Bitcoin: What It Is And What It Isn’tNovember 29, 2017
Bitcoin has garnered much mainstream media coverage in recent months which is the natural reaction to its meteoric ten-fold rise this year. The digital currency’s rise to about $11,000 today was met with awe, and then it quickly fell by 20% in a matter of hours, as has been widely reported. Still, bitcoin is 37% higher against the USD compared to one month ago and that alone is enough to get people paying attention. But in all the analysis about the astonishing price action what is all-to-often missing is a basic analysis of what bitcoin is and what it isn’t. Specifically, pundits often jump to the premise that bitcoin is money. We couldn’t disagree more for the reasons we’ll cover in this post.
Going all the way back to our first economics class, we recall that money can be thought of as anything that is simultaneously a 1) store of value, 2) unit of account and 3) medium of exchange. Let’s take one at a time considering the properties of bitcoin.
Store of Value
For money to be useful its value must be generally stable through time. A user of a currency – whether it be USD, gold, silver, shells, etc – must have faith that the purchasing power of the currency will be similar one, five, or ten years from now as it is today, less realized inflation. This is such because economic agents need the ability to plan and invest and cannot do so without taking for granted the value of their money. Even under the broadest definition of a store of value, bitcoin fails on this test. So far bitcoin has mostly gained value against the USD, which is an alluring prospect for current and potential holders of bitcoin. But it can also lose value at a jaw dropping pace, as we witnessed again today. If we can’t even predict with some measure of certainty the value of bitcoin in one hour, let alone tomorrow, how could bitcoin possibly be considered a store of value?
Unit of Account
Money must also be a unit of account, or a generally accepted way to measure the value of goods and services. On this metric we give bitcoin a half pass. Its value is observable and thus prices of goods and services can be quoted in terms of bitcoin. Bitcoin is as much, but probably no more, a unit of account as a share of Apple in that prices of goods could theoretically be quoted in terms of it. Where it falls down is that bitcoin isn’t a generally accepted way to account for goods and services. For example, we have yet to see published in the Wall Street Journal the price of stocks in terms of bitcoin.
Medium of Exchange
Finally, money must be generally accepted as a means to pay for goods and services. This is so because if one accepts a form of payment for services rendered one must then be able to use the form of payment received to subsequently make purchases. If a form of payment is not nearly universally accepted by economic agents then that form of payment cannot be considered money in any basic sense. Even though some retailers have begun accepting bitcoin, it is most certainly not a medium of exchange. For example, back in July Bloomberg reported that bitcoin is accepted by only three of the top 500 online retailers in the US, down from five in 2016.
There is no doubt the bitcoin story is interesting to follow and for holders of the digital currency it’s been a fun ride. But we think its appropriate to categorize bitcoin correctly as a speculative instrument that one day may be considered money. We are nowhere near that point now.