Cryptocurrency 101 – what is money?

Here is an interesting question; what is money?

We have a list of things we expect money to be good for. Medium of Exchange, Store of Value, Unit of Account.

Bitcoin has got the “Medium of Exchange” thing covered – that is what it does better than any extant currency.

But it doesn’t make a heck of a good unit of account, because it’s too volatile. For a unit of account, you want something that a lender will be happy to be paid in, or a debtor happy to pay, when an account comes due in a month or a season or a year. (Note that “lender” includes the idea of “savings account holder” and “debtor” includes the idea of banks borrowing money by offering people savings accounts… )

To be happy about that, the lender *AND* the debtor would both need a much firmer idea about what the value of a Bitcoin at that future date will be. Without that knowledge, you just don’t get a common view of the world where the lender and the debtor can both be happy about their prospects of paying/getting paid when what they owe is measured in these units.

And it doesn’t make a heck of a good store of value, for pretty much the same reasons. In a store of value, you want something that will allow you to get your value back out, undiminished, at pretty much any time, without worrying too much about fluctuating rates. The fact that people who “stored value” at $1100 last december only could get out about $600 today means that BTC is a failure as a store of value over that term, as compared to $USD. A good store of value is necessarily low-risk, and when we use BTC to store value we’re exposing ourselves to a fairly substantial risk.

Now, if like most of us you believe in a long-term upside to BTC value, that makes it a speculative instrument whose risk is measured against future gains — not a store of value whose risk is minimal.

So, on every count *EXCEPT* medium of exchange, it’s not doing all that well when measured against our traditional definitions of ‘Money.’

And how do people use a medium of exchange that isn’t a good store of value or unit of account? They keep track of what they own/owe in different units, then just buy some when they need to send money, send it, and the recipient instantly sells it to cover debts in those other units. This is what happens to national currencies whose future is uncertain but which can (or must) be used for transactions or remittances in those countries.

And what does that mean about the future of cryptocurrencies? I think that it means if we don’t find a way to regulate their value – that is, to make them better units of account and stores of value – they’re forever going to be limited in what you can do with them, because they’ll exist only as an auxiliary to the main economy – people will need to convert back and forth to other kinds of money in order to actually use them as a medium of exchange.

The problem with this is that cryptocurrencies have security based on mathematics – on cryptography, and ultimately on physics. But non-cryptocurrency types of money have security based on institutions, on laws, on courts, and on barriers to entry. Both of these work, but at least so far the handoffs between them have been abysmally bad. The scams and failures and hacks in the history of Bitcoin and cryptocurrencies in general, have not involved breaking the cryptographic security; they’ve involved subverting or misdirecting the institutional security at places where people were trading their bitcoins.

What this teaches is that the interfaces between crypto-secured and other types of commerce are highly vulnerable, and the more we can do without ever leaving the crypto-secured realm, the less we will suffer from hacks and cracks and scams. Using cryptocurrency as a medium of exchange, without also being able to use it as a store of value or unit of account, would be the worst kind of security in the world; our cryptography-secured money transmission would be compromised on both ends by a poorly-secured interface with institutionally-secured moneychangers.

So we need to find a good way to regulate and stabilize the value of a cryptocurrency.

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