In traditional economics talk, money has 3 functions and 6 characteristics.
The 3 functions are:
- Money as a store of value
- Money as a medium of exchange
- Money as a unit of account
And the 6 characteristics are Durability, Portability, Divisibility, Uniformity (i.e. Fungibility), Limited Supply and Acceptability.
If you don’t already understand this, here’s a great article from the Federal Reserve Bank of St. Louis to explain it:
However, the crypto crash over the past 6 months and the fact that cryptocurrencies like Bitcoin (BTC) and Ether (ETH) are still not widely used for commerce have led me to believe that the current economic model is incomplete.
BTC supporters tout BTC as being like digital gold. It can, theoretically, perform all the 3 functions, and has 5 out of the 6 characteristics. The only thing missing is Acceptability, because BTC, unlike the US Dollar, is not universally accepted by most people and most governments.
Let’s put the government’s distaste for crypto aside first, let’s talk about people. While a lot of people own crypto, why is it still not widely used to pay for goods and services?
For a start, merchants don’t want to price their goods and/or services in crypto. They may accept payment in crypto, but that’s not the same as denoting their price in crypto.
For example, this is from a website that accepts crypto payments. It sells a small bowl for SGD 21.89 including shipping.
When I progress to the payment stage and choose to pay in crypto, I was initially quoted a price of 0.00054119 BTC.
30 seconds later, I refresh the page, and the price changed to 0.00054145 BTC.
As illustrated, even merchants that accept crypto payments don’t denote their prices in crypto. The prices are fixed in a fiat currency and then converted to variable amounts of crypto at prevailing exchange rates.
Why don’t merchants denote their prices in crypto then? The reason is simple: instability of value. Let’s use an example of a retailer selling a laptop that is worth either USD 1,200 or 0.04 BTC (at the time of this writing), when 1 BTC is worth about USD 30,000. He then chose to fix the price at 0.04 BTC.
If the price of BTC next week rises 20% to 1 BTC = 36,000 USD, his laptop will be selling at the equivalent of USD 1,440, pricing him out of the market as his competitors are still selling the same laptop at USD 1,200.
If the price of BTC drops 20% to 1 BTC = 24,000 USD, he will no doubt get a lot of orders since he’s now 20% cheaper than his competitors, but he would make $240 less on every deal. Furthermore, he may run out of stock and won’t be able to capitalize on the increased sales.
What if something worse happens? If BTC suddenly crashes and goes down by 50%, he may not even be able to cover his costs and lose money!
Ultimately, a merchant’s costs are primarily pegged to fiat currencies and not to crypto. If the rent, salaries and inventory are paid for in a fiat currency, denoting prices in a highly volatile currency like crypto is too risky for the merchant. At the end of the day, his core business is in the supply of goods and/or services, and not in speculative investments like a hedge fund.
At the same time, most consumers aren’t too keen on spending their crypto. While the merchant’s fear is that crypto will drop in value, the consumer’s fear is the direct opposite. Most people buy crypto in the hope that it will rise in value, possibly making them very rich. If they were to spend 0.0005 BTC to buy a small bowl, they’re worried BTC may appreciate 10x in future, which means the small bowl would eventually cost 10x more. It is the perceived opportunity cost that leads consumers to hoard their crypto instead of spending it.
Instability, therefore, lies at the crux of acceptability. Merchants don’t want to price their goods/services in crypto for fear of their value dropping. Consumers don’t want to spend their crypto for fear of missing out if the value appreciates.
Therefore, for crypto, and in fact, all forms of money, to be effective as a medium of exchange, its value relative to goods/services must remain stable. A gradual, slow appreciation over time is acceptable, but not 10x, 100x increases in a short time like what we have seen in the crypto market.
In traditional economics, “limited supply” is the characteristic meant to ensure stable value. BTC is, by design, limited in supply. However, why hasn’t this translated into a stable value?
I believe the answer is that there is a 7th characteristic needed to ensure stable value, and that is stable demand. A stable value can only be achieved when both supply is limited and demand is stable.
BTC has a limited supply, by design. But its demand, at the time of this writing, is far from stable. Thus, the values of BTC and other cryptos (with the exception of USDC) relative to goods/services are simply too volatile to be useful for any of the 3 functions of money. The reasons? Unstable demand. It is unstable because demand thus far has been driven mainly by investors and speculators who buy in the belief that it will go up in value. But once the bubble pops, confidence becomes fear and demand goes the other way, pulling down the value dramatically.
This volatility may or may not decrease in future, I am unable to foresee. But what I’m sure of is that, until the volatility is reduced, most of the cryptocurrencies in existence at the time of this writing will not be very useful as money.