Attention cryptocurrency holders! It’s time to compare Bitcoin to gold and the .U.S. Dollar again. This post will cover the history, basic functions and characteristics of each currency and offer a glimpse of what may happen as our world’s understanding of economics continues to evolve.
The History of Money: Before Bitcoin
Money is nothing new. Looking back at humanity’s earliest ancestors, it’s not exactly a mind-bending stretch to imagine people trading a cow for a horse, or fruits for coal. Before humanity even formed societies, people traded goods and services. As societies evolved, humans began to cultivate various skill sets and specialize in certain trades. It was no longer practical to trade one commodity for another. The impractical nature of exchanging goods and services directly is further explained by a concept called the coincidence of wants.
The Coincidence of Wants
The coincidence of wants is the idea that while people share the same wants and desires, they don’t necessarily have the same wants at the same times. This makes trades of any good or services between two parties difficult when large numbers of people are with varying access to resources are trying to fulfill their needs.
To illustrate, let’s say you want to trade a cow for a new outfit. You find somebody that has the outfit you want, but that person doesn’t need or want your cow. With no other means of exchange at your disposal, you’re forced to bring in a third individual who will give you tools in exchange for your cow. You’ll then take the tools and trade them to the seller of the outfit, who just so happens to need tools to perform repairs on his home.
In the above example, money can act as the substitute for the third participant and his tools. That’s exactly why money exists. To act as a third-party that communicates to all parties what a particular transaction is worth. That’s what all currencies really are, communication tools that articulate value with some degree of universal recognition around the globe.
The Evolution of Currency and Fractional Reserve Banking
In the early days of the caveman, humans traded sticks and stones. Later. Our civilization developed barter systems (trading one commodity for another). The 16th century saw gold being used as a means of exchanging value, and then the British figured out they could just use paper notes as representations of the gold. They did this because it was dangerous and impractical to transport large amounts of gold from one individual to another.
As time continued to pass, it became obvious that people wanted to use paper money even if they didn’t have gold in their coffers to account for it. They wanted to buy now and pay later, and thus, the fractional reserve banking system was born. How so, because bankers realized that they could issue notes as money and charge a rate of interest for providing the notes, even if the gold wasn’t readily available. Check out the video explanation below:
The Basic Functions of Currency
No matter what form it takes, currency is simply a way of communicating value. It doesn’t matter if we’re talking about Bitcoin, paper money, cows or anything else. But overall, a valid currency tries to perform three main functions to the best of its ability:
- To act as a store of value
- Be a medium of exchange; and
- Act as a unit of account
On the surface, traditional paper money accomplishes these three functions better than Bitcoin or gold. However, the truth of the matter is the value of paper money is decreasing. It’s worth 95% less today than when it was first recognized as a valid form of currency. This is because of phenomenons like inflation, where governments produce more money and essentially make the entire supply less valuable to the individual. Also, it becomes more difficult to use the money supply as an accurate representation of resources that are available once the population and the money supply grows.
This is actually one of the reasons why Bitcoin is thriving in a country like Venezuela, where the government is trying to cover large debts by printing more money that isn’t actually a reflection of more real economic value. Just consider for a moment that the inflation rate of the Venezuelan Bolivar nearly 54,000% in 2016 alone and increased further in 2017 and 2018. That’s not a typo!
If you’re from North America or Europe and you can go to the store and buy the food and other goods you need without even thinking about it, you probably think paper money is a good store of value. After all, we’ve been using it for hundreds of years. Try to convince a Venezuelan of the same thing. Although paper money tries to be a good store of value, it’s only as valuable as the government officials who control it. The main advantage paper money has an functionality is that it’s globally recognized as a unit of account and a medium of exchange based on its long history in our society.
What about Gold?
Gold is certainly recognized as a valid store of value. Whenever times get tough economically, people are often encouraged to buy gold as a hedge against a falling stock or real estate market. In fact many detractors of digital gold say that Bitcoin cannot provide the real world applications of a mineral commodity like actual gold can. The counterargument to that however is that gold isn’t really used as a medium of exchange and nobody accounts for it in proper financial statements, save for those who use gold in their investment portfolio.
So while the value of gold is relatively stable compared to Bitcoin and that was once upon a time a valid medium of exchange, the truth is it just doesn’t represent the necessary principles of currency in today’s digital age in a way that makes it useful for society.
Is Bitcoin the Future of Financial Functionality?
Paper money isn’t as good as it used to being at acting as a store of value. Gold is never really going to make a comeback a medium of exchange. So that means Bitcoin is the future, right? Not so fast! As time wears on and blockchain technology continues to evolve, more and more people are recognizing Bitcoin as a valid store of value. Even .U.S. Senators are coming around to the idea. Still, adoption has a long way to go before people are using cryptocurrency as a medium of exchange on a daily basis. As far as Bitcoin behaving as a valid unit of account is concerned, until people are using it every day, you won’t see Bitcoin in quarterly financial statements as an undeniably stable asset or means of doing business.
