4 min read.Updated: 01 Feb 2018, 10:09 AM ISTNoah Smith
Bitcoin or other cryptocurrencies represent a belief in the theory that fiat money is doomed, and a hedge against the possibility that fiat-based payments systems will one day collapse
I hate to say I told you so, but … well, I told you so. Bitcoin, while still a popular financial asset, is looking less and less like a currency. Online payments company Stripe is ending Bitcoin support. It cites several reasons for doing so:
“[Bitcoin] transaction confirmation times have risen substantially; this, in turn, has led to an increase in the failure rate of transactions. … By the time the transaction is confirmed, fluctuations in Bitcoin price mean that it’s for the “wrong" amount. ... Furthermore, fees have risen a great deal … making Bitcoin transactions about as expensive as bank wires."
A steady trickle of companies is no longer accepting Bitcoin as payment for goods and services. Such transactions never became very widespread in the first place. Even a Bitcoin conference in Miami refused to accept Bitcoin for its attendance fees!
There are essentially three reasons Bitcoin isn’t working out as a currency—two technological, and one economic. Technologically, Bitcoin tends to be slow and laborious to use because it verifies transactions in small blocks. That problem isn’t particularly hard to overcome—just use bigger blocks, or use a form of temporary credit to ease the burden on the network. More ominously, Bitcoin relies on people known as miners to verify all transactions, and compensates them by creating new Bitcoins. But soon, this will stop, since the total number of Bitcoins is capped at 21 million—at that point, transaction fees will be needed to pay miners.
It’s very possible that all of these technological problems will be overcome, either by Bitcoin or by rival cryptocurrencies. Lots of smart people are working feverishly on solutions. But there’s also an economic reason why Bitcoin and other cryptocurrencies will never be useful as money. Things that are good financial investments don’t make good currencies, and vice versa.
In any reasonably efficient financial market, there’s a risk-reward trade-off. Things that make good long-term stores of value, like stocks and real estate, tend to fluctuate in value in the short term. Short-term volatility is bad for payments, especially if it takes time to confirm a transaction, as in Bitcoin’s case, because you don’t know how much you’re actually paying for things. The guy that bought a pizza for 10,000 bitcoins in 2010, or more than $100 million based on recent prices, certainly regrets it now! Similarly, if you got your paycheck in stock, or real estate, or Bitcoin, you wouldn’t even know at the beginning of each month if you’d be able to afford your rent, food and other necessities at the end of the month.
This is why most workers get paid in US dollars, and why nobody buys groceries or pays rent with Apple shares. Instead, they use fiat money, like the dollar. Dollars are terrible long-term stores of value—they depreciate at the rate of inflation, about 2% a year. But since that rate is very steady, it’s predictable—you know how much you’re paying and getting paid.
So cryptocurrencies won’t be actual currencies, except for drug dealers and other people who can’t use normal forms of payment. But will they be good financial investments? Some won’t—some will be scams, and many will simply fall into disuse and be forgotten. But some may remain good investments, and even go up in price over many decades.
A similar phenomenon has already happened: gold. Legendary investor Warren Buffett once ridiculed gold for being an unproductive asset, but the price of the yellow metal has climbed over time.
Why has gold increased in price? One reason is that it’s not quite useless—people use gold for jewellery and some industrial applications, so the metal slowly goes out of circulation, increasing its scarcity.
But another reason is that people simply believe in gold. In the end, the price of an asset is what people believe it’s worth. Many people believe that fiat currencies will eventually collapse, and that gold will reemerge as the global currency. That narrative has survived over many decades, and the rise of Bitcoin as an alternative hasn’t killed it yet. Maybe there’s a deeply embedded collective memory of the Middle Ages, when governments around the world were so unstable that gold and other precious metals were widely used to make payments. Gold bugs, as advocates of gold as an investment are commonly known, may simply be hedging against the perceived possibility that the world will enter a new medieval period.
Similarly, Bitcoin or other cryptocurrencies may never go to zero, even if no one ends up using them for anything. They represent a belief in the theory that fiat money is doomed, and a hedge against the possibility that fiat-based payments systems will one day collapse. When looking for a cryptocurrency to invest in, it might be useful to think not about which is the best payments system, but which represents the most enduring expression of skepticism about fiat money itself. Bloomberg View
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