I don’t often write 2 posts on the same topic in a week, but one of my Facebook friends, Victor J Lugo, just made this post, which set me to thinking:
Is Bitcoin Money?
I’ve referred to bitcoin as a commodity in previous posts, to much bewilderment.
Is it a digital currency? Well, maybe, but not yet.
To better understand my perspective on this topic, let’s spend a short time understanding the fundamental differences between currencies, stores of value and commodities - the links go to Investopedia, which has some solid definitions, but here’s a brief summary.
Currencies are essentially a common basis for trading. It would be very difficult to haul around bars of gold or other stores of value, so money was created and historically backed by gold (although in the most part no longer so). Currencies constitute money and are used as a medium of exchange , otherwise you would constantly be trying to figure out the exchange rate of one commodity versus another.
Commodities are basic goods in an economy which, though they may exist in different grades (A, B, C, etc), are in essence homogeneous and easily traded. Gold, Silver, Copper and other metals are good examples of commodities, as are wheat, corn, coffee, etc.
Stores of Value
A store of value can be a commodity that’s not perishable (so wheat, corn and coffee are not stores of value) or subject to depreciation over time (for instance, mass produced motor cars, or other homogeneous products where technology and time can render a store of value worthless).
There is typically a base level of demand where the price is not expected to drop below a certain level (for example Platinum, because of industrial demand), with the possible exception of structural changes to the local or global economy, or perhaps a “Black Swan” event.
Stores of value do not have to be homogeneous either , for example a Michelangelo sculpture. Essentially, stores of value are items where the value does not decay over time and may in fact increase.
I can already hear the cryptocurrency fans raising their voices to argue that Bitcoin could decay over time because of better technology – which is true. However, Bitcoin has an enormous network effect, similar to that of Facebook. I feel comfortable saying that better technology elsewhere will not necessarily enable another cryptocurrency to get bigger than Bitcoin anytime soon, if ever. It’s no longer about the technology, it’s about network effect and the demand for the commodity.
So, what is Bitcoin?
Bitcoin started off being defined in Satoshi Nakamoto’s white paper as a “Peer-to-Peer Electronic Cash System” (which misled a number of people). Yes, it’s a great long term vision, but it really doesn’t explain what the steps are to becoming a digital cash system and how Bitcoin needs to evolve through these phases.
For Bitcoin to become a trusted medium of exchange, i.e. a currency, it needs to be stable and have low volatility. You can’t have a situation where your money is worth less (or even more) in a day or an hour. Volatility and unpredictability in currencies is harmful to business in particular. If a business cannot be assured that the Bitcoins they received the previous day will help them replenish their stock, then they will be unwilling to accept it and risk their livelihood.
This equally applies to people who are willing to earn Bitcoin. I’m not talking about using Bitcoin as a payment network and converting to fiat currency, such as Abra or Bitpay. I’m talking about accepting and holding Bitcoins because they are trusted and will not drop in value.
I made my first purchase of Bitcoin in September 2013, when its value against the US dollar was $147. Bitcoin has come a long way since those highly volatile days for a number of reasons, the not least of which is the expansion over the last 4 years of the market capital / liquidity pool. In fact, BTCVol shows Bitcoin volatility is at an all-time low.
It’s getting close to being stable, but I don’t think we are there yet. I believe that we first need to see it get to the $3,000 price range (which some forecasters are saying will happen this year) and I believe this is entirely possible. But it must happen while maintaining low volatility and steady growth – countries falling apart and pouring money into Bitcoin will not help the cause if it happens too quickly. If we see Bitcoin spiking quickly towards the $4,000+ level before end of the year, then I anticipate there will be an accompanying crash and we will be back to square one.
As to whether Bitcoin is money, I think we’ve just gone past Phase 1.
Bitcoin is well accepted as a digital commodity. Millions of people own it, miners mine it and run successful businesses doing it and it’s recognized that it’s scarce and deflationary, so time does in fact benefit the price over the long term. There can be no more than 21 million Bitcoin ever and it’s estimated that it will take over 100 years to “mine” the next 5 million.
So, if Phase 1 was about establishing Bitcoin as a digital commodity, then Phase 2 is going to be about proving that there is sufficient global demand for it and that the perceived value rises steadily over time. I shall be looking for 2 – 3x gains every year for the next couple of years. I expect those returns will be steadily declining over time, but always going up and to the right. The power of compound growth will ensure that we still get 20x returns, but over a longer period of time and in more sustainable fashion. The more stable that Bitcoin becomes, the more it will be a store of value, and eventually it will become a currency .
This could take 5 – 10 years to play out and, all other things being equal, it should happen.
Then I believe we can think of it in the same terms as “Money”.
Acknowledgement for supporting information to Woobull