For A Few Bitcoins More

The emergence of Bitcoin into the mainstream, and why it still isn’t money

Bitcoin is not money. That is the view of Mark Carney, governor of the Bank of England, in a speech given to the Scottish Economics Conference in March 2018. Mr. Carney draws upon the key characteristics of money as set out by Adam Smith in The Wealth of Nations: money must be a useful medium of exchange, a good store of value, and a suitable unit of account. In layman’s terms, the user of money must be able to buy things with it, must be reasonably confident that its buying power will be more or less the same on Friday when he gets it as it is on Monday when he needs to spend it; and must be able to define the value of other things by reference to it.

Clearly, we cannot expect cryptographically-secured assets and distributed ledger technology to have been within the contemplation of an eighteenth-century economist, no matter how visionary, and The Wealth of Nations does not contain a chapter on Bitcoin. However, Adam Smith’s principles are formulated in a reasonably technology-agnostic way and still retain considerable… currency – there’s really no other word for it – among today’s economists and regulators.

Bitcoin, Mr. Carney argues, fails on all counts, and his view is echoed by regulators across the world, including the Securities and Exchange Commission. To many observers, Bitcoin’s failure to satisfy all three of Smith’s criteria has at its heart one issue. As anyone who bought in at $19,783 / BTC in December 2017 and watched 65% of the value of their investment wiped away by the following March will testify, the price of Bitcoin is volatile. This volatility is the crux of Bitcoin’s struggle to be considered money: if it does not reliably keep its value, it has little chance of meeting any of Smith’s tests.

There were, as of January 2019, only around 500 to 600 retailers across the UK who accept Bitcoin. Volatility, caused by speculative activity, hype and the lack of a central bank to keep monetary policy under review, hampers the uptake of it by retailers and consumers. It makes it a very dangerous way to store value. And what shopkeeper in his right mind will denominate his prices primarily in a currency that comparatively few people use and understand, when price swings may mean he has to go round and change all the prices several times a day?

In fact, it might be said that Bitcoin’s problem is self-perpetuating. The lack of consumer demand for shops where it can be spent – fuelled by its unreliability, fuelled in turn by its volatility – keeps the volume of trade for the purpose of buying and selling other things low. Consequently, the proportion of trading volumes accounted for by speculative buying and selling remains high. Usually, the result of a high proportion of speculative trading is more volatility. The situation appears hopeless.

However, there are signs that Bitcoin’s stature continues to develop. In February 2019, the cryptocurrency financial services company BitGo announced that it was providing $100 million of insurance coverage, via Lloyd’s of London, for cryptocurrency assets stored in its cold wallets. Doubtless minds were focused on risk mitigation strategies by the travails of Quadriga, the Canadian exchange whose owner (it was reported, although the investigation continues) unexpectedly died, rendering over £100 million in cryptocurrency assets suddenly inaccessible, as I discuss in a previous blog. It seems that Lloyd’s insurers, not renowned for their devil-may-care attitude to value at risk, consider that they can accurately price an insurance policy covering Bitcoin and other cryptocurrencies. This may be indicative of a growing belief that the worst excesses of Bitcoin’s price fluctuations, now that the initial speculative hype has been firmly undercut by reality, are largely behind it.

Elsewhere, Bitcoin’s emergence out of the murkier reaches of the dark web and into the mainstream is further evidenced by the fact that Nasdaq, the world’s second-largest stock exchange, started quoting Bitcoin and Ethereum indexes on 25 February 2019, increasing the profile of, and access to, cryptocurrencies among traditional Wall Street investors. Time will tell what effect this has on price stability.

Of course, Bitcoin’s problems do not begin and end with volatility. Its emergence as a true mainstream currency may also be thwarted by capacity constraints. The speed at which the system can process new transactions is limited by the speed at which new blocks can be added to the blockchain, which results in a current maximum capacity somewhere between three and seven transactions per second. Visa, by comparison, can handle about 24,000 transactions per second. Visa also charges fees of around 1.5% of the size of the transactions, whereas Bitcoin transaction fees are an indeterminate affair, theoretically optional but practically geared around attracting the prompt attention of a block miner. Therefore transaction fees can greatly exceed those charged by Visa, introducing a measure of uncertainty and expense that may again hamper its widespread uptake.

Bitcoin was the first cryptocurrency. While its mysterious inventor, Satoshi Nakamoto, whoever he, she or they were, clearly knew how important an invention it was, it was understandably not designed with foresight of the huge extent to which distributed ledger technology and cryptographically-secured assets would capture the attention of industry and the wider public. Perhaps newer cryptocurrencies, conceived and designed in a post-Bitcoin world, will be better suited to mainstream use. Perhaps stablecoins – cryptographically-secured digital currencies that are pegged against the dollar and other fiat currencies, and which are currently causing regulators so many headaches – will prove to be the cure to cryptocurrencies’ volatility problem.

Perhaps, indeed, the refusal by Mr. Carney and other regulators to recognise cryptocurrencies as money goes beyond the economic limitations of the system, and is part of a wider fear of people transacting directly with each other, using mechanisms that are naturally resistant to regulation, putting global trade beyond the command of governments and central banks. If that should come to pass, The Wealth of Nations might not just need a new chapter. It might need a new title.


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