Why cryptocurrencies aren’t money. (yet)
Cryptoland is a strange place. On the one hand is a place where technology pioneers, developers, companies and vibrant communities are working together to develop a new kind of technology with implications in many fronts: the financial system, smart contracts or cybersecurity among others. On the other hand, is a place where honest debates between different projects are rare and many people actions are driven by greed and psychological biases. A great example of this situation is the proliferation of scam artists such as Craigh Right who take advantage of the ignorance of many investors in order to pump their respective coins.
One of the strangest things in this space is how most cryptocurrency projects use the term “money”. For example, if you go to bitcoin.org the first thing you’ll see is: “bitcoin is an innovative payment network and a new kind of money”. This use of the term money is absolutely wrong and a mere marketing slogan. In order to provide some clarity about the topic, I’ll try to explain through this article what money is and why cryptocurrencies aren’t yet money. Only by clearly understanding the nature, functions and characteristics of money, can developers design systems which can be one day the bedrock of a new monetary system, more inclusive, efficient and fairer than the current one.
Why is money important?
The origins of money can be traced back to the beginnings of commerce and there is little coincidence in that. Money is a fiction essential for coordination and cooperation in society. The value of money doesn’t come from its physical support but from the collective believe that money has been, is, and will be accepted by everyone as medium of exchange. Thanks to money the price system arises, making possible coordination in today hypercomplex economies. The more complex the economy, the more important an appropriate monetary system is. Prices are signals which contain information scattered in the economy, in the minds of thousands of people (or machines), in just a number. A single price contains all the information of the supply and demand of a product.
Once the importance of money is clear let’s dive into its properties, functions and characteristics. Later on, we’ll apply this theory to cryptocurrencies in particular.
Which assets can be money?
Not all assets can perform the function of money. For an asset to become money it needs to present the following physical properties or characteristics:
- Durable.
2. Scarce.
3. Fungible and divisible. It can be divided into smaller units to adjust the prices more accurately.
4. Small transactions costs. It must be easily transferable and difficult to steal and forge.
What are the functions of money?
However, fulfilling these properties doesn’t mean an asset is money. For an asset to become money, it has to be monetized, that is, it has to be used by a sufficient number of people to carry out the functions of money, which are:
- Medium of indirect exchange with widespread acceptance.
2. Value deposit. This function is complementary to the first one: while an interesting buying or investing opportunity is not found, money is hoarded until better circumstances arrive.
3. Unit of account. Price references and financial accounting of goods valued in money.
What are the ideal characteristics of money?
For an asset to properly perform the previously mentioned functions of money it has to meet, ideally, the following economic characteristics:
- Its value or purchasing power is invariant or stable in the light of changes of person, time, place, and quantity.
2. It is the most liquid good, it can be sold and bought fast and in huge quantities without hardly altering its price or purchasing power: it is used, demanded and offered by everyone all the time. (its supply and demand are wide, deep and constant, with possible variations depending of economic activity). If you are now heading to Coinmarketcap to check the volume of your favorite token, take into account that according to recent reports up to 80% of the volume listed in Coinmarketcap is fake.
3. Its value doesn’t fluctuate in the short term and doesn’t present tendencies in the long term (it isn’t a speculative investment instrument, which implies some kind of risk and uncertainty).
4. Its geographical and spatial area is wide.
5. Its marginal utility is almost constant.
6. It has a minimum spread between the price asked by the vendor and the price offered by the buyer.
At this point, we can consider money as a characteristic which certain kind of assets present in a greater or lesser degree. If the economic characteristics of an asset are getting close to those of money and if it is been used to perform the functions of money we will say that the asset is being monetized. On the contrary, when those characteristics are moving away from the ideal ones, we will say that the asset is being demonetized.
Now that we have a clear picture of what money is, let’s apply this theory to cryptocurrencies.
Cryptocurrencies are assets immerse in a monetization process.
