Forget Bitcoin – Digital Currencies Can Only Work With Gov’t Backing

“Money is a matter of four functions: a medium, a measure, a standard and a store.”

This song quoted by Alfred Milnes in the 1919 book entitled “The Economic Foundations of Reconstruction” sums up the four fundamental properties of money.

This is one of the basics you learn as you study economics, which will help us understand why decentralized digital currencies probably don’t perform the same functions.

In order for money to fulfill its purpose, it must be:

1. Medium of exchange
2. Value measurement
3. Payment standard (deferred)
4. Store of value

In other words, it should be commonly accepted for transactional purposes so that you don’t have to pay for one good with another good or service; it must faithfully reflect the value of the products and services; it allows payments to be settled on deferred dates (ie debt); and it can also be used to store the value of anything you sell (i.e. registered).

To perform well at least three of these four functions, a currency must have a stable and predictable value.

Bitcoin volatility

It is difficult to accurately measure what something is worth using a medium whose own price fluctuates sharply all the time.

A $ 100,000 car would have cost 10 BTC in October, but less than two BTC today – and it’s unclear in which direction it will go in the coming months.

Bitcoin price history from 2016 to 2021
Bitcoin price history from 2016 to 2021 / Image credit: Coingecko

As you can see above, over the past five years the price of Bitcoin has gone from $ 500 to $ 20,000, then to $ 3,500, up to $ 12,000, to $ 5,500 and recently over $ 60,000. . In just a few days, its value can fluctuate by 10-20%.

With such rapid and frequent changes, it creates chaos as yesterday’s prices may no longer be relevant today. In many ways, it’s like living in a country with hyperinflation – only that the price changes quickly back and forth.

For the same reason, it is difficult to use digital currencies to settle deferred transactions. Most business payments are executed on predetermined dates or within a defined future time frame.

Contracts for the delivery of products or services can be settled in a window of a week, a month or even a quarter. Of course, as long as a currency’s value is predictable, that’s not a big deal because it’s unlikely to change drastically.

30 days is a fairly standard timeframe for issuing payments. However, with cryptocurrencies being able to jump a few hundred percent over a period of several weeks, you cannot predict what the deferred payment you accepted may be worth on the due date. This would make the conduct of any business very risky.

Finally, the worst charge against digital currencies is their demonstrable inability to store value in a safe and predictable way – for the same reasons outlined above.

If you saved your 10 BTC in October, then you’re obviously very happy now – your $ 100,000 in savings turned into $ 500,000. But if you save 10 BTC today and prices return to past levels over the next few months, you’ll make a few hundred dollars for it.

You cannot stabilize the value of Bitcoins

Bitcoin – like other cryptocurrencies – does everything except store value. It can be treated as an investment or, more specifically, as a speculative bet, as there really isn’t much the currency is supported on other than dominant demand.

Traditional currencies are currently backed by entire economies that the rest of the world is trading with (or not). This is further stabilized by central banks which accumulate foreign exchange reserves and use their power to print additional currencies if necessary, to ensure that the national currency remains stable and meets the four criteria.

Currency of Zimbabwe
Zimbabwe Currency / Image Credit: Wikipedia

Whenever local authorities are unable to maintain this stability, catastrophes ensue, usually with local money losing value to the point of becoming completely worthless, as in Venezuela or Zimbabwe.

This is why in some of the poorer and weaker countries, the preferred currency more readily accepted than local banknotes is often the US dollar.

Since cryptocurrencies do not have any mechanism that would stabilize their value in response to fluctuations, nor do they represent a particular market or country that people would be willing to trade with, they do not have the anchors that would maintain their value. value in place.

National currencies provide access; you need it to buy goods and services in a particular country. Whether you are a local buying a burger, a tourist visiting Disneyland, or a foreign government buying fighter jets, you need to pay in US dollars to complete the order in America.

It works the same everywhere else. If you want to visit Europe you need a few euros, if you go to China be prepared to buy Yuan, Yen in Japan, Ringgit in Malaysia, Birr in Ethiopia and so on.

