall that much of what you use now as "money" is simply electronic transfers: credit cards; debit cards; PayPal. Now, grasshopper, are those more "real" than Bitcoin?

The bad old days

Digital currencies are like how the US currency system used to work, before we had a national dollar.

Local banks issued its own currency supported - in theory - by the deposits of customers. To redeem the currency you'd go to the bank and exchange the notes for coin. When business crashed people would "run" to the bank to exchange their notes for specie - gold and silver coins.

Since banks borrow short term and loan long term, they would often run out of coinage and close - often costing depositors their life savings - which was Very Bad for business. That's why the US has a national currency, a Federal Reserve Bank and insures bank deposits (FDIC).

Digital currencies have none of these protections. But maybe that won't matter if the utility of them is greater than the fear that they'll become worthless.

How would that work?

"Gold bugs" advocate going back on the gold standard rather than letting the dollar "float" against other currencies. After all, advocates contend, without gold the dollar isn't backed by anything at all.

And yet the dollar remains the worldwide currency of choice, not only for B2B but as a store of value and convertibility as hard cash. Proof: most US currency circulates outside the US - Americans prefer credit cards.

Since the US dollar isn't backed by gold, and since the Fed can loan as much money as it wants to banks that can use it as reserves against loans - if only they were making loans! - why do we ascribe value to the dollar? Global acceptance and ready convertibility are two major reasons.

Which is where the value proposition for digital currencies makes the most sense. So can a digital currency replace - or at least supplement - national currencies? Yes.

The Storage Bits take

That isn't much different from what we used not so long ago - or what we use today. Digital currency is the new frontier in more ways than one: the 19th century dressed up in 21st century tech.

I hope to have more to say about it because I'm attending a Bitcoin conference that starts today. If you see me, say hi!

Comments welcome, as always.  Would you use a virtual currency? Would you put your life savings into it?

Note: Another version of this post appeared earlier on StorageMojo.