In our last crypto blog post, we asked introduced this new section of our blog dealing with digital currency and all things crypto.
Naturally, the first thing most people ask when they think of Bitcoin or any other cryptocurrency is whether it is some form of money.
To answer that, we naturally need to know a little bit more about what money is.
What is Money?
The question of what money is could fill an entire book or course. We obviously don’t have that kind of time to go into depth here and therefore, by necessity, we will make some simplifications and generalizations.
Let’s begin by taking a look at the function of money. It is generally accepted that money has three main functions:
- Medium of Exchange – An instrument, item or thing that is used as money must be able to facilitate the exchange of products and services. A Canadian dollar is a medium of exchange because I can swap $3.00 Canadian Dollars for a Starbucks Latte. Money evolved to solve the problem of having to barter one good for another. Exchanging money for a good or service is more efficient than having to swap products and services. For something to be a good medium of exchange, it needs to be relatively stable, at least in the short term.
- Store of Value – Money is used as a mechanism by which value can be saved and retrieved in the future with some level of certainty that that value is retained or at least predictable in amount.
- Unit of Account – In a modern society, we find it convenient to be able to quote the price of a good or service in terms of a denomination of money rather than another good or service. It’s easier to function by defining the price of that Starbucks Latte as being the equivalent of $3.00 Canadian Dollars as opposed to the equivalent of 100 size 7 Rubber Bands.
Some other characteristics of money that make it useful are:
- It must be accepted by a significant portion of the population
- It must be accepted by merchants as a form of payment
- Society must have faith that it holds value and will remain so in the future
The history of money is very interesting. All sorts of things were used as money long ago, from cowry shells, whale’s teeth and grain to coins, gold and silver. Eventually, notes representing some deposit of gold or silver at a bank came into circulation and were the beginnings of paper money. This evolved to the issuance of paper and coin money by national governments.
Today, when we speak of money, we typically think of the currency that is issued by a sovereign nation and is accepted as legal tender in that jurisdiction. A currency is legal tender if the government of that jurisdiction mandates its use as the only legal currency that must be accepted by debt holders as payment of an underlying debt. In the past, we simply referred to that type of currency as money. With the advent of digital currency, we now use the term fiat currency or fiat money to when we are referring to sovereign nation backed currencies.
Again, whole books and programs could be written on the history and development of money, but for our purposes, this brief analysis will serve us adequately.
Is Digital Currency Money?
Having identified these basic principles of money, lets apply this analysis to digital currency. For purposes of discussion, lets ask the question here whether Bitcoin specifically is money.
- Medium of Exchange – Is Bitcoin a medium of exchange? That is not an easy question to answer. Bitcoin is in fact used as a medium of exchange in that you can in fact pay for goods and services with it. More and more merchants are accepting Bitcoin as a form of payment. One could argue that it is indeed a medium of exchange and is becoming more so with each new merchant who begins to accept payment with Bitcoin. The problem with Bitcoin being used as a medium of exchange is its wild price volatility. Bitcoin price swings of 15-25% in hours and days is a common occurrence. This severe price volatility makes adoption of Bitcoin as a medium of exchange problematic. No one wants to pay 25% more for their Starbucks Latte one day, let alone one hour later, compared to what they paid for their last Latte. This is even more limiting for higher priced goods or services. Until digital currency prices become more mature and stable, digital currency is not likely a good medium of exchange.
- Store of Value – Is Bitcoin a store of value? In other words, is it a good place to park your money and hold it for the longer term in the hopes that it will remain relatively stable and/or grow in value? That question too is not an easy one to answer. Opponents of Bitcoin will again argue that the severe price volatility makes it a poor store of value. Those who invested in Bitcoin prior to 2017 or even way back to its inception in 2009 might have quite a different opinion. Their holdings have appreciated significantly. When asking the question of whether a currency is a good store of value, it seems to me that you must necessarily have a long-term time period in mind. Sure, prices can fluctuate quite wildly in the short term, but the more important question is whether value will be retained or appreciate in the long term. I would argue that Bitcoin could very well be a good store of value on this basis.
- Unit of Account – Is Bitcoin a unit of account? Do we see the price of goods and services being denominated in Bitcoin in the future? We have already discussed this concept and have to conclude that with continued price volatility, Bitcoin can never become a reliable unit of account. Again, as Bitcoin and the entire digital currency space evolves, we may see more stable pricing. If that happens, Bitcoin may become a more reliable Unit of Account.
Looking at some of the other characteristics we identified earlier, we can apply them to Bitcoin:
- Is Bitcoin accepted by a significant portion of the population? That is an interesting question. The market capitalization of Bitcoin has gone from $100 billion to over $1 trillion at it’s peak. More and more, it is becoming accepted as an investment vehicle, albeit a risky one, by a large portion of the population. More and more institutional players are becoming involved. There can be no arguing that Bitcoin is becoming more and more mainstream as well. The trend is set to continue in this regard. I would argue that Bitcoin is quickly becoming an accepted means of transferring value in society.
- Is Bitcoin accepted by merchants as a form of payment? We are indeed seeing more and more merchants accepting Bitcoin and other forms of digital currency. Tesla recently announced that it would accept Bitcoin as a means of payment for their products. Despite the fact that the company later retracted that decision because of the negative environmental footprint that Bitcoin entails (more on that later), Elon Musk remains open to accepting other more environmentally responsible cryptos as payment mechanisms. Apple has also recently hinted that they may be open to accepting payment in digital currency.
- Does society have faith that Bitcoin will hold value? Again, the market capitalization has increased over tenfold in the space of a few short years. Institutional money is flowing into Bitcoin. Despite it’s wild price volatility, more and more, society is investing and placing its confidence in Bitcoin.
So, we have come full circle and again ask the question, is Bitcoin money? The answer still isn’t clear and will no doubt evolve with the passage of time and further acceptance by society. What is clear is that Bitcoin and digital currency is not going away. It is here to stay and whether or not we want to call it money and use it for transactions, it remains a viable store of value. On this basis alone, society will want to follow the development of Bitcoin and invest accordingly.
In fact, it is this investment vehicle which has most people interested in cryptocurrency.
Next month, we will survey the different ways that you can invest in crypto.