Putting aside the issue of whether Bitcoin will succeed as a transactional currency, I can’t help but challenge some of the detractors.
One argument I’ve seen cited a lot is Krugman’s paper from 1998, about the “Babysitter Co-Op” as if it somehow foretold the failure of Bitcoin.
This is the original 1998 Krugman piece: Baby-Sitting the Economy
In it, Krugman refers to a Babysitting co-op and the coupons they invented to allocate babysitting duties. The upshot is that the babysitting co-op entered a recession because there were not enough coupons in circulation. The lack of circulation was due to the couples’ propensity to save and hoard the coupons. That story touched Krugman, and he frequently uses it to generalize to the economy, where he typically offers it in support of expansive monetary policy (to show the perils of high interest rates, low inflation, and too much saving).
Since Bitcoin’s early adopters include a hefty pool of passive investors, the saving rate is quite high. This, combined with the 21 million circulation cap, has caused people to draw parallels between the Babysitting Co-op.
Along these lines, a nuanced case for why Bitcoin will never work comes from Felix Salmon, who spells out the danger of hyper-deflation, and why Bitcoin's upward trajectory would be necessary deflationary, making it untenable as the primary currency of an economy.
Article is here: The Bit Coin Bubble and the Future of Currency
Basically, if the value of the currency used to make payroll is doubling every week, who is going to hire someone today? A whole population adopting this “wait for my currency to deflate” mentality would have disastrous consequences for any economy.
Furthering Salmon’s case is the fact that if Bitcoin succeeds as a transactional currency, the value per BTC will necessarily be enormous. Were Bitcoin to capture any “bit” of share in the currency market, you would need an aggregate value in the trillions, not billions. And with a finite circulation of 21 million, you would end up with a per-bit-coin value north of $100,000. In other words, it is the circulation cap that ex-ante dooms it as a transactional currency, because the only way for a currency to properly function in a growing economy is to naturally create more units as there's more growth.
Still here, he's too drastic with his deflationary concerns. Because BTC doesn't need anywhere close to 100% market share of any economy to be a long term store of value, Bitcoin can capture significant market share without ever having wages denominated in BTC.
Furthermore, it would have to approach an astronomical value before a single wage in the developed world was ever denominated in BTC. The point at which BTC has a robust enough market cap to be the currency of use for wages, growth will be on a much slower trajectory. Yes, the value today of a Bitcoin may fluctuate 200+% in the course of a week, but that is because the market is still in its infancy, with only a few billion $USD total in total circulation. If it were to become a transactional currency, it would necessarily have a big enough aggregate value, to make any additional value generated as a result of economic growth, a much slower phenomenon. Assume that the currency needed to keep pace with GDP growth; even that would warrant just a few percentage points per year. Hardly enough deflation to prevent you from spending your bitcoins today.
But again, this all assumes that Bitcoin’s either succeed as a dominant transactional currency or not at all. It is in fact plausible to have a hybrid commodity/currency. Salmon makes the mistake of treating those two ends as diametrically opposed. Bitcoin can stand apart by being more frictionless but less innately valuable than gold. After all, any commodity that is as transportable and valued as Gold has transactional qualities; I'm sure the folks at Pawn Stars would trade me a Rolex for a shiny little bar.
Ironically, Krugman himself doesn’t cite the Babysitter issue directly against Bitcoin (as far as I’ve seen). In a recent NYT column, he instead accuses it of something far more incredible: being “antisocial”:
The article is riddled with aesthetic points about Money being an invariably "social" construct, and argues that somehow Bitcoin ignores this reality. Amazingly, Krugman misses the fact that Bitcoin’s value is already entirely derived from social acceptance of it as a store of value. I wouldn't be able to immediately liquidate my Bitcoins into cash if there weren't a social creature (read: human) on the other side who accepted its value. And based on the daily averages from MtGox, (one of the larger Bitcoin exchanges), there is enough liquidity to exit 7 figures worth of Bitcoin without significantly altering the value.
Furthermore, a few major online retailers as well as drug dealers, (who by the way, Mr. Krugman, are also “social” creatures, despite being sociopathic at times) accept Bitcoin as a form of payment. All this while Bitcoin is still a pain to buy and transact with. And there is no evidence that this momentum is slowing down; in fact at the ground level there are a plethora of venture funded startups (from highly respected investors), ranging from “wallets” to banks, that are being funded to make the process of transacting using Bitcoins more seamless. Give it a few years…
I personally think the single biggest risk here are sovereigns clamping down, and preventing Bitcoin’s use as a transactional currency in brick and mortar scenarios.
Barring governmental interference, I believe Bitcoin has a fighting chance.