The main advantage Bitcoin possesses over its counterparts is not so much about current functionality, but rather future potential. As the Bitcoin blockchain matures, the value will eventually stabilize itself. At least that’s the hope. For now, it seems the average person is still intent on using paper money, albeit through a credit or debit card.
Here’s a breakdown of the functions of each:
|Store of Value||Yes||Yes||No|
|Medium of Exchange||Yes||No||Yes|
|Unit of Account||No||No||Yes|
The Seven Characteristics of Bitcoin, Gold and .U.S Dollar Currency
Practical functionality is reflection of principal characteristics. While both Bitcoin, gold and the .U.S. Dollar exist because of the human need for functionality, principles are what define whether or not a trend or technology is built to last in the long run. Bitcoin bears will argue that digital gold is just what’s trending right now. Bulls will say it’s a technology built to last. Perhaps a breakdown of the seven characteristics of currency will help you decide for yourself.
This one is an easy one. Gold is soft enough to melt and bend under heat. However it still has many commercial applications and can technically be traded for goods. Paper money is durable, even if you throw it in the washing machine or dryer accidentally. And then of course we have Bitcoin. It’s impossible for something to accrue wear and tear if it only exists digitally. Bitcoin and other digital currencies are the most durable forms of value that will ever exist. You can check that box!
Paper, gold and Bitcoin can physically transfer from place to place with relative ease. Although the utility of paper money is limited in foreign countries, the .U.S. Dollar is virtually universally accepted everywhere. It goes without saying that gold, particularly in small amounts, and bitcoins can also move around easily. Everybody wins in this category.
The .U.S. Dollar trades to two decimal places. So does gold. Bitcoin trades to 12 decimal places. You read right! You can trade fractions of bitcoins so small they’re worth less than an American penny. Talk about divisibility. Bitcoin has the advantage here given that it’s not a physical object. Gold would be the least divisible in a physical sense because the average person would need tools in order to break up a gold bar.
When financial gurus and computer scientists talk about Bitcoin as a store of value, this sense they contend that it will hold a value of more than zero for all eternity, and to some extent that the value will increase over time. Bitcoin is indeed going up in value year over year, but the price isn’t as consistent as the price of gold or the American dollar. Bitcoin can drop in value 40% in the next 48 hours and it would be no surprise. The best and worst performing cryptocurrencies can swing up or down dramatically on a daily basis. Although gold is more volatile than American dollars, neither one of those two forms of currency will drop that much in the next couple of days. More traditional forms of currency therefore hold the edge over Bitcoin in terms of consistency.
Bitcoin is making waves in 2019. It’s certainly instantly recognizable, but it wasn’t always like that. In 2008 most people do not understand what Bitcoin was. Gold and paper money have certainly been around long enough for people to recognize. Instantly recognizable is really just a synonym for adoption, so Bitcoin needs time to brand itself so to speak, but in general all three currencies rank well in this category.
Paper money is acceptable everywhere. Gold technically is acceptable everywhere. It may not be practical, but it is legally acceptable at virtually any merchant around the globe. Bitcoin is definitely not acceptable everywhere. The overwhelming majority of the global population still doesn’t truly understand its value. It’s also not that easy to explain the technology to the average consumer to the point where they would feel comfortable using it. Yes some merchants accept Bitcoin and more will as digital currencies evolve, but we as a society are still nowhere close to mass adoption. Bitcoin will have to be worth trillions of dollars to be that widely accepted.
Of all the categories listed in this post, intrinsic value is probably the most controversial. A cryptocurrency enthusiasts clearly believes that a decentralized payment network not owned by any central authority is valuable because it serves the greater good of society. Old-school thinkers say Bitcoin adoption is really just a huge pyramid scheme. As the years go by more and more people are becoming believers. Yet still, the average person maintains that there is more value in paper money and gold. It takes decades if not centuries for a human race to accept anything as intrinsically valuable. Especially when it comes to currency. Perhaps the next 20, 30 or 50 years will cement the intrinsic value that Bitcoin purists are already preaching exists.
Whatever your particular stance is on the value of Bitcoin or other forms of currencies, at least now you can take a look at a side-by-side comparison and think critically about the future of money. Obviously this blog post is just a snapshot of ideas that we all need to consider when evaluating how we exchange value as a society. Engaging in further discussions is neccessary in shaping the future of money.
Which form of currency do you think suits society best? Do you think that will change in the future?
Only time will tell.