Are Bitcoin & Other Cryptocurrencies Money?
What Makes Money Money? Does Crypto have monetary advantages?
What Is Money?
We live in the age of fiat, government issued currency and have for decades now so it’s easy for people to be confused about what money is. The USD is not money because the government issues it, however, it is legal tender because the government says so. And right now, the government has a monopoly on what is legal tender and what isn’t.
Legal tender is important, but different from money, cause it means legal tender can be used to pay off all debts public and private and in the enforcement of contracts.
So can Bitcoin or Ethereum or Litecoin or DASH ever be money?
The Properties of Money
The reality of money is that there are 3 properties:
A unit of account
A medium of exchange
A store of value
So how does the USD stack up as money?
Unit of Account- the USD is definitely a unit of account. Revenues, Expenses, Profits, Taxes, Items on store shelves in America are priced in USD.
Medium of Exchange- USD trades hands daily and often
Store of Value- here’s where we have some doubts. The Federal Reserve shoots for a monetary policy goal of 2% or less inflation per year. In other words, they are baking in a LOSS of value of 2% for you, the USD holder, every year. Maybe more in some years
How Does Bitcoin Stack Up?
One of my favorite leaders on cryptocurrencies and the law, Caitlin Long, explains in an article she wrote for Forbes Crypto about Price stability vs System stability.
She says early in this article that Bitcoin is ‘designed for systemic stability, not price stability.’ But what does that mean?
Caitlin argues that monetary systems probably cannot be both price and system stable.
The real world is not stable. Things happen. Unexpected things. But fiat currencies and stablecoins (like FB Libra will be) are designed to maintain price stability. It’s hard to pay for eggs with Currency X if it’s value keeps changing so that one day X buys 6 eggs, the next day 4 eggs and the next day 12 eggs. This is tough for people to manage. Just ask people in Venezuela, Zimbabwe or Argentina, all of whom have more than 30% annual inflation. In the case of Venezuela and Zimbabwe, it’s much, much more than 30%. People make this argument about Bitcoin too, and they have a point.
Bankers have to intervene and manipulate the currency to help keep it price stable when unexpected events like tariffs and a trade war take place. It’s a great article that you should read about how fiat systems seem stable, but are in fact fragile.
OTOH, Bitcoin is set up to be system stable. It’s security is the best and highest it’s ever been since the creation of the network. In 10 years, it’s never had a hack. The fixed supply of 21 million coins is another system stable feature. So let’s look at how Bitcoin scores on the money test.
Unit of Account-Bitcoin is the unit of account for the crypto-economy. With the exception of some stablecoins like Tether, nearly everyone who wants to buy an altcoin needs to have Bitcoin first and convert it. Many alts trade in relation to the BTC price.
Demelza Hays of the Crypto Research Report presents a different take on the GENTWO blog stating that both Bitcoin and Gold are too elastic to become units of account, yet too inelastic to be effective money.
What is Elasticity of Demand? Elasticity is the responsiveness of the quantity demanded when there’s a change in the price. Gas is one of the most famously inelastic goods. People need gas for their cars and machines and still buy even if the price moves up 10 cents a gallon. That’s being inelastic. Luxury goods like a Mercedes are more elastic. Some will buy a Mercedes (assuming they can afford it regardless of price), but at the margins, fewer people buy as the price increases because it’s not a necessary good.
Currencies need to be sufficiently elastic to be responsive to changes in the marketplace.
Hays argues that ‘stability of purchasing power and stability of the coin fees (for transactions) are mandatory for becoming a unit of account’ thus Bitcoin with its volatile price and changing transaction fees make it a poor unit of account.
Medium of Exchange- Of the 3, Bitcoin falls short the most here. People pay for things with Bitcoin or get paid in Bitcoin. I myself had a client pay me in Bitcoin a couple years ago. But payments in general, and small payments like paying for your coffee in particular are an area where Bitcoin falls short. In the regular economy, Visa and Mastercard do this great and in the cryptoeconomy, Litecoin and DASH are both more payments oriented than Bitcoin is. The Lightning Network is working on this problem too.
Store of Value-It’s tough to think of something where the price is so volatile as being a store of value, but Bitcoin really is a store of value. It does not correlate to traditional financial assets, yet it clearly has value on its own. The comparisons to Gold for long term value continue and I talked about the 4 year buy and hold strategy that has never failed to show a profit in a previous newsletter.
Bitcoin vs Gold
The 2 competing non-government issued monies are Gold and Bitcoin, and they are complementary assets with many Bitcoiners holding gold too. The Hays article goes into a more in-depth comparison of the two. Both are seen as inelastic, making them poor forms of money. The Hays article outlines the solutions to making gold more elastic so it’s useful as money include
Bimetallism-inclusion of silver, which is more elastic
The Real Bills doctrine-issuing bills backed by gold
Fractional reserve-like Central bankers around the world already do
Potential solutions to make Bitcoin’s inelastic supply of 21 million coins more elastic include
Altcoins especially stablecoins, whose supply is not fixed and determined by demand and the amount of assets available at any given time
The Lightning network, which enables smaller and micro payments. Known as a Layer 2 solution
Hays argues both are way too inelastic to be great money, but the Hal Finney Bitcoin banks argument that most adjustments would have to be Layer 2 or 3 solutions and not on the Bitcoin network itself (Layer 1) are already starting to form with the issuance of stablecoins.
What do you think? Do you think Bitcoin is a good form of money?