Wild swings in the value of cryptocurrencies have once again raised questions about the fundamental role and function of cryptocurrencies such as Bitcoin. Is Bitcoin a digital currency that represents the future of money? Is it a form of digital gold — a stable store of value and an inflation hedge? Or is Bitcoin a purely speculative asset that is prone to massive price swings?
To tackle these questions, one must first grasp the unique status and role of money in modern economies. In the dystopian novel “The Mandibles: A Family, 2029-2047” by Lionel Shriver, a character (an economics professor at Georgetown University) observes: “Money is emotional. Because all value is subjective, money is worth what people feel it’s worth. They accept it in exchange for goods and services because they have faith in it. Economics is closer to religion than science. Without millions of individual citizens believing in a currency, money is colored paper.”
In her novel, Shriver imagines a scary scenario in which people lose confidence in the U.S. dollar and its value crashes. (The dollar loses its global reserve currency status and the resulting crisis precipitates a default by the U.S. government on its debt obligations.)
Many techno-libertarians, influenced by fears of a real-world collapse in the value of fiat currencies as well as by a desire to establish a decentralized payment system that would end government’s supposed monopoly over money creation, became early adopters of Bitcoin and continue to be major advocates for the increased use of cryptocurrencies.
The problem with fictional scenarios, like the one painted in Shriver’s novel, as well as with the widespread belief that modern fiat money is purely based on a shared illusion, is that they ignore a key aspect of reality involving key fiat currencies. Major fiat currencies, in fact, have some derived “intrinsic value” due to their status as legal tenders — they are backed by the full faith and power of stable national governments and supported by an elaborate and sophisticated regulatory and financial system.
In her congressional testimony, legal scholar Katharina Pistor noted: “States that have their own currency, issue most of their debt in their own currency and under their own laws, and oversee financial intermediaries that also issue most of their debt in the currency of their home regulator. States ensure asset safety by putting the future productivity of their economies and taxpaying citizens on the line. They insure bank deposits (up to a ceiling) and they stand in for the sovereign debt they have issued.”
Meanwhile, Bitcoin has no intrinsic value and its supply is inelastic. It is not recognized as legal tender by major governments and no central bank will provide a backstop to cryptocurrency-oriented institutions. Furthermore, cryptocurrencies are unlikely to play the role of a widely accepted medium of exchange or act as a unit of account given their tremendous day-to-day volatility. The fact that significant market turbulence can be generated by random tweets from a celebrity entrepreneur highlights the inaptness of using Bitcoin or other cryptocurrencies for undertaking day-to-day transactions.
Costly and energy-intensive mining and transaction verification processes also reduce the attractiveness of cryptocurrencies like Bitcoin. Furthermore, Bitcoin’s popularity among those involved in illegal activities will generate regulatory scrutiny and negate its anonymity advantage. Looking ahead, state-supported central bank digital currencies are more likely to become the future of money.
If not the future of money, can we make a case for Bitcoin as digital gold? Proponents argue that since Bitcoin, by design, is limited to a maximum of 21 million units, it can act as a stable store of value. Given its short history and its intangible nature, it is unclear that Bitcoin offers a true alternative to traditional gold. Gold has a long history as a medium of exchange, and the yellow metal has impressive physical properties that have caused humans to value it highly for thousands of years. Even today, many societies widely use gold for jewelry and ceremonial purposes. Additionally, from a financial standpoint, Bitcoin is currently too correlated with risky assets to act as an effective inflation hedge.
At present, Bitcoin and other cryptocurrencies appear to primarily function as speculative assets whose fluctuating valuations may be driven by financial mania or a form of contagious narrative. Central bank liquidity injections, massive fiscal transfers, rise of a new generation of retail investors utilizing online platforms (like Reddit) to coordinate their actions and the emergence of zero-commission online trading platforms (like Robinhood) have created a speculative frenzy.
Frankly, nobody really knows the fundamental value of Bitcoin and other cryptocurrencies as we have yet to settle the debate surrounding their primary utility and function.
Proselytizers and critics continue to debate various use case scenarios for popular cryptocurrencies. Even as volatile cryptocurrencies grab the headlines, we may be failing to grasp that a genuinely transformative era involving new financial technology and innovations may soon be upon us. Blockchain-based smart contracts, non-fungible tokens and a shift towards decentralized finance all have the potential to radically alter the financial system. Such developments deserve greater attention from the media as well as from long-term investors and policymakers.
Vivekanand Jayakumar is an associate professor of economics at the University of Tampa.