At a conference held last week in DC, the European Central Bank presented their opinion of virtual currencies including discussions about bitcoin. On slide 6 of their presentation they made a striking argument: bitcoin does not fulfill any of the three functions of money: Medium of Exchange, Unit of Account, or Store of Value. Most likely, their counterpoints to these three functions relate to the large volatility that bitcoin’s exchange rate has experienced since it’s inception.
While it is difficult to refute their exact points since the soundtrack is not included, it does raise an interesting question of how the properties of bitcoin compares to fiat and gold. There are nine distinct characteristics of money: scarce, durable, portable, divisible, easy to recognize, easy to store, fungibile, hard to counterfeit, and widespread use. At first glance, bitcoin has a significant advantage over fiat currencies and gold in many of these, and this will be even more obvious after a further examination.
Fiat money – a term used to describe currency that is officially used by a country. While many countries used to peg their currency to gold, this is not considered fiat. Fiat currencies are not directly convertible to commodities or pegged to the value of any commodities. Currently, a vast majority of the world’s currency are fiat.
Gold – this it is being used here as an example of a commodity money. Gold has been used as money for over 2,500 years in coin form, and is a popular store of value for those looking to diversify away from fiat money. For many years it carried significant advantages over any other form of money with respect to the 9 characteristics outlined earlier.
Bitcoin - is completely digital and not controlled by any government or business entity. Bitcoin issuance is scheduled, predictable, and finite. Addtionally, bitcoin transactions are verified by the largest computer network in the world to ensure transactions occur quickly and accurately.
This article will presume a fundamental understanding of the need for money, and how it functions as a medium of exchange, a unit of account, and a store of value. Additionally, this analysis will not address the infrastructure built around any of these products, since this infrastructure can largely be used for any of the three monies, and does not add to the comparison.
Money’s scarcity should fall into a narrow band of objects that are widely available, however can not be easily created or found. Objects such as sea shells, which were once used as money, are too rare to be widely used except in specific locations, and objects such as sand are too abundant to have any significant value in small quantities.
|Fiat||Yes||Fiat currency can only be created by a small group of people creating a limited supply, however the actual cost of production is low so it can be created in large enough quantities to be readily available. Except in cases of extreme inflation, the scarcity of fiat currencies has held up well.|
|Gold||Yes||Compared to other precious metals, gold exists in an ideal combination of being rare to find (scarce), yet widely available (people have found an abundance already). Copper is more plentiful and difficult to transact in large values, and platinum is too scarce to be used for most transactions.|
|Bitcoin||Yes||The supply of bitcoin is tightly controlled and highly predictable. WIth some margin of error the supply of bitcoin can be forecast out 100 years. The 21 million units should be sufficient for large amounts of trade – accounting for its divisibility.|
To function as an acceptable store of value, a proper form of money should not degrade over time. Things that were previously used as money such as cattle and grain do not last for more than several years, and would not be considered durable.
|Fiat||Neutral||The paper that fiat currency is printed on is not an ideal medium for a longer term store of value. It is easily damaged, wears out after repeated use, and will degrade if proper measures are not take for long-term storage. However, damaged notes are easily replaced, so the actual value that it represents is not destroyed.|
|Gold||Yes||Gold bars will last hundreds of years with little maintenance. Gold coins may tarnish or become malformed with wear, however the metal itself will not degrade except under extreme conditions.|
|Bitcoin||Yes||Bitcoin is completely digital, so it will not degrade with use. Additionally, bitcoin wallets can be easily duplicated to prevent file corruption. Contrary to fiat, lost coins are not reprintable so extra care must be taken.|
Proper money should be able to be used in day-to-day transactions, and as such it needs to be highly portable in order to carry on one’s person. Money’s use as a medium of exchange is to make life easier, and most people would not consider carrying around large quantities of lead, or herding cattle to town for trade easy.
|Fiat||Neutral||Neutral For daily purchases, the money carried in a wallet will be sufficient. However, larger transactions require more elaborate measures such as armored trucks. There is additional infrastructure available such as debt or credit cards, however these come with associated fees and are not really an intrinsic value to fiat – if gold was popular to use the same infrastructure could be applied to that, or even cattle. It doesn’t reduce the inherent issue of storing paper fiat.No Gold is heavy, and even more difficult to carry than fiat money.|
|Gold||No||Gold is heavy, and even more difficult to carry than fiat money.|
|Bitcoin||Yes||Bitcoin scales exceptionally well for larger quantities since it is completely digital. Anything from $0.01 to $1B can fit on a flash drive. Additionally, bitcoins can be transferred almost instantly to a recipient anywhere in the world that is connected to the internet.|
Few transactions in the world are for exact integer denominations. Almost every transaction has the need to make change. This can be achieved by storing different denominations of the money, or dividing physical objects into multiple segments without any loss of value. This make items such as art act poorly as money since the can not be easily divided.
|Fiat||Yes||Fiat is widely available in a large variety of denominations. Additionally, the fact that it’s printed on paper makes storage of a wide variety of denominations easy|
|Gold||Neutral||Dividing gold is possible, however it is not easily performed and requires a smelting process. Additionally, maintaining a variety of denominations in gold would be challenging due to storage concerns.|
|Bitcoin||Yes||Bitcoin is currently divisible up to 8 decimal places, and could be extended further if the need arose. At the current exchange rate of $100 this is a divisibility down to $0.0000001|
Money needs to be readily identified and verified. This reduces the risk to people accepting it for payment, and reduces the transaction time if it’s easy to verify the authenticity. Frequently, coins have their edge reeded to reduce clipping and value debasement.