However, decentralized cryptocurrencies aren’t really needed for anything.

You can buy the same goods and services with dollars, books, euros. In fact, the only things Bitcoin and the like can open to you are illegal stuff, which you wouldn’t want to see or in any way tracked purchases, like drugs.

All that glitters is not gold

Bitcoin’s volume is capped by design at 21 million, and units are progressively more difficult to mine over time.

Outside of the digital world, price stability is achieved by adjusting the money supply to reflect the country’s economic growth (what is the role of central banks), but it is impossible to do with cryptocurrencies due to their limitations. intrinsic and lack of external control.

There is currently approximately $ 40 trillion of currency in circulation around the world. In a simple example, that would mean that for BTC to replace them today, each coin would have to cost around $ 2,000,000.

And as the world grows – both economically and in terms of population – the scarcity of BTC would keep its price on the rise. This contributes to the deflation of the prices of all products and services, which only exacerbates economic crises; as it forces people to hold currency in anticipation of its higher future value, thus reducing economic activity leading to prolonged recessions.

gold
The Gold Standard / Image Credit: Metals.com

It’s a bit like the gold standard, when the money supply was tied to a country’s ability to back its currency with the precious metal. If the government did not have enough, it was stuck because it could not increase its money supply in response to economic growth.

Countries that stepped off the gold standard and were able to adjust their monetary policies more freely came out of the Great Depression of the 1930s faster than those that did not. In the end, the whole system was unsustainable and collapsed with floating fiat currencies that took its place in the 1970s.

At the very least, however, the gold standard had the advantage of being based on a rare metal that had intrinsic and practical value.

You can take gold or silver anywhere in the world and exchange it for cash, because there is always a demand, but cryptocurrencies are not based on anything. If their value drops to zero, the only thing you’ll have is a digital recording that you couldn’t even use as toilet paper.

There are of course alternatives, like Ethereum, that don’t have a total maximum cap – at least in theory. But in all cases, the money supply is controlled by predetermined mathematical calculations that do not respond to changing economic realities.

Many people are wary of governments and central bankers, but they are still a safer bet than a computer algorithm that progresses steadily under any circumstances. Keeping control in human hands means that policies can be adjusted quickly, in response to economic challenges.

Ironically, of all the useful applications of blockchain technology, its use for digital currencies is probably the least practical.

So much so that even Tesla – which recently widely demonstrated its adoption of Bitcoin by allowing customers to pay for their cars using digital currency – states in its disclosures that in the event of a return, the company will decide how to return the payment ( whether in BTC or USD), and you assume all risk. This means that they will give you back what costs them the least.

tesla bitcoin
Tesla Disclosure / Image Credit: Tesla

In other words, the company doesn’t really treat Bitcoin as a currency – more like a method of payment – and is only interested in managing it under conditions favorable to its business.

It’s quite possible that Elon Musk wants to both surf and stimulate the cryptocurrency lifting wave, so that the company itself (or himself) can make a lot of money in the process.

Bitcoin shouldn’t be considered a currency

The market is exciting due to its high volatility as it allows speculators to make large profits very quickly, but it also carries the risk of large losses.

Many tears have been shed by digital token owners depending on whether they bought too late or sold too early.

And for these reasons, we shouldn’t talk about Bitcoin et al as currencies, because they just don’t meet the basic criteria to be one.

The whole idea of ​​digitizing money is excellent and perfectly rational these days.

Various blockchain applications open up many possibilities outside of finance, but for it to be widely used it needs to be implemented in a controlled and regulated way that millions of ordinary people who do not want to spend their money on. life to follow can be trusted. daily exchange rates of some imaginary digital coins.

For a currency to maintain a stable value, it must be managed by state authorities, setting realistic expectations and using monetary policy tools to achieve them.

This just isn’t possible in the open-source world of anti-establishment nerds. I’m sure independent digital currencies won’t go away – they’re here to stay for both use and speculation, but the real revolution will come when governments start issuing theirs.

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