As the monetary base of Bitcoin sharply rises past $1 billion, spending the coins on physical goods makes little sense.
People who think they are ‘late to the game’ are quick to call Bitcoins a pyramid scheme. The currency can seem ridiculous, like Farmville tokens. It becomes only more suspect as holders of Bitcoins preach their merits in the cacophonous chambers of the Internet. Those simultaneously holding and explaining Bitcoins sound nerdy at best, and unapologetically crazy at worst. “But it’s worth something because of the GPUs solving problems, really!”
On the other side of the coin, those flush with coins who invested early have their own problems, and these are more easily discussed in terms from behavioral economics. If you bought a pair of alpaca socks using Bitcoins two years ago, you spent what amounts to several hundred dollars in BTC today. In two years, could those coins buy the farm? From an outsider perspective, this rapid rise in the price is stunning. From a buyer’s perspective, this severely changes how you approach the act of spending even a tenth of a BTC in the future. Knowing with some surety that the value could increase dramatically in a matter of months causes our decision-making process to be dynamically inconsistent. This has implications for the liquidity of the currency. Let’s call this the alpaca problem.
The Pizza Index tracks the rising price of the first real-world purchase made with 10,000 Bitcoins in exchange for $25 of pizza.
It’s not an easy thing to anticipate. How will our future selves react to value increases in money we hold? How does an economy function amidst reliably increasing purchasing power? Buyers, sellers, traders, miners, and hoarders alike must come to terms with the behaviors of their future selves and adapt to their own predictions. Everyone in the mix needs to somehow map out their disparate approaches to this unique currency for a healthy economy to form. While the future supply of Bitcoins is predictable based on the rules built into the protocol, the psychology of actors within a deflationary virtual currency is completely unknown territory.
The $1,000 Pint of Maple Syrup
Onto a concrete example. I’ve setup a site to sell maple syrup from my girlfriend’s family’s farm in Vermont for Bitcoins. At first, I thought it would be a popular item. Maple syrup doesn’t spoil, it’s something many people buy (especially in the U.S.), and I even discounted the price by 30%. It’s the cheapest place to buy organic Vermont maple syrup, which normally sells for much more than plain old maple. However, in the 6 months the site has been up and advertised, only four pints have been sold. FOUR. I think it’s worth mentioning that my order number on Bitmit.net, the ‘Ebay of Bitcoins’ for the most recent order was #8900. Bitmit came on the scene in September of 2011, so that gives us about 16 orders a day. If people can’t expect “Bitcoin Millionares” to purchase things, what’s next?
Pricing for Deflation
Here’s how deflation affects merchants: As a ‘merchant’ (if four pints a merchant makes) I know that I can heavily discount items sold for Bitcoins due to the current trajectory of the currency. I could even put up the syrup for 50% off and expect to break even within two weeks. As long as deflation feels predictable, the merchant can confidently undercut brick and mortar fiat merchants.
If buying additional Bitcoins to offset any expenditures is part of the buyer’s plan, this can work to everyone’s benefit. Sellers can expect to earn more money when their held Bitcoins increase in value, and spenders benefit from low prices and increasing purchasing power, especially if they replace spent Bitcoins. Of course, this assumes that the merchant’s costs are low and can hold onto a portion of sales, and that one can move money into exchanges easily (this is not always the case).
The smell of lost opportunity
Not all transfers in the Bitcoin economy cause the spender to dwell on increasing purchasing power. When the transactional benefits of Bitcoin become a more central part of ‘the spend’, Bitcoins flow more freely. Here are the core situations where the alpaca problem is less of a problem:
- Sending money across borders. Expensify is smart to make this a part of their featureset.
- Avoiding credit card fees and chargeback risks, or helping a merchant lower their costs
- Sending money to a family member — the recipient benefits from any increase in purchasing power, and could convert quickly to another currency to avoid risk.
These uses will continue to drive the demand for Bitcoin, but I will continue to watch the relationship/activity among merchants and consumers. Spendes of Bitcoins (and consumers of syrupy pancakes), must confront a cloudy crystal ball. “What will these 78 mBTC become in a month when I’m done with this maple syrup?”
Spending on physical items for oneself, no matter how small or large the purchase is, sets the stage for an unique case of buyer’s remorse months later. The possibility of deflation doesn’t inherently give buyers pause. The buyer feels it, sometimes months later. Holding something in your hands that had the potential for so much more value leaves a bad taste in your mouth. This taste is unique in the history of money and it’s something everyone using Bitcoin needs to come to terms with. Until the rate of increase in purchasing power slows, it’s much more psychologically palatable to purchase durable goods with old fashioned money.