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It would appear that 2017 could be fairly called the Year of Bitcoin. The most popular and thus valuable cryptocurrency has been breaking record after record this year. On 8 November, 1 BTC was trading somewhere around $7,700; at the beginning of the year it was worth about $960). Crazy.
However, due to the fork that did not happen (and the Bitcoin community was rather looking forward to it, as the intended development should have increased the speed of transactions), the market reacted harshly. Bitcoin quickly lost quite a chunk of its value. At one point in time, it was as low as $5,600, but at press time had rebounded to $7,200. Hence, it is growing. Again.
Despite seeing all of this, I am still quite surprised that many people tend to think that Bitcoin is a currency, though at this point in time it is not a threat to our regular fiat currencies. On the other hand, a number of people seem to realize that transaction times, energy inefficiencies in Bitcoin mining and the like are some of the key challenges that prevent Bitcoin from becoming a true alternative to USD, GBP or EUR.
No matter which position you hold, I must disappoint you (but stay me with nevertheless!) – Bitcoin is no longer a currency, and it will never be one. Here’s why.
Money, or essentially any fiat currency (such as USD, GBP or EUR) should satisfy three key criteria:
It should function as a medium of exchange,
It should be a unit of account, and
A store of value.
Although Bitcoin has some of the attributes listed above, it most definitely fails to meet them all. Let us take a look at them one by one.
Medium of exchange
We most probably have to agree with this one as more and more merchants are starting to accept Bitcoin as a payment option (Google has launched its payments API with Bitcoin, Amazon is rumored to soon start accepting payments in Bitcoin, etc). Moreover, the network of Bitcoin ATMs and the number of Bitcoin Payment Cards is growing constantly, which makes this crypto similar to our beloved fiat.
However, this is only one side of the coin. In fact, the most popular cryptocurrency performs quite poorly as a medium of exchange. This is fundamentally due to high volatility, which makes it inconvenient and impractical to denominate goods or services in Bitcoin. For example, at the beginning of the day you might price your MacBook at 1 BTC, but due to daily fluctuations (that can range up to 30 to 40 percent), at the end of the day it should cost 1.5 BTC. To put this into perspective, the daily exchange rate between USD and EUR is on average 1 to 3%.
Unit of account
In economics, a unit of account denotes a nominal monetary unit of measure or currency used to represent the real value of any economic item such as goods, services, assets or liabilities, income, expenses. Again, referring only to volatility, we can understand that Bitcoin does not satisfy this criterion.
Another important point to consider is that no lenders use Bitcoins as the unit of account for such things as consumer credit, loans or mortgages, nor are credit or debit cards denominated in Bitcoin, per se (you can spend your Bitcoin, but the real transactions happen in fiat since the digital currency is sold on the back-end).
Store of value
The last trait that should be found in any currency is probably the only one that fits Bitcoin the best.
It is quite clear, and I have argued this numerous times, that Bitcoin has emerged as a digital peer-to-peer cash, and thus is challenging current monetary systems. Yet, over the years it has outgrown its initial purpose, and now it is more similar to a store of value, or an alternative investment.
The latter two are essentially driven by speculation and hype around the cryptocurrency space in general, and Bitcoin in particular. We can look no further than Google search trends for Bitcoin, and compare those with the price of BTC. Put those together, and you will see nearly 1-to-1 correlation.
Moreover, many people are buying (or storing their wealth in) Bitcoins simply because they expect the price to rise, at least for a while. This is reminiscent of the Greater Fool Theory which states that people buy something simply because they expect that there will be a greater fool that will buy their asset later at a greater price.
But there are others who are storing their wealth in Bitcoins simply because the alternative (fiat) is non-functional. Look no further than Zimbabwe or Venezuela. In the former, BTC is priced somewhere around $13,000! Due to high inflation, the demand for Bitcoin has skyrocketed lately in this Southern African country, as not only people, but also businesses demand Bitcoin for day-to-day purchases.
Nevertheless, though the store of value resembles Bitcoin pretty well, it is still rather different to what conventional money should have. Probably one of the key features of currency as a store of value is that it should be stable. And this is especially important for countries that are striving to attract investment. Simply put, those who invest are expecting some stream of future earnings, and unstable currency compromises investors’ ability to accurately predict future earnings, which makes investments less valuable, and hence less attractive.
Bringing it all together
After taking a look at the key attributes of a currency, we can easily see that Bitcoin is not one. Taking into account slow transactions, relatively high costs and energy inefficiencies for running the network, as well as some fundamental disagreements (in terms of future developments) within the Bitcoin community, it is more than obvious that this cryptocurrency will never seriously challenge USD, GBP or EUR.
However, this does not mean that Bitcoin has no future. Quite the opposite. I can imagine it being quite a popular and strong (alternative) asset class. With the help of network effects, rising interest from institutional investors, as well as more crypto-friendly regulatory framework, Bitcoin can become quite a something.
Disclaimer: The views and interpretations in this article are those of the author and do not necessarily represent the views of Cointelegraph.