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Bitcoin and the 3 Main Functions of Money
People can transact with Bitcoin and other cryptocurrencies globally, given the requirement to have internet access. Even in nations with restrictive cryptocurrency measures like China, Bolivia and Iran, people still explore ways to use cryptocurrencies for trading and mining purposes. So, we can assume that Bitcoin is borderless and global, but is Bitcoin really “money”? To answer this common question, we have to check whether Bitcoin satisfies the 3 Main Functions of Money.
- Medium of Exchange
- Store of Value
- Unit of Account
In order to evaluate Bitcoin as money in comparison to traditional currencies, we need to dive into the definitions of these 3 functions. Consequently, we will be able to understand whether Bitcoin can become a global monetary system.
Medium of Exchange
The ease/efficiency which a currency can be exchanged for products and/or services.
Traditional currencies like USD, EUR and GBP is an efficient method for people to exchange products and/or services. Therefore, money acts as an intermediary for the products and/or services that people wish to trade. Ideally, Bitcoin can become even more widely accepted than any other traditional currency, in case of global adoption. It is already more efficient in terms of costs, speed and transparency for the majority of business transactions.
The following features demonstrate that a currency is a decent “Medium of Exchange”:
The resistance to physical damage
- Traditional currencies are quite durable and resistant, but there are some instances of damage and wear especially for paper money
- Bitcoin purely exists online and is fully durable
The ease of transfer from one place to another
- Transfers of traditional currencies easily occur in a person’s pocket or even in huge containers. But can all transfers occur online without limits?
- Bitcoin transfers occur online without limits and minimal costs, whereas there are many types of limits on transfers of traditional currencies
When money is divided into small increments in order to facilitate the exchange of products and/or services of lesser value
- Traditional currencies are divisible i.e. John can exchange one 10 dollar bill for two 5 dollar bills etc.
- Bitcoin is even more divisible than traditional currencies i.e. up to eight decimal points
The degree to which an individual unit of a currency is interchangeable with another individual unit of the same currency
- Traditional currencies are interchangeable i.e. 1 euro coin has the same value with another 1 euro coin
- Bitcoins are fully interchangeable as well. Note that NFTs are cryptocurrencies which are not fungible in order to represent different value i.e. a game credit and an artwork
Whether money cannot be duplicated and used for real transactions
- Fake paper money is a big problem for all traditional currencies
- There are no duplications of Bitcoin on the same chain, due to its consensus algorithm and decentralization
Bitcoin appears to satisfy all features of a good “Medium of Exchange” in a more convincing manner than traditional currencies. For instance, Bitcoin is much more durable, transporable, divisible than EUR and USD and cannot be duplicated.
Unit of Account
The degree to which money can act as a standard measurement of the value of products, services, assets and liabilities.
A good “Unit of Account” is what allows us to measure and compare any given values like:
- Prices of 10 laptops, 1 car, 5 apples
- Monthly grocery shops of a household
- Price of the new iPhone
- Price of Bitcoin
- Net worth of Jeff Bezos
- Financial statements of a multinational company
- GDP of USA vs the GDP of Russia
Traditional currencies are the best tools to measure values globally. A key feature of a good “Unit of Account” is stability. Stability of a unit’s value, makes it much more convenient to be used as a “Unit of Account” within an economy. Therefore, traditional currencies are currently much more convenient to be used as a “Unit of Account” than Bitcoin due to their price stability and adoption rates.
Bitcoin fluctuation rates may indicate that cryptocurrencies are not adequate to act as a “Unit of Account” for an economy. However, circumstances may change over time if the price of Bitcoin becomes more stable accompanied with the emergence of stablecoins.
Fun Fact: A currency is usually, but not always both a “Medium of Exchange” and “Unit of Account” in a country. For example, during the time of high inflation in Chile, merchants posted prices in dollars but settled in the local currency at the current exchange rate.
Store of Value
A mechanism by which value can be saved and retrieved in the future with a high degree of predictability about its future value.
“Store of Value” is an attribute for a number of assets besides currencies. Arguably, the value of any given asset cannot have a perfect degree of predictability. Therefore, there is no perfect “Store of Value”, but most traditional currencies can nearly satisfy this concept, due to limited price fluctuations compared to other assets such as cryptocurrencies and real estate.
The ability of a currency to be a good “Store of Value” depends from the current expectations of stable or predictable future demand and supply for the asset. Notable examples besides traditional currencies include gold, stocks, bonds. As mentioned, all of these assets are subject to volatility and none of them is a perfect store of value.
Holding Bitcoin and other cryptocurrencies over the years, would be a great investment according to the price history so far. Due to this reason, some argue that Bitcoin is the best investment devision one could take and therefore the perfect “Store of Value” which maximized returns for investors. However, by strict definition, cryptocurrencies excluding stablecoins, are highly fluctuating assets and involve low degree of predictability regarding their future value.
The 4th Function… Standard of Deferred Payment
The recent classification of Bitcoin as legal tender in El Salvador, raised awareness regarding the 4th funtion of money, which could take Bitcoin to the next adoption level. The “Standard of Deferred Payment” implies that assets like a traditional currency and Bitcoin are widely accepted to buy goods and services.
Several countries are considering to rule cryptocurrencies like Bitcoin as legal tender in the future with the community voting Paraguay and Venezuela as the most probable. Industry stakeholders await to evaluate the outcome of new regulatory developments, which could affect business operations within the crypto ecosystem.
No currency exists that perfectly satisfies all the main functions of a currency. The same applies to Bitcoin and the thousands of cryptocurrencies within the ecosystem. However, given the competitive features of cryptocurrencies in comparison to traditional currencies such as decentralization, finality, transparency, speed and irreversability, who can bet against this mind-blowing technology?
More crypto educational material coming soon on The Crypto App blog.