What Is Bitcoin: Internet’s Native Money, Hedging Instrument, or Asset for Speculation?
At the end of the last year, the G7 released a report, reading that Bitcoin and other cryptocurrencies “have so far failed to provide a reliable and attractive means of payment or store of value.”
The authors of the report believe that cryptocurrencies are excessively volatile and difficult to use, suffer from scalability problems, and face regulatory risks.
An American billionaire Ray Dalio, founder of investment firm Bridgewater Associates, said that the first cryptocurrency is a speculative asset and isn’t effective for payments or store of value.
We try to find out if Bitcoin is able to be money and what is it, exactly: the internet’s native money, a hedging instrument, or an asset for speculation?
Bitcoin and Monetary Economics
Regulators far and wide still haven’t reached a consensus regarding cryptocurrencies. Everyone has their own interpretation as to the nature of this phenomenon. People put Bitcoin in one line with payment instruments, commodities, and all sorts of things. Some governments even go for an outright ban on digital currencies because of their utility to speculators and criminals.
Before trying to answer if Bitcoin is anything like money, we should get a grip on some of the basics of monetary economics.
Money is defined by its functions as:
- A unit of account that helps setting prices and therefore trade.
- A medium of exchange. It is important that money is liquid, meaning that it is easy to exchange it for any other good for a near-market price.
- A means of payment useful in fulfilling debt and other obligations. Some economists believe that the line between “means of payment” and “medium of exchange” is fuzzy, so these two functions can be combined into one.
- A store of value, which is an equivalent of value recognized by economic agents. Currency, but also precious metals, stocks, bonds and other financial instruments can act as a store of value. Works of art, real estate, and cryptocurrencies can also be a store of value.
- World money that caters to the transfer of value within the international economic turnover.
Bitcoin can be reasonably effective in all five functions of money.
Despite its volatility, the first crypto is demanded as a unit of account and a medium of exchange in Venezuela, a country struck by hyperinflation where prices for goods can change over one day.
Bitcoin is also used as world money by those who pay freelance specialists across borders. It is an alternative to slower, more expensive, and at times unavailable bank transfers. Moreover, as the market for cryptocurrency loans develops, Bitcoin and other digital assets are adopting the function of a means of payment.
The first cryptocurrency works well for diversifying one’s investment portfolio. Over the years, Bitcoin price generally grows, so it can be a store of value
On the other hand, Chainalysis’ research shows that just over the first half of 2019 users spent about $515 million on illegal marketplaces. The largest such marketplace is Hydra and the most popular goods are drugs. Notably, Bitcoin is more popular with such platforms than Monero, an anonymous cryptocurrency criticized for being instrumental in illegal operations.
Money as a medium of exchange is as good as its purchasing power. This power isn’t necessarily dictated only by things like the factual value of gold that makes a coin or backs a banknote. It can also be defined by the trust of those who hold the money.
Bitcoin’s Advantages Over Traditional Money
- Strictly limited emission. Bitcoin’s supply is limited to 21 million coins, over 85% of which is already mined. This makes the first crypto one of the rarest assets on Earth. Its price should only increase, given the same or growing demand. Therefore, Bitcoin can easily act as a store of value, especially when the timeframe is years-long.
- Low and predictable inflation rate. This property is closely related to the previous one. The current inflation rate of Bitcoin is about 3.79% and will drop below 2% after the next halving in May. Most countries have higher inflation rates.
- Lack of a central authority. This makes Bitcoin resistant to censorship and voluntary manipulation of its parameters. Anyone can send or store Bitcoin without special approval from the authorities.
- Low transaction costs and acceptable processing speed. These properties are especially important for those who do international transfers. Lightning Network is aimed to make payments faster and cheaper, while also solving Bitcoin’s scalability problems.
- Security and irreversibility of transactions, without ever disclosing parties’ sensitive information.
- The early stage of adoption. Most people still think that Bitcoin is either strictly speculative, or simply not serious enough, disregarding the pros of decentralization, cryptography, and the potential network effect.
- High volatility. Bitcoin price swings are still quite massive, although the volatility decreases over time. Significant volatility repels potential conservative investors who prefer low-risk low-profit assets.
- Some countries have prohibited or restricted operations with Bitcoin. Reasonably or not, regulators are often creating barriers to the global adoption of cryptocurrencies.
- The deflationary nature of Bitcoin can be both a pro and a con. Over time, the coins get concentrated in the wallets of wealthy investors. The growing demand and limited supply may lead to an exponential increase in price. Yet, if a lot of whales to fix the profit simultaneously, the price will plummet.
- Transaction irreversibility can also be a problem if there are risks is a risk that an agreement will be unfulfilled. In this case, an online shop can refuse to grant a refund if an order wasn’t delivered. When paying via VISA or MasterCard, customers can ask for a transaction to be recalled.
- Only the owner of the coins can sign transactions and spend funds from their wallet. The loss of a private key means the loss of funds. Such is the compromise of financial sovereignty. In traditional finance, you can immediately block a lost plastic card and request a new one without losing all the funds stored.
Along with all the advantages over fiat money, Bitcoin is still a highly volatile asset without wider adoption on the global level. Not everybody is in favor of decentralization, as well as the transaction irreversibility and a full spectrum of risks and security problems entailed by financial sovereignty.
Right now, the first cryptocurrency is mostly used as a long-term store of value or a speculative instrument for short to medium term. Bitcoin is also getting popular among the whales, considering the activities on CME and Bakkt.
In the long run, Bitcoin price will depend on how good of a money it turns out to be. If the digital gold will be accepted as a medium of exchange and its volatility will be reasonable for value accumulation, the market will value that.
Written by Alexander Kondratiuk
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