By now, it should be clear that cryptocurrencies are not money, as they don’t present its characteristics and neither are they used to perform its functions. Rather, we can consider them assets immerse in a monetization process. Right now, Bitcoin is, with a clear advantage over other cryptocurrencies, the most monetized one: its volume and value are the greatest, it’s easy to buy and sell it for fiat (which is a crucial thing, as in the first phases of a monetization process, when the asset is highly volatile, economic agents will want to minimize the risk derived from its volatility by selling and buying it fast) and it’s the most used. However, bitcoin is still in a very early stage of the monetization process and it will likely never complete this process. To see why is that, let’s see first how this monetization process would be. The monetization process for a cryptocurrency would look as follows:
First, a cryptocurrency needs to fulfill the properties of money better than other alternatives such as fiat. Thanks to the superior properties of this cryptocurrency, people will start to use it for specific use cases where the cryptocurrency is specially suitable, such as sending money over the Internet, developing new business models based on micropayments or smart contracts, or as a value deposit in economies with hyperinflation. As more people use it to carry out the functions of money the asset will gain value, volume and stability, making it even better to carry out the functions of money and so the process feedbacks itself until the asset is so close to the ideal characteristics of money that we can consider it money.
So the main fuel of the monetization process is adoption. It is also clear that the value increase of cryptocurrencies nowadays is not fueled by adoption but by pure speculation. Bitcoin is the main exponent of this: it’s clearly not suitable as a payment method, as we have seen innumerable times, as soon as its use slightly increases fees skyrocket; and it’s also not a value deposit, despite many bitcoin investors repeating this mantra over and over again: How can an asset with the volatility of Bitcoin be a value deposit? Do you really know anyone who has bought bitcoin in order to keep the value of his wealth stable? This is true even in countries with hyperinflation, where bitcoin fees represent a non negligible fraction of the average wage. The bitter truth for many bitcoin investors is that bitcoin is, nowadays, mainly a speculative instrument, nothing more. Just as every other cryptocurrency out there.
Why most cryptocurrencies will never become money.
Let’s go back to the fundamental properties of money. As we have just seen these are the foundations upon the monetization of an asset is built. If cryptocurrencies are not able to offer a huge improvement in this respect over current forms of money, they will never be monetized. Most cryptocurrencies are durable, scarce, fungible and divisible, but so are most fiat currencies. Regarding the scarcity aspect, it’s true that central banks incur in all kinds of manipulations (i.e financial repression)of the money supply to benefit certain actors such as governments, but is naive to think that mass adoption is going to come this way specially when cryptocurrencies are yet in a very early stage of the monetization process, and thus they are by no means an alternative to the fiat system. However, it’s true that if governments and central banks keep insisting in this policies the monetization process of cryptocurrencies could accelerate. The only property of money where cryptocurrencies can offer a huge improvement over the current financial system are transaction costs. So, the key aspect for the monetization of cryptocurrencies are transaction costs.
First of all, we can divide transaction costs in two parts: how long will it take for a transaction to be confirmed by the network and, the most important, how much will be charged for each transaction. As it is greatly explained in this article, transaction fees (which are an inherently part of most DLT solutions), are a huge issue when it comes to mass adoption as they are detrimental to any large-scale business application.
The thing is, in most DLT projects out there, fees are an inherent part of the network, as they are used to compensate validators for securing the network. Validators are also a governance nightmare as their interest is opposed to the interest of users. Users want to transact as fast and as cheap as possible and validators want to earn money. In consequence, validators will likely never approve changes in the network which could result in less fees for them. They also won’t approve any change which might make their investment worthless. Do you think bitcoin miners are going to accept a more eco-friendly change in the protocol (nowadays is clear that there are better alternatives than proof-of-work based consensus) which may make their mining hardware useless?
From my point of view, the monetization process of any DLT that depends on validators is very problematic. Some cryptocurrencies are moving away from this approach of securing the network through fees. The most prominent one is Iota, which uses instead a collaborative approach: if you want to use the network you must validate two other transactions. Using this approach the validation of the ledger depends of users and node operators, resulting in a system without fees and without a dichotomy between users and validators. However, the technology of Iota (like the technology of all other DLT projects) is not yet mature. Right now, due to technological reasons, no cryptocurrency is ready to complete or even advance significantly in the monetization process. Indeed, with the current technology the mass adoption of cryptocurrencies is impossible.
All in all, no cryptocurrency is money right now and, until technology is mature enough to permit thousands of transactions per second at a negligible cost, they will never become money. Nowadays cryptocurrencies are hardly used to perform the functions of money, making their price very unstable and based only in the mood of speculators.
I really hope this article had help to shed some clarity around the topic of whether cryptocurrencies are money.
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