03 July, 2021

Can Bitcoin be money?

Proponents of Bitcoin argue that it is a better money than the money we have today. The arguments in favour of Bitcoin as money appear to be based on the fundamental assumption that government cannot be trusted.

The paper money most of us are regularly using is also called fiat money. Fiat money has no intrinsic value and is not backed by any commodity. A trustