What are some of the limitations of Bitcoin? Could it be used as a replacement for all currency? I ask this as there is still the “exchange rate dilemma” where people are trading different value currencies to get in and out of Bitcoin. Does the “standard system” still apply for non Bitcoin-to-Bitcoin transactions?
Theoretically it could replace all currency – you could even have Bitcoin-backed physical coins or notes.
There is a thread on the Bitcoin discussion forums challenging somebody (and proposing a Bitcoin reward if done successfully) to "live solely off of Bitcoins" for a month, see: http://www.bitcoin.org/smf/index.php?topic=3500.0. I haven't been keeping close tabs on that thread (I tend to be busy with the development and technical discussions), but just the fact the people are talking about that being possible fairly soon is interesting.
The goal is to grow the Bitcoin economy so it is large enough you don't have any exchange rate dilemma – you can buy the products and services you need using Bitcoins that you earn by providing products and services that others need. You will probably still have to exchange some of your Bitcoins into dollars to pay your taxes, though.
One criticism is Bitcoin won’t handle supply and demand driven inflation and deflation very well. How do you think it will stay relevant amid such fluctuations in “value”? Supply is capped, but the value can dilute over time.
Bitcoins are designed to be like gold – only a limited supply, so, assuming demand continues to grow (as it should if the economy becomes more productive), the value rises over time.
There should be a natural feedback loop with respect to hoarding of Bitcoins — if people hoard their Bitcoins instead of buying goods and services or investing them by giving them to somebody else to spend on productive activities, then the economy will NOT become more productive. So there will be less demand for money, and their Bitcoins either won't rise in value as fast or, if the economy is doing really badly, might actually fall in value. And if that happens, then people have a natural incentive NOT to hoard them.
For me, the key feature that makes Bitcoins extremely attractive as a currency is their predictability. We know how many are going to be created, so at least the "supply" side of the supply-demand equation is fixed. That should make it much easier for entrepreneurs and investors to figure out whether or not a project or investment makes sense.
What, if any, is the relationship with Bitcoin and other Internet-centric money management services such as PayPal?
Bitcoin is more like dollars or Euros than PayPal. In the future, I hope I will be able to hold Bitcoins in my PayPal account, just like I can hold US dollars or Australian dollars in it today.
It gets confusing because Bitcoin is both a currency and a payment network. In the future the Bitcoin payment network might be used only by major banks and financial institutions, with large-value payments made to "settle accounts" periodically through the day. Small transactions might be bundled up by the banks over proprietary payment networks, as is done now with Visa and MasterCard or bank debit-card payments.
I don't think it will evolve that way – I think computer and networking technology will keep up with the volume of Bitcoin transactions so we can all "be our own bank". But either model works.
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