Bitcoin versus the Dollar

Haubrich, Joseph G., Orr, Ashley, Economic Trends

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08.14.14

You can't hold a bitcoin in your hand, 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.

Though 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 tiny level of activity compared to credit cards and US currency. In 2011, for example, 20 billion credit card transactions were processed, according to one report, while fewer than 2 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 simultaneously for different prices on different exchanges, and the price is highly 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 allows the holder of a US dollar to have confidence that the value of his or her money will not be subject to great losses, an assurance bitcoin holders do not have.

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Another way to note the changing value of bitcoin is to look at what it will buy. The average monthly price of a gallon of gasoline in US dollars since 2011 has varied $0.69. 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 instance, if bitcoins were used to purchase a gallon of unleaded gasoline in June 2014, the price would have been 0. …