Bitcoin and the blockchain technology are wonderful inventions; its anonymity, decentralised technology and speed of transactions just to mention a few features that have aroused supporters. The extension of competition into the domain of money that it represents is perhaps even more welcomed, coming as it does after almost a century of completely dominant fiat currency regimes (or feeble gold exchange systems). A bit like the internet of the 1990s, many are the proponents of cryptocurrencies predicting and imagining all the wonderful things BTC and its technological brethren will accomplish.
But is it really that great? As BTC-USD exchange rates soar even higher, its zealous followers grow bolder, prouder and more firm in their beliefs. Is the impressive gain and media hype really the vindication of their beliefs, or are most of its ardent followers simply blinded by vertigo?
The internet wiz’s of the 1990s were eventually right in substance but wrong in timing; their enthusiasm was premature, the then-fantastic technology lacking consumers’ willingness to embrace it. A similar story may unfold itself for BTC, its proponents cashing in its success way ahead of time. To show this, I’d like to draw your attention to an often-overlooked aspect of monetary theory: the quality of money.
Many economists have spent entire careers surveying and arguing aspects of money, the brightest shining star in that tradition was of course Ludwig von Mises. Among his most recent disciples, Phillip Bagus has taught us many important things about money – for instance: different monies and their accompanying monetary regimes have different qualities and that those characteristics matter for whether market participants are likely to adopt them:
“Money’s quality can be defined as ‘the capacity of money, as perceived by actors, to fulfill its main functions, namely to serve as a medium of exchange, as a store of wealth, and as an accounting unit.’1
The quality of monetary systems influences the demand for money and, thereby, money’s purchasing power. While much emphasis has been put on the quantity of money and its influences on money’s purchasing power, money’s quality, and the quality of monetary systems are equally important for money’s price, if not more so. In fact, money’s quantity may be interpreted as one of several characteristics that determine money’s quality and the likelihood and capacity of monetary regimes to increase or decrease money’s quantity is one of the important characteristics of the quality of a monetary regime.2
Different monies can generally provide the accounting functions equally well and most of the characteristics of well-functioning mediums of exchange are well-known and mentioned in most economics textbooks, whereas qualities under “store of value” are discussed much less often.3
Mediums of Exchange and the Store of Value
A good money commonly has certain features: low storage/transportation costs; easy to handle and recognize; durable and divisible. To this, Bagus adds a high number of users and a non-monetary demand for the commodity as insurance for money-holders.4
Among the most important characteristics of money under the store-of-value function is the potential for the quantity of money to change. A money that is subject to substantial increases in its quantity leading to a reduction in its purchasing power and value (or even the ability for such increases to take place), performs the storage function less well than does a money whose supply is more predictable and limited.
A second feature here is the relationship to the rest of the financial system; a fiat money system under fractional reserve banking (FRB) makes it prone to business cycles, with collateral damage across that money’s domain. A monetary regime without such risks therefore provides a better store of value than FRB fiat currencies.
Thirdly, the relationship a money has to the government in that particular monetary regime also matters. If there is a risk that governments confiscate, say, a gold reserve, that gold reserve’s ability to function as a store of value is diminished. All things equal, a money less vulnerable to interventions by a government enhances that money’s quality.
Some of these qualities may make bitcoin vastly superior to gold or fiat currencies, but on other accounts of quality it is surely not. The services particular monies provide through its functions as medium of exchange and store of value may be better or worse, making those monies better or worse providers of monetary functions, always determined from the point of view of the acting individual.
So let’s examine bitcoin, comparing it to the U.S. dollar.
A Check-list for the Quality of Money
Fiat currencies (USD)
Small but potentially very large (losing codes)
Small, slow transfer
Very small, instant transfer
Ease of handling
New technology, new knowledge
Not that easy; intangible
Weak, but digitised USD much more durable
Fairly high, requires change (again digitised USD does not suffer from this)
High number of users
Very small: novelty and “early-adopter” value only
Quantity of money
Subject to authority’s whims
Stable Purchasing Power
Low, predictable price inflation
Relationship to financial system
Strong, with recurrent business cycles and financial crises.
Thus far, no lending has taken place through BTC,
Very vulnerable and very uncertain
Thus far most governments have ignored BTC.
At first glance it seems that bitcoin fares rather well in our direct comparison of monies’ quality. A closer inspect reveals that the areas where BTC has advantages over fiat currencies, those advantage are minor and increasingly irrelevant (durability, divisibility, transportation) or almost solely based on its rigid quantity growth. Lending has this far not taken place in BTC and governments have fortunately left it alone.
The major disadvantages of bitcoin are well-known and tend to be the first objections against it; the risk of permanently losing your coins, the information hurdle in learning new ways of paying, the lack of an established network, the comparatively few producers who do accept BTC, and the volatile exchange rate, leading to very uncertain and unpredictable day-to-day prices. While the speed of transfer may look like an appealing quality where BTC is ahead, most fiat systems have specialized apps improving that quality already (Venmo, Transferwise, Npesa, Swish).
As for purchasing power and quantity of money: while it is true that bitcoin has a predetermined and preferable money supply structure, that has not yet translated into predictable prices. The highly volatile exchange rate means that from the point of view of a consumer using money to acquire other goods, the day-to-day price he pays is highly uncertain – much more uncertain than the few percentages he may lose in fiat price inflation every year.
Malavika Nair made a fairly convincing case in her Mises University lecture this summer: merchants have good reasons to start accepting bitcoin, saving entire percentages in transaction fees on sales – but consumers have no good reason to switch to bitcoin. Even among a group as her Mises University audience — which is presumably well-disposed toward using cryptocurrencies — not a single person had actually bought or sold a good in bitcoin.
Many of the flaws of bitcoin may stem from its early stage of development and it will undoubtedly improve as more people adopt it. Should BTC ever reach the size required for improving its quality, it is unlikely that governments would stay out of it for long, meaning that its potential benefits over the dollar may be severely reduced. Moreover, consumers have very few reasons to transact in bitcoin and use bitcoin as money, despite the known drawbacks of a fiat currency system. As Phillip Bagus has emphasized, the quality of money matters — sometimes more than its quantity or technological brilliance. Until those qualities yield enough benefits for consumers to be willing so switch, it seems hard for bitcoin to take off as money or to ever threaten the dollar as the world’s most liquid and used money.