The value of bitcoin has been on a steep upward rise in recent times. So understandably, the case for bitcoin is at its strongest. And it’s not just bitcoin, but cryptocurrency in general. In early April, cryptocurrencies pushed past two trillion USD in market cap. For context, that’s about a tenth of the US economy. And that market cap continues to rise. In early May, Internet Computer (a freshly minted cryptocurrency) reached a market cap of 45 billion USD just two days after listing. The momentum around crypto is as real as it gets. And with institutional investors eyeing crypto as an investment option, it’s worth taking a moment to reflect on what it is, fundamentally, and the opportunity it represents.
About Currency
Cryptocurrency is (in principle) currency. And currency serves a few practical purposes. It is a medium of exchange, a unit of account, and a store of value. The first two functions are tied to each other, but due to the reality of inflation, the third (store of value) is often only true in the short term. As a result, most people store long term value in assets such as financial instruments and property.
For a currency to serve as a medium of exchange or a unit of account, its per-unit value must remain stable over time. This would give anyone that holds it confidence in its ability to serve these functions. And since that confidence is essential to the smooth running of any economy, governments invest a great deal of effort to ensure that their sovereign currencies are stable. They have central banks that take measures to do just that.
Currency is fundamental to how we both define and exchange value.
Speaking Of Crypto As Currency
But cryptocurrency is different. There’s no government oversight for it. Indeed part of its proposition is this lack of government and institutional involvement. It is decentralised. As a result, there are no hidden fees. Another selling point is that the accuracy of transaction data is safeguarded by the underlying technology.
But how does crypto fare as a currency? Let’s consider this question on two key dimensions:
Stability
At the time of writing this (the 20 May 2021), bitcoin is trading at $40,055.52. It was just $135 on 28 April 2013. That means each unit of currency has more than doubled in value every year for the last eight years. This type of trend would make bitcoin seem like a juicy investment opportunity. But it takes away from its usefulness as a currency. Simply put, nobody would trade if holding currency was that lucrative. The other extreme is no good either. There’s no point in holding a currency that sheds its value faster than you can earn it. Cryptocurrency has consistently exemplified both extremes and remains a scene of rampant financial speculation.
Legal Tender
Understandably, governments are not eager to ditch their sovereign currencies for crypto. Not only would this strip away their powers to control the stability and distribution of currency, but a sovereign currency is also a source of national pride. For these reasons, no government has pronounced cryptocurrency as legal tender. Hence the legality of exchanging goods and services for crypto would seem questionable at best.
If crypto ever graduates into a full-blown currency, it would have to scale these structural challenges first.
But as it stands, people buying crypto are not planning to exchange it for goods and services. They see an opportunity.
Speaking of Crypto As An Asset Class
In a CNBC interview earlier this year, renowned investor Warren Buffett was quoted saying:
“I don’t own any cryptocurrency and I never will.”
Further stating that cryptocurrencies have no value and they don’t produce any. It’s helpful to appreciate what this statement means.
The value of an asset stems from its ability to generate returns. Said returns are anticipated in line with a known business model. For example, equity (an asset class) allows for part ownership in a company. When the market values that company based on its business model, this valuation informs the value of individual shares.
Cryptocurrency is not a business model. Although it doesn’t conform strictly to the definition of an asset, this hasn’t stopped the buzzword crypto-assets from taking flight.
So What Is Cryptocurrency?
It’s hardly functional as currency and fails the asset test. But it brings together some attributes of both. Like sovereign currency, there is an active market for it, and as a result, like assets, investors are buying and holding it for gain. It’s a hybrid of sorts. But the question of what it is remains unanswered.
In my view, bitcoin (along with cryptocurrencies and the blockchain technology) is a manifestation of several ideas and propositions. The most prominent of these are:
- A market of self-governing participants is ultimately better than a market with institutional oversight.
- Ruthless transparency and data integrity are worth having even at high computational costs.
- The lack of trust in the current financial systems warrants a rebuild along fundamentally different thought lines.
Ultimately, cryptocurrency will need a critical mass of participants buying into these ideas to make it work. That includes your buy in. On their own, these ideas have pros and cons. Their manifestation as cryptocurrency (and assets), however, makes it hard to embrace. That is because currency and assets are already well-established concepts. And the argument that assets and currency would be more useful in a digital format that embodied these ideas does not seem very robust at the moment.
The Future Of This New Technology
If we consider the underlying (blockchain) technology behind cryptocurrency, you realise this is something with potential. It presents new possibilities for doing things better. And that’s true even though the technology is still in its infancy.
But like every new technology, it needs to solve real-world problem compellingly to be accepted. And the search is on for these problems and use cases.
I leave you with this interview of Liana Douillet Guzman, the then COO of Blockchain.com. It’s an honest conversation about blockchain technology and the opportunity it presents.
credit McKinsey & Company
