The price of the digital currency Bitcoin has skyrocketed this year for myriad reasons, and many cryptocurrency advocates are nodding approvingly as rising prices reflect higher demand.
In March, Bitcoin was hovering at just $1,000 per coin, and now the prices have tripled. Currently, a single bitcoin (BTC) is worth almost $3,300. But while the meteoric rise is good for speculators, it is extremely bad news for people who wish to see Bitcoin’s adoption as a functional currency.
If you open any macroeconomics textbook, it will identify a “currency” based on three things, says Lawrence White, a professor at NYU’s Stern business school. “It’s a medium of exchange, which means you can use it to buy and sell stuff. It’s a unit of account, to keep track of stuff. And it’s a store of value,” he tells Yahoo Finance.
Bitcoin’s massive gains of late make it even tougher to function in those three arenas. For people to want to use a currency for commerce, keeping track of value, and storing value, at least some stability is vital.
Bitcoin’s value is all over the place
“I have a fair amount of trust that a dollar today will be worth approximately the same amount of stuff tomorrow,” White says. “I don’t have the same confidence that may be true with Bitcoin. It’s also the reason why General Motors stock has not become a substitute in transactions for dollars.”
White strikes the heart of the matter with this description. Bitcoin has been behaving much more like a long-term, buy-and-hold investment than a currency for daily use.
As such, people who are betting cryptocurrencies will take off aren’t looking to empty their Bitcoin wallets, but to buy and hold. There is absolutely no motivation to transact in Bitcoin besides the privacy and security aspects, which are not a major factor for most people. What if one bitcoin is worth $4,000 next month? It’s not hard to see how a bull market is bad for the transactional vision of the cryptocurrency.
For Bitcoin to gain traction, it has to achieve at least a semblance of steady value. “We are reluctant to transact in something where the day-to-day value for our transactions’ purposes could vary substantially,” White said.
Acceptability is everything
Bitcoin does have a few things going in its favor. Some retailers like Overstock.com do accept Bitcoin. According to White, acceptability is perhaps the most important mark of a currency, and that’s one of the reasons the U.S. dollar is so powerful: The government says it legally must be accepted.
Bitcoin does not have this governmental guarantee of universal acceptance, so citizens or businesses are not obligated to accept those payments. “It’s self-reinforcing,” White said. “Why do people accept it? Because they believe other people will accept it. Why do they frown and are reluctant or refuse? Because they’re afraid they wouldn’t be able to find anyone to accept it.”
For Bitcoin to become more currency-like, it needs to conquer the currency paradox: When more people accept it, more people will accept it. This network effect is key.
There is no insurance to back it up
Bitcoin has another serious roadblock to complete acceptability as currency: insurance. Since the 1930s, the U.S. has offered deposit insurance, and currently up to $250,000 per account is insured by banks chartered with the FDIC. The system has never failed.
For a cryptocurrency, none of that guarantee is there, making it tougher to justify in large quantities. A disappearance is not unheard of in the Bitcoin world, and in 2014, 850,000 bitcoins went missing from Mt. Gox, a Japanese Bitcoin exchange. While some have been recovered, there was no insurance to make depositors whole.
Bitcoin’s founder(s) got a lot right though
Despite having some serious headwinds that may prevent Bitcoin from being a more mainstream method of transaction, Bitcoin’s founder (or founders—no one knows, still, the true identity of the pseudonym Satoshi Nakamoto, who wrote the Bitcoin white paper in 2009) cleverly hurdled many issues for fledgeling currencies. The genius of Bitcoin is that it managed to solve many of the standard issues of currency. If a successful currency needs to gain people’s trust and near-universal acceptance, it needs to assure people that it won’t flood the market.
“With US currency, we’ve mostly been relying on restraint of our national government, not to just run the printing press,” White said. With Bitcoin, the mining process and blockchain seem to successfully restrain the amount of growth and prevent hyperinflation.
Not only is it likely impossible for Bitcoin’s founders to simply crank the printing presses to make themselves rich, potentially hyperinflating the market, but the Blockchain technology means that another issue is solved: counterfeiting. Fighting counterfeiting is an extremely important process for making a currency more stable; it’s why the U.S. expends considerable resources to protect its currency.
These barriers to becoming currency may last a while
It is certainly possible Bitcoin won’t stabilize any time soon to become a widely used currency. Predictions for Bitcoin prices in 2022 from Fundstrat put a single bitcoin’s potential value at $12,000 to $55,000 per unit, a growth factor of around 3x to a whopping 16x from today’s prices.
But it would be unimaginative to only view Bitcoin in terms of investing or transactional currency. There is most certainly a middle ground, usually exemplified by the asset class most associated with Bitcoin — gold. Both are asset classes with a unique inherent value, gold is a useful material, and Bitcoin is also a self-supporting payments network.
Since it stopped being proper currency, gold has become something between an investment and transactional currency — a way to hedge, and an alternate, albeit awkward, quasi-currency with the built-in benefit. And this fate, rather than actual use-it-at-the-store currency, may be Bitcoin’s ceiling.