Money by definition is an arbitrary medium for a store of value. In
ancient times, people used what was considered rare in order to exchange
as money; precious metals, cowry in landlocked countries or Central
areas, precious stones, pearls, and many other things. In more modern
times we have standardized forms of exchange in the form of a coins or
banknotes approved by a central Authority.
All money serves some basic functions; just to quickly recap, they
are:
1.Money must be a store of value. If the ‘value’ of money changes
drastically from one day to the next, people will stop using it and
turn to other types of stores of value.
2.Money must be usable as a unit of account. You need to be able
to relate the “value” of money to the value of something else,
say 10 cowry shells for a bowl of noodles or one gold ingot for a
horse.
3.Money must be usable as a medium of exchange. You cannot be
the only one trading in cowry shells, everyone else must be ready
to accept them as a means of payment. If you go from the
landlocked areas where cowry shells are rare to the seaside
towns where cowry shells are plentiful, it may not be recognised;
the same as when you travel to a different country today.
Today almost every nation in the world has its own form
of fiat currency backed by no assets and issued by the
government valued at its ability to serve as tax credit.
When we look back that’s actually not much difference
between cowrie shells and fiat currency both of them
arbitrary means of a store of value. When you think about
it, there is as much value and utility in a piece of paper as
there is in a cowry shell, but we recognise them not for
their intrinsic value but rather their exchange value.
Additionally, cowry shells and bank notes share some
similar characteristics that enable their common use as
money: durability, portability, divisibility, uniformity,
limited supply (or rarity) and acceptability.
Characteristics of Crypto-Money
So how about crypto? How well does cryptocurrency work as
money? I wouldn’t just say that it works well, I’d say that
cryptocurrencies are even better than what we are using
today as money (government issues fiat and bank-issued
credit). Let’s take a look at each characteristic in the context
of crypto:
1.Durability Crypto isn’t even physical! It’s definitely durable
compared to a physical product. But wait, isn’t it just data?
Can’t it be destroyed like hard disks and thumb drives?
Technically it could, but the blockchain which record every
individual fraction of crypto is distributed across nodes. You
can’t destroy 1 node to wipe that record, you’d need to
destroy all of them.
2.Portability Due to its electronic nature, crypto is stored “in the
cloud” similar to dollars in your bank account. All you need to pay
in crypto is a phone application and wifi or a mobile data
connection to send requests to the blockchain.
3.Divisibility While you can break dollars into cents and think
that’s very divisible. Not only that, every time you break a dollar
into cents, you actually decrease the portability of money on your
person as weight and space go up but the value of money goes
down. This creates another interesting issue faced by some
countries in relation to coins; in some cases of inflation, they find
criminal or citizens debasing their currency and melting it down
due to the metal value of the coins being higher than their
exchange value! Fortunately, we will never have this issue with
non-physical cryptocurrencies and be able to divide as much as
we choose.
4.Uniformity Each unit of cryptocurrency is indistinguishable from
the next. While even some notes have serial numbers to indicates
authenticity or minting order, if you transfer 1 Bitcoin to a wallet
with 9 bitcoins, even the owner is not able to you which of the
Bitcoins he received; they are perfectly identical and fungible.
5.Acceptability Probably the only aspect the crypto currently
loses out to fiat from is in its acceptability as a medium of
exchange. However, the situation is quickly changing and the
more cryptocurrencies get exposure, the greater the rate of
public adoption of crypto as payments and transactions.
6.Limited supply Governments will print money endlessly in order
to fund public spending as taxation is usually insufficient in itself.
Cryptocurrencies like Bitcoin, however, have a hard limit as
determined by software: no one can ever create more Bitcoin and
even if they performed a hardfork to do so, they would likely be
the only ones who accepted the “new” currency created.
When it comes to pure utility as money, it seems that
crypto is unmatched as long as it is accepted. So why is it
not accepted at more vendors/merchants/service
providers and why do more people not use it since it is so
much better?
