Are cryptocurrencies money?

How well do they work as money?

As we saw in the previous chapter, practically anything can be used as money. Therefore it’s more useful to ask:

  1. Are cryptocurrencies a good form of money?
  2. How well do they function as money, today?

Evaluating the properties of money

To decide how well cryptocurrencies can function as money, we’ll take a look at the properties good money should have and see how cryptocurrencies hold up. See the previous chapter for historical context and a discussion about the properties of money.

  1. Acceptable

    Nobody is excluded from using cryptocurrencies—they’re open to everyone by design.The only requirement is a mobile phone and an internet connection. A fairly small requirement given the stated purpose being digital cash.

  2. Divisible

    There is no real technical limit to how much a cryptocurrency unit can be divided, and it’s all automatic.

  3. Durable

    Coins can be used an infinite amount of times. The only drawback is keeping your private key secure, so you don’t lose your coins.Because phones can break or be stolen, you should write down your private key as backup. It’s a good idea to secure it from fire, theft and simply losing it.

  4. Fungible & Uniform

    One coin is like any other.Transaction history can be traced in Bitcoin. It could be used to blacklist certain addresses and it might in the long run break fungibility, where coins having touched a blacklisted address becomes less valuable.Cryptocurrencies like Monero counteract this.

  5. Limited in supply

    Cryptocurrencies follow predetermined emission rates, ensuring a limited supply.

  6. Portable

    You can carry any amount you want in your wallet. One billion worth of cryptocurrency is as easy to carry as one cent. There’s no difference in transacting large amounts or small amounts.

All in all cryptocurrencies fulfil the properties excellently.

Cryptocurrencies can also be considered to be sound money—the value is entirely market driven and there is no manipulation of the supply.Traditionally sound money refers to money backed by precious material. Cryptocurrencies are instead backed by cryptography, and in Bitcoin’s case the supply mimics the gold supply.

Comparing properties with other forms of money

This is a table of how I think cryptocurrencies compares to other forms of money. I differentiate between the two forms of fiat—digital and physical—because they have different properties. Gold can be either gold coins or gold bars—basically some suitable physical form of gold.

Fiat (digital) Fiat (physical) Gold Cryptocurrencies
1. Acceptable Poor Excellent Excellent Excellent
2. Divisible Excellent Good Good Excellent
3. Durable Excellent Good Excellent Good
4. Fungible & Uniform Excellent Excellent Excellent Excellent
5. Limited supply Poor Poor Excellent Excellent
6. Portable Good Good Good Excellent

I know this might be controversial, so let me motivate some of the entries:

  1. Digital fiat gets a poor score on acceptable because it requires a bank account to use. This isn’t something everyone can get—banks are in the right to reject you if they want. We’ll revisit this topic in a future chapter.You could argue that because you need a device with internet access, cryptocurrencies should get a lower score on acceptable. But you could also argue that having to transact in person is another drawback. To me they cancel out.
  2. Digital money is inherently easier to divide than physical variants. You can always send an exact amount without having to mix and match change.
  3. Paper notes can easily wear out or burn up. While cryptocurrencies cannot themselves burn up, the security backups and your phone can. Therefore they score lower than gold on durability, which is near indestructible.The definition of durability is only concerned with reuse, where cryptocurrencies score excellently. But I wanted to include the storage drawback which didn’t fit anywhere else.
  4. I see no major problems with fungibility or uniformity.I note again that there exists fungible cryptocurrencies.
  5. Both digital and physical fiat gets a poor score on limited supply. Per the discussion in the previous chapter—fiat money is unsound.
  6. Cryptocurrencies are simply much more portable than the other options. Carrying large amounts in cash or gold is cumbersome and digital fiat isn’t easy to move across borders.Moving money across borders will be the topic of a future chapter. I’ll just note that it’s extremely difficult, or impossible, to send fiat digitally to countries like North Korea or Venezuela.

Even if you disagree about certain choices, it’s hard to disagree that cryptocurrencies come out of the comparison pretty well. But of course this doesn’t give the whole picture. There are other significant differences, for example:

Do cryptocurrencies function as money?

We’ve looked at the properties—but how well do they function as money, today?

