The received wisdom among academics is that for something to be considered ‘money’ it has to perform three functions. It must act as a unit of exchange (you can pay for goods and services with it); a store of value (you can have confidence in just how much you can buy with it); and a unit of account (it’s a means of recording financial balances).
And the received wisdom is that cryptocurrency, because it is not widely used for transactions, and because it is volatile, and because it is not widely used as a unit of account, cannot, therefore be considered money.
There are several problems with the received wisdom, however. For one thing, it is incorrect to suppose that all three of the above three criteria are equally necessary, or indeed independent of one another.
It is the quality of being an accepted form of payment that really makes money money. Being stable in value helps bring about this acceptance, but it is not essential. It’s more of a ‘nice to have’. Plenty of fiat currencies are very unstable, after all. And being a unit of account is something that is likely to arise as a result of being an accepted form of payment.
Essentially, the academic objection to crypto being considered money, boils down to whether or not it is used as a medium of exchange. And many of the objections on that front are likely to diminish over time, as adoption and usage rise.
Here, we consider each of the three criteria for money, starting with the most important: can you spend it?
Medium of exchange
Now, apart from a few stores, you can’t spend crypto very readily. At the moment, you’d find it difficult to enter a shop on main street, or online, and pay in crypto. And that does tend to undermine the extent to which cryptocurrency can be considered money.
The obvious counter to this argument is that, in time, acceptance of crypto as a form of payment will almost certainly rise. Not many retailers accept crypto yet, but many more probably will in, say, ten year’s time. And even if the uses of crypto remain niche, considered on a global scale, usage will surely come to rival that of at least some fiat currencies.
Moreover, the race is on to provide crypto-friendly marketplaces. Some are traditional e-commerce websites, while others are themselves powered by blockchain, like BitBay. As these marketplaces grow, and the feature-rich platforms created by smart-contracting allow new types of transaction to be made, and new uses emerge, adoption will rise.
There is also the advent of so-called ‘second layer’ solutions to improve transaction speeds and reduce costs for Bitcoin itself, which seek to make it less like digital gold and more like digital dollars. And there are numerous projects underway to improve the crypto-to-fiat interface for retail spending.
Crypto may not be a convincing medium of exchange now, but it certainly will become so, perhaps soon.
Store of value
The second criteria, and a slightly lesser one than the first, is that the value of money should be stable. Therefore, the argument goes, the extreme - and it is extreme - volatility of crypto effectively rules it out as currency. It’s value is too unreliable to be thought of as any kind of a store of value. This argument, again, may not age well, as Bitcoin and others will inevitably reach their ‘true’ or fundamental value eventually.
Now, nobody knows what the fair value of Bitcoin is or how long it will take to get there. That’s partly because there are feedback loops involved. A higher price creates interest in the asset. Increased interest leads to greater demand and adoption. And that, in turn, leads to higher prices, and so on. It will take time for the process of price discovery to play out, but once it has, the price of cryptocurrency should become less volatile. At that point, it fulfils the store of quality criterion. That, in itself, will raise the fundamental value of cryptocurrency further.
That feels like a pretty long-winded process, however. And it’s possible that the market simply remains highly volatile. That’s where stable-coins come in. Stable coins, variously, all seek to address the problem of volatility. They try to provide a stable store of value.
The only effective stablecoins in operation at present, however, are tethers, which are tokens that are pegged to fiat currencies and achieve stability by promising one-for-one backing with the underlying. But there is no guarantee, or even a suggestion, that the token is convertible to the the fiat that backs it. And there are question marks about just how well-backed these tethers really are.
Fortunately, genuine blockchain stable-coin alternatives are being developed. These take different approaches to solving the problem of volatility. Most are some way off, but there is a major peg attempt coming later this year by BitBay.
The aim of BitBay’s ‘dynamic peg’ is to dampen volatility, with a view to providing users of the marketplace sufficient confidence to transact without concern about the risk of arbitrary transfers of wealth arising from price changes. In other words, it seeks to provide users with precisely the store of value that would qualify it as being money-like.
Besides, as the crypto economy grows, and as its use as a medium of exchange grows, it may well be that parts of the economy reside fully within that environment. Attachment to fiat values might, then, decline. If the price in satoshis is stable, the price in dollars, variable or not, may become moot.
Moreover, a store of value performs better if it is also liquid, portable and it can be used to transfer wealth quickly and efficiently. Stability isn’t everything, when it comes to defining what constitutes a ‘store’. It’s clear that part of what makes money a ‘store’ of value is its convenience.
But the academic literature looks at this aspect of money entirely through the prism of existing banking arrangements and payment systems. On each of these dimensions, crypto compares very favourably with fiat. In terms of portability and transferability, crypto beats fiat currency hands down.
Again, taking BitBay as an example it can be accessed via secure web wallets, cold wallets, the client and soon, too, a mobile app. Transactions anywhere in the world, at any time of day or night are fast and close to costless.
Arguably, what users of money place greatest weight on, in terms of the usefulness of money, may be the freedom it provides from cumbersome, and expensive, banking arrangements and payment systems. There are trade-offs that might mean crypto comes to be viewed as currency, despite its volatility.
Unit of account
The third characteristic of money is that it should act as a unit of account. It’s the base price by which assets and liabilities, credits and debits, incomes and outgoings, are tallied up.
It almost goes without saying that any asset that performs the first two of the above functions, will also perform this third function. Indeed, arguably, it follows simply as a logical consequence of satisfaction the other two functions. Failure to satisfy this criterion, then, is not a distinct grounds for denying the moneyness of crypto.
Ironically, however, one might argue that if there is one thing that crypto does do, it is to act as a unit of account. Indeed, that’s what a distributed ledger is, nothing more, nothing less. It’s the value of the units - the tokens - that is the issue.
In a sense, cryptocurrency tackles the three purposes of money in precisely the opposite order to that taken by fiat. The distributed ledger provides a trustless record of ownership and transactions, the basis of which is a token, or unit of account. The store of value function will flow from that, as adoption grows and the equilibrium value of that token is discovered. And, eventually, that token will be used as a medium of exchange, as its speculative appeal diminishes.
So, where does all this leave us?
It probably is too soon to declare cryptocurrency meets the standard requirements needed to be considered money. But that does not imply that cryptocurrency will never satisfy these criteria.
And things move fast in crypto. It seems highly likely - certain, even - that some time soon, cryptocurrency will satisfy these criteria. Some tokens may even be doing so already, just on a small scale.
Moreover, the criteria for what constitutes money may themselves soon be in need of a rethink.
Barely a month passes without news of some hack in which banking details have been stolen, or banking IT system meltdown that leaves tens of thousands without access to deposit accounts, or payments systems failure that prevents clearing of transactions. Crypto, with its superior security, and its complete independence from outmoded and creaky banking and payments systems, may ultimately prove to be more accessible and reliable than conventional deposits - and so represent an altogether superior form of money.
And perhaps, in a decade or a century’s time, smart contracting and use-case will be as much a part of what makes money, money, as those more primitive requirements associated with being a simple medium of exchange.
Ultimately, the defining characteristics of money that were suitable in the fiat age are unlikely to be the same as those that define money in the age of blockchain.