A version of this post was published in the Zintro Blog for 6-May-2013.

Most of the commentary on Bitcoin centres on its in-built scarcity, which is meant to ensure its value rather like the inelastic supply of gold was meant to confer value on paper money under the gold standard. But what fascinates me about Bitcoin is, paradoxically, its potential to expand the money supply. Here’s why:

If Bitcoin retains its enthusiastic user base, I can envision the need for maturity-transformation. This is a fancy way of saying that people will begin to lend in Bitcoins. But they won’t be the original Bitcoins, they’ll be a “synthetic” Bitcoin, which will be issued up to a pre-pledged maximum amount of the issuer’s actual Bitcoin holdings. When you take out a Bitcoin loan, you’ll be given a deposit of these synthetic Bitcoins.

In the real world, we do this all the time with the money we use in the economy. When we receive funds in the form of a loan, those funds aren’t the money created by the Federal Reserve (the central bank), they’re created by the bank who wrote us the loan. The whole thing works because we proceed as if the two types of money are indistinguishable.

As it happens, the advanced economies today face a shrinkage in the overall money supply — even though the central banks are expanding the kinds of money they can create. (The shrinkage is because most of the money utilised in the economy is not the kind created by central banks.) Since I believe that economies respond poorly to this shrinkage in the money supply, I’m intrigued by the idea that Bitcoin might actually boost monetary liquidity.

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