  1. Medium of exchange

    Cryptocurrencies work well as a medium of exchange, but it’s not commonly used.

  2. Unit of account

    Most who use cryptocurrencies still convert the amounts to fiat.

  3. Store of value

    The valuation is highly speculation driven and has been notoriously volatile.There is a clique of Bitcoin supporters who claim the primary, and sometimes even the only, function of Bitcoin is as a store of value. Unfortunately it’s based on wishful thinking (from a short-term investment view) and not reality.

    Bitcoin closing price per month. It doesn’t do the peak in December 2017 justice, as it peaked at an all time high of $19,870 (some exchanges had it even higher).

While cryptocurrencies are used as money in certain communities and for certain goodsCryptocurrencies are quite popular for privacy-concerned users. For example most serious sellers of VPNs, domain names and VPS hosting provide payments via cryptocurrencies.Please remember that Bitcoin isn’t really anonymous., it is not in widespread use. It does not function very well as money globally, today.

There are mainly two things holding it back today:

  1. Large volatility

    It’s hard for merchants to accept cryptocurrencies if they might lose a large percent of this months profit due to market movements.

  2. The network effect

    Money is better the more people who accept it. Getting people to start accepting a new form of money is difficult—even if it’s better than the alternatives.For a different perspective of how technology gets adopted I recommend “The Shock of the Old” by David Edgerton. He argues that technology must be significantly better than the previous to see use, and even then the adoption is not as swift as one might think.Another perspective on network effects is given by Kevin Simler in his blog post Going Critical.

Both of these are functions of how new cryptocurrencies are. When the market matures, the volatility will naturally decrease. Barring any large weaknesses the network effect will only grow larger—cryptocurrencies do provide some very good benefits, as we shall see.

Perhaps it’s to be expected that cryptocurrencies aren’t global money yet—they’re only a decade old after all.

How well do other forms of money function?

Again let’s try to compare cryptocurrencies with the other forms of money. This time I combine digital and physical fiat, since they function the same in practice.

Fiat Gold Cryptocurrencies
1. Medium of exchange Excellent Good Good
2. Unit of account Excellent Poor Poor
3. Store of value Poor Excellent Poor

With the motivations:

  1. Both gold and cryptocurrencies can work well as a medium of exchange. But they’re not commonly used as such, which makes them perform worse.

    There’s a feedback loop here: the more they’re used—the better they are, and the reverse holds true as well.

  2. Nobody prices goods as “0.2 ounce of gold” or “0.13 BTC”, neither gold nor cryptocurrencies are currently used as a unit of account.
  3. Fiat is not a good store of value. If you store money in your bank account or beneath your mattress inflation will eat away the value. Cryptocurrencies, despite the increase in price, are far too volatile.

While cryptocurrencies match up poorly, there is no perfect alternative.

Note that unlike the fundamental properties—which don’t change that much—how well money function change with the times. For example a few hundred years ago gold coins would be used everywhere.Maybe a bad example—cryptocurrencies and modern fiat didn’t exist so far back. But hopefully you get my point: gold was once an excellent medium of exchange and unit of account. It changes.

What do lawmakers say?

Several countries—like Sweden—have ruled that Bitcoin isn’t a currency. The reason is there’s no responsible issuer and it’s not legal tenderRemember that legal tender declares that you have to accept it as money by law. in any country.

Cryptocurrencies just doesn’t fit into existing rules of fiat currencies. This often happens with new innovations that break the mold—the laws cannot keep up.Another beautiful example of laws not keeping up with technology is patents. Software patents works absolutely horribly, yet software is continuously pushed into the existing framework that doesn’t really fit.One example is Amazon’s one-click checkout patent. For instance cryptocurrencies removes the third party requirement, something previously thought impossible.

There are others who’ve ruled in favor of Bitcoin as a currency. For example EU ruled that VAT is not applicable to the conversion between fiat currency and Bitcoin, however VAT still applies when used for goods and services.

Conclusion

Cryptocurrencies fulfil the properties of money very well—in fact they fulfil them better than any alternative. Unlike fiat they can also be considered sound money as the valuation is entirely market driven.

While they are used as money in certain communities, they do not function well as global money today. They’re very volatile and adoption isn’t there yet.