Is Bitcoin a currency? Is it money? Are those the same thing? They're not but I don't think that matters. Inspired by this episode of Econtalk, the more I think about it, the more I think Bitcoin could be revolutionary for the very fact that it is not a currency, but a wonderfully transportable, fraud-resistant, commodity. This approach is going to be controversial because many worry that if Bitcoin is not commonly accepted as currency, then it is doomed. I don't agree and I'm going to try to explain why as best I can.
Across history, various commodities have acted as money in different places and times: examples include grains of rice, arrow heads, giant disc-shaped pieces of limestone, salt, silver, and eventually gold. These are referred to collectively as "commodity money". These come to be accepted as payment because of the transactions costs of barter; it’s hard to find someone to trade with who had exactly what you wanted and also wanted what you had (called the double-coincidence problem). All forms of money solve that problem to some degree. You just accept money for your goods and use it to buy whatever you want. The system works because even if the commodity is useless to you it is valuable to many. You accept it only because it has value to others who will give you what you want in return.
Where it gets interesting is that, across history, commodity money such as gold always gives way to a commodity "standard" where the commodity itself does not have to be transferred. Instead, people are happy to accept notes/guarantees issued by a trusted source. The guarantee allows the bearer to exchange their note for the commodity that is being stored by a trustworthy institution. This move to a commodity standard happened spontaneously throughout history and will always be the case with commodities. People don't want to physically transfer the actual commodity, they just want to change its ownership as simply as possible.
Take gold as an example; in a gold "standard", buyers and sellers accept notes that can be redeemed for gold safely held by the government in vaults. Originally goldsmiths issued the notes but because of counterfeiting, deception, coin-shaving, and all manner of other economic forces (such as international trade) government-issued notes and coin - stamped, assured, and reliably redeemable for gold - were the only ones that were trustworthy. These notes and coins were valuable only because you could trust that you could exchange the currency for gold.
The gold "standard" went away in the 20th century as governments issued more and more notes and decided that people were so used to using them, that they no longer needed to be able to redeem them for gold, at all. Currency that has no redeemibility, nothing "backing" it, is called fiat currency. The US dollar is a fiat currency. It is accepted for payment because everyone believes they can use dollars to buy whatever they want at some point in the future.
Bitcoin is a commodity but not a "currency". Specifically, it is commodity money. It is "mined" like gold. Additionally, Bitcoin's supply is mathematically limited to 21 million coins, each coin being harder to get than the last as the math problems that need to be solved to mine a new Bitcoin become more and more difficult to solve. This causes a major economic problem. Bitcoin, like gold, is naturally deflationary. You know your Bitcoin is rare, so you think it will be more valuable tomorrow. If it's more valuable, that sweater you want to buy will feel cheaper if you just wait a day or two. If everyone would rather keep their Bitcoin rather than spend it, then no one buys anything. Economic collapse ensues.
Interestingly, gold has the same problems, it is harder and harder to find and gets more and more valuable. However, government simply issued more and more notes to avoid the dilemma posed by deflation. People spent their notes because their value was eroded as more notes were printed.
Where does this leave us? Bitcoin is basically the same as gold. It might just be chains of numbers in a computer file, but gold is just a bunch of atoms, protons, neurons and other sub-atomic particles. Most people wouldn't know a real versus a fake gold bar if it hit them in the face, and certainly wouldn't have any use for it. It is valuable to you only because other people think it is. Bitcoin is exactly the same.
But if Bitcoin is valuable, then a contract/note that promises it can be redeemed for Bitcoin is also valuable. I don't see why we couldn't have a new currency backed by Bitcoin. I'm calling it the Bitcoin Standard.
There would be notes and coins, bank accounts, etc. denominated in "Bitcoin" but that are merely fictions provided by banks that we "trust" can give us Bitcoins if we ask for them. This would preserve many of the great features of Bitcoin but avoid the deflation problem.
Remember, this exact process happened with all other forms of commodity money. The history of the shared illusion that is money is fascinating. It is possible Bitcoin is different but it really isn't. It's just a matter of time.