What is Bitcoin? Part 2

In Part 1 of this multi-part blog series, I tried to define what Bitcoin is by explaining it as a crypto currency.  This leads us onto a fundamental question – is Bitcoin digital money at all?  To understand more about this, let’s examine what money is. This is a weird question for most of us to ponder.  Since childhood, we have intrinsically gotten the concept of what money is… So, why do we need to go back and reevaluate this fundamental component of how our lives work?  If we are going to pervasively adopt Bitcoin, then we must be doing it for a reason, and that reason, many would argue, is that something is wrong with the existing structure of how money works.  The crypto community firmly believes that we need a replacement for how money works today.

A great place to start when researching money is the International Monetary Fund. They are the global steward of Money, so why not start with the experts? They have an excellent and informative blog called “What is Money?”. The IMF blog authors break it down like this:

Money can be anything that can serve as a:

  1. store of value, which means people can save it and use it later—smoothing their purchases over time; 
  2. unit of account, that can provide a common base for prices; or 
  3. medium of exchange, something that people can use to buy and sell from one another.

The IMF blog goes onto clarify:

At first, the value of money was anchored by its alternative uses, and the fact that there were replacement costs. For example, you could eat barley or use peppercorns to flavor food. The value you place on such consumption provides a floor for the value. Anyone could grow more, but it does take time, so if the barley is eaten the supply of money declines. On the other hand, many people may want strawberries and be happy to trade for them, but they make poor money because they are perishable. They are difficult to save for use next month, let alone next year, and almost impossible to use in trade with people far away. There is also the problem of divisibility—not everything of value is easily divided, and standardizing each unit is also tricky; for example, the value of a basket of strawberries measured against different items is not easy to establish and keep constant. Not only do strawberries make for bad money, most things do.

But precious metals seemed to serve all three needs: a stable unit of account, a durable store of value, and a convenient medium of exchange. They are hard to obtain. There is a finite supply of them in the world. They stand up to time well. They are easily divisible into standardized coins and do not lose value when made into smaller units. In short, their durability, limited supply, high replacement cost, and portability made precious metals more attractive as money than other goods.

Let’s break this down further. Bitcoin is a store of wealth; we can get hold of Bitcoin and use it later. It can also be defined as a unit of account because Bitcoin provides a common base for prices and I can use it to buy and sell things.  But can we really? Yes, we can. Bitcoin has all the properties of a currency, but some would argue, me included, that while it passes the test of ‘is it money?’, it is not being used as such.

My personal experience is that I have ‘invested’ in Bitcoin with no intention of using this new form of money to buy anything.  I am what is known in the Bitcoin community as someone who Hodl’s Bitcoin. Hodl is a slang term in the crypto community that originates from a December 2013 post on the Bitcoin Forum message board by a spelling challenged user who posted in the subject “I AM HODLING”.  The term has stuck.  The most famous Hodlers are the Winklevoss twins who have amassed a Bitcoin fortune by never selling.  The recent book about their Bitcoin adventures is a great read. Bitcoin Billionaires.

Metaphorically speaking, I am putting my Bitcoin under the bed and not using it as a form of exchange; I use the $ and GBP for that.  So, why am I not using Bitcoin as money when I believe in it so much?  For a variety of reasons. Firstly, I believe its value will increase over time. What is fast becoming the go to blog which explains this theory is this one written by Plan B. It’s tough going, so I warn you in advance this is not for the beginner, but is very well worth the time for extra credits.  Basically, the theory goes that Bitcoin has a limited supply, 21 million Bitcoins, and therefore when something is scarce and in demand, the price will go up…  I plan to come back to Bitcoin as an investment ‘store of wealth’ in future blogs, as this is a mind field of opinions and regulations.

The other reason that I believe Bitcoin is not currently operating as a replacement for fiat currencies is its lack of widespread adoption.  Fiat currencies are a form of currency whose legal tender (bank notes and coins) are backed by a government.  Think of the dollar being backed by the US Government as the best example. According to consensus estimates, Bitcoin is used by 60m people globally, or roughly the population of the UK. I have yet to see anywhere in a retail context that will accept Bitcoin as a replacement for dollars.  Until this changes and adoption is widespread, I think Bitcoin fails one of the basic tests of ‘is it money?’.  

Now, before the Bitcoin revolutionaries revolt, I do believe it will past this test at some point in the future and we will get to a point where it is the norm to buy pizza with Bitcoin, rather than a crazy story from 2010 of how Laszlo Hanyecz paid 10,000 bitcoins for 2 pizza’s.  We need a lot to happen before this becomes true.  We need to see less volatility in the price for a start.  Why would I use something as medium exchange when it stands a chance of appreciating in value by 20% in 24 hours? You would just wait 24-hours and it would be 20% cheaper relatively speaking.  

Again, not to anger the Crypto gods, volatility is not unique to Bitcoin or crypto currencies, nor is it a bad thing.  By way of a personal example, I moved to the US 5 years ago and the exchange rate was 1.5 dollars to the pound. Now the exchange rate is 1.25 dollars to the pound.  Therefore, the pound has devalued against the dollar over the last 5 years because people have less faith in the UK and its government than they did 5 years ago.In case you were unaware, we mainly have Brexit to thank for this scenario. However, this level of volatility in fiat currencies is something we can live with. The levels evident in Bitcoin right now, however, we can’t live with.  This gets more interesting where fiat currencies are under stress and hyperinflation has taken root, i.e. Venezuela, but we will come back to their woes and how the Petro crypto currency is being touted as the answer in a later blog post.

I believe we are currently in the stage of Bicoin’s development where we are discovering the price.  If you think Bitcoin is only 10 years old, this is not surprising.  Price discovery, as the financial guru’s describe it, is a whole blog topic in of itself so I will come back to this in subsequent posts.

To summarise, I believe Bitcoin is a currency.  I also strongly believe, that at this current moment, it is not being used as such, and its current usage is more akin to a single company share.  Investors being over exposed to one company’s share price is a path to a wild ride.  The total value of all the Bitcoins in circulation is about $200bn and IBM’s Market Capitialisation is ~$125bn. A simple way to think about where we are today with Bitcoin is to imagine you are solely investing in IBM stock and expect the same level of volatility.  When this stage of Bitcoin development will calm down and we reach mass adoption and truly operate like money is the real question, and if I knew that, I wouldn’t be writing this blog.

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