The answer is simple: Price
A common complaint you may have heard regarding
Bitcoin or cryptocurrencies, in general, is that they are
“too volatile” and thus are not really usable as money.
Indeed, it is a valid concern if your 2 Bitcoins could be
worth a dollar right now and only 10 cents the next
minute. The truth is that such large volatility in value
actually happens for fiat currencies as well! The only
reason we don’t think of fiat as highly volatile is that we
are not exposed to its volatility on a regular basis and it is
in many governments interests to prevent too much price
volatility.
The truth is that fiat currencies are valued against each other, and
against commodities. The most painfully obvious time we experience
fiat currency volatility is when we are overseas on holiday and find
exchange rates at money changers differing from one day to the next!
Sometimes by as much as 10 to 20 percent! Some people, based on
their geographic locations, may also experience fiat price volatility
firsthand. Many nations with large lass mass that enable them to have
an agriculture industry will never experience this, as they are able to
buy produce with local currency and may never ever need to import
certain goods.
If that is insufficient evidence for the volatility of fiat
currencies, take into consideration the Asian Financial
Crisis and the European Sovereign Debt Crisis, both while
not a direct result of fiat volatility, could not have
occurred if the individual currencies of nations or states
did not fluctuate.
So, is Bitcoin really more volatile than fiat? Could you really
use this as “money” if its value changes from second to
second?
The current problem with cryptocurrency is that it is not widely
accepted as a form of exchange today, causing a need to perform an
exchange to fiat in order to obtain liquidity. This creates a situation
where the price of crypto is defined, not relative to the value of the
goods and services it can be exchanged for (as there are few
merchants who accept them currently), but relative to its value in fiat
or other cryptocurrencies it can be traded for. In such a situation, it
becomes extremely volatile as there is no longer an asset to which it is
possible to “peg” its value against, but rather against other volatile
currencies. The end result is that the price volatility in crypto is
amplified by the volatility of all the currencies it can be traded
against. Crypto is not more volatile than fiat, crypto gets its volatility
from fiat.
What is the solution to this problem of crypto volatility in
this case?
It’s simple: the increased adoption of cryptocurrencies
as a form of money by more and more merchants.
While many purists aim to entirely eradicate fiat, this has faced many
roadblocks in the form of regulations and oversight by the same
authorities who have control over fiat. However, crypto does not need
to replace fiat, as long as it is recognised more widely and can be used
in conjunction with fiat to purchase goods and services, the price
volatility of crypto will start to even out.
Another key factor that creates the impression of greater crypto
volatility comes from the fact that there is no central authority
governing the price of cryptocurrencies. With fiat, central banks are
able to control the prices of their currency to a certain extent,
through various mechanisms, by affecting both the demand and the
supply. To keep it short, central banks can choose to control demand
and supply by affecting interest rates, issue of treasury notes or
simply by buying up excess currency in the forex market.
Why would they want to do this? Because that is the entire purpose of
a central bank; to reduce uncertainty in the market. In crypto,
however, we have no central bank to provide a “cushioning” effect in
the case of sharp spikes up or down the price charts. To make matters
worse, cryptocurrency trading literally happens 24/7. There are no
brokers to close on weekends that can close the doors on retail
investors. With trading enable 24/7, you could imagine that it
becomes a lot more volatile.
Conclusion
Well, hopefully first and foremost, I hope I’ve addressed
any fears you’ve had about crypto perhaps from hearing
various statements from banking or finance industry
leaders. Secondly, I hope I’ve given you some insight into
the value proposition of cryptocurrencies over traditional
fiat. And lastly, I hope that you now have a basic
understanding of the technology behind it and why it is
built on real innovation and not a scam or a pyramid
scheme. Personally, I won’t advice you to put your life
savings into crypto as the adoption rate today is not very
high and volatility is truly a concern, but it could be a
good long-term investment