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posted: 2/15/2014 1:01 AM

Will home purchases ever be transacted in bitcoins?

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Q. Will home purchases and mortgages ever be transacted in bitcoins?

A. That this question gets asked with increasing frequency is an indication of how far the bitcoin phenomena has come. Readers should recognize that any answer at this point has to be highly speculative.

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Real estate transactions won't be executed in bitcoins before bitcoins become a generally acceptable medium of exchange -- which is the textbook definition of "money." Right now, we are a long way from bitcoins being money.

While a number of things can be purchased with them, acceptability is still very limited, and real estate transactions are unlikely to be among the early adopters. Indeed, if the existing dollar-based system continues to work effectively, it might never happen.

The bitcoin is a decentralized digital currency that allows payments to be made over the Internet without an intermediary. A bitcoin is a computer file owned by someone, say A, who can discharge a debt to B through the transfer of the file to B, without any third party involvement. To prevent A from using the same bitcoins to purchase something from C, the transaction with B is recorded in a public file called the "block chain." Every transaction is checked against that file, so if A tries to use the same bitcoins twice, the second attempt will "bounce."

Whether bitcoins become money depends on whether or not they have (or will have) all the features required for general acceptability as money. Two required features that they clearly have are homogeneity and divisibility. Every bitcoin is identical to every other bitcoin, and they can come in any denomination. In these respects, bitcoins are just like bank deposits.

Another required feature, more nebulous but equally critical, is credibility. When I try to explain bitcoins to friends, they invariably ask "what is the backing?" This is another way of asking about the source of bitcoin credibility.

Historically, all the monies of which I am aware have either had some non-monetary value, the best example being gold; were convertible into assets with non-monetary value at a fixed price, such as notes issued by banks that were convertible into gold; or were issued by or on behalf of government, such as our current Federal Reserve notes. These are not convertible into anything, but they carry the imprimatur of the federal government.

Bitcoins are computer files with no intrinsic value. There are no third parties offering to convert bitcoins into any other assets at a fixed price. And bitcoins do not have the backing of any government -- in fact, some governments (including that of China) are hostile to them and have taken steps to curtail their use.

Yet none of this means that bitcoins cannot acquire credibility in a way that is different from that of all prior monies, and that was a major purpose of the anonymous guru who designed the system. It was not only made tamper-proof but also has a built-in mechanism for regulating and limiting the total supply of bitcoins that can ever become available. In time, this could make the bitcoin system more credible than those that depend entirely on the sponsorship of government, which all too often break down.

Governments that succumb to the temptation to create money in order to pay their bills eventually destroy the credibility of their money system. The most recent example of this is Zimbabwe, where the government destroyed its own system and now uses the U.S. dollar system.

Finally, money must provide a relatively stable store of value. No one wants to be paid with assets that can decline sharply in value shortly after they have been received. Bitcoins do not meet this requirement, since the value of one bitcoin in dollars has fluctuated wildly to date. However, that should be expected for a new program and there are indications of greater stability in recent months. If the bitcoin market continues to grow, it is reasonable to assume that bitcoin value will become increasingly stable.

The outlook for bitcoins is heavily influenced by the fact that it is developing in countries that already have functioning money systems, which makes bitcoins a second type of money. This has been a major advantage to bitcoin acceptability because it has largely neutralized the negative effect of value instability. The price of an item or service can be set in dollars (or euros, etc.), and the transaction executed in bitcoin at the dollar price of the bitcoin on the transaction date. This would work even for a house purchase, where final payment may be deferred for weeks and sometimes months.

On the other hand, the long-run prognosis for bitcoins depends on its being able to replace the existing money system in at least some major uses. To do that, it must provide a transaction-cost saving or some other benefit relative to the existing money system. The greatest potential seems to be those markets in which transaction costs are high relative to total transaction value. This would include credit cards and cross-border transactions that require conversion of one currency into another.

So long as our existing money system continues to work well, I don't see any such potential for domestic real estate-related transactions, because transaction costs are a trivial part of transactions values.

But I may be missing something, if so, I hope the reader who sees it will clue me in.

• Contact Jack Guttentag via his website at mtgprofessor.com.

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