|Fiat||Yes||Most people are comfortable with the visual and physical identification of currency from years of experience handling it. Additionally, there are quick chemical tests (using markers) that can assist in identification.|
|Gold||Neutral||As for commodity monies, gold is sufficiently different in color, weight and malleability from similar materials that these properties can usually be identified with a trained eye. Chemical tests can be performed to prove authenticity, however the process is significantly more elaborate than the fiat test.|
|Bitcoin||Neutral||Bitcoin cannot be visually identified since it does not exist in physical space. Software can be used to identify it in the block chain, however at it’s current stage this requires a fair amount of technical knowledge. Additionally, physical instantiations such as paper wallets and casascius coins are difficult to verify the true quantity of bitcoins stored.|
In order to operate as a store of value, it is necessary to be able to store in large quantities. Objects such as art and chemical compounds are difficult to store and require significant effort to maintain value. Livestock such as cattle used to be easy to store when land was abundant, however the mass migration to cities made livestock difficult to store in apartments.
|Fiat||Neutral||Because fiat currency does occupy physical space, they do require somewhat significant infrastructure to store. However their weight is relatively light, so this is easier than alternatives such as gold|
|Gold||No||Gold requires large vaults to store high value. Gold is infamous for requiring significant infrastructure to guard and store, such as Fort Knox.|
|Bitcoin||Yes||Similar to the portability characteristic, there are no scaling concerns storing bitcoin. There may be concerns as the block chain gets larger over the years, however this should scale appropriately with advances in hardware. Additionally, backup methods such as cloud storage of encrypted files and using Shamir’s Secret Sharing key add redundancy and reduce risk of loss due to error.|
All units of the money must be considered equivalent, and equally replaceable. We’ll see art fail here again since different pieces of art will have significantly different values. Additionally, gemstones have a similar problem, as even diamonds of the same weight can have significantly different values due to clarity, color, and other characteristics.
|Fiat||Yes||All equal denominations are considered equal, i.e. all $10 bills are equally valuable. People don’t look usually look at the serial number or mint to determine the true value of the currency.|
|Gold||Neutral||At a chemical level all gold is the same. However different purity levels and stamping authorities have to be take into account. Frequently gold bars are weighted to examine for counterfeits since only the surface of the bars are readily examinable.|
|Bitcoin||Yes||Currently, all bitcoin are considered equal. There has been increased discussion about the purity of coins, and whether agencies should police transactions for stolen coins it is possible in the future that transactions will be penalized if stolen coins are mixed in, however this is still a significant way from implementation|
In order to be a reliable store of value, the object itself must be hard to counterfeit. Recipients should be confident that they are receiving authentic items, or else they will be reluctant to use it for trade in the future. Here cattle may have an advantage – since faking a live cow would be quite a feat.
|Fiat||Neutral||The US Federal Reserve estimates the amount of counterfeit USD has been as high as 50% of currency in circulation in the past, however this has estimate has dropped to <1% over the past few years. It is worth noting that North Korea is expected to be funding some of their operations with counterfeit super dollars that are nearly indistinguishable from $100 bills.|
|Gold||Neutral||While gold itself is almost impossible to counterfeit, there are numerous instances of gold bars being filled with lead or tungsten to reduce the true value of the asset. Frequently gold vaults will only test a small sample of the bars, so it is difficult to determine the true percentage of counterfeits.|
|Bitcoin||Yes||It is cryptographically impossible to counterfeit a bitcoin. The closest analogue would be attempting a double spend attack, where the recipient believes they received coins that were not actually transferred to their account. However, this has only occured once during the fork in March, and remains a low risk while the network hash rate remains high.|
Lastly, money should be able to be traded for a wide variety of products and services. The reliability of being able to spend money when you need to, and not having to be concerned with whether a merchant will accept it adds significant value.
|Fiat||Good||Fiat is accepted at virtually every location within its issuing country. While many currencies with the exception of the USD has little use outside it’s political borders, it is easily traded for a local currency.|
|Gold||Bad||It is rare that anything can be bought directly with gold. It currently functions mainly as a store of value outside of it’s relatively small utility in jewelry and electronics.|
|Bitcoin||Bad||Bitcoin is only accepted by a small fraction of web sites, and an even smaller fraction of brick and mortar stores. While this number grows on a daily basis, it is still the vast minority of merchants.|
Fiat currencies and gold have hundreds or thousands of years of established value as money. They have been vetted by governments and have significant case-law to determine legal methods of use. Bitcoin is in it’s infancy and still in the price-exploration stage. The biggest complaint of detractors is concern over it’s price volatility. While this is difficult to debate, as the market matures and grows it will become less influenced by money entering and exiting the system.
When comparing the characteristics of money across fiat, gold, and bitcoin it is difficult to ignore bitcoin’s advantages. As bitcoin builds a solid history and clarifies regulatory concerns, its inherent advantages should provide ample opportunity to disprove the ECB that it really does provide the three functions of money.
Editor’s Note: Gold has been downgraded from Yes in the original publication to Neutral to proper reflect the difficulty of authenticity tests in point 5. A reference to the hard fork double spend in March was added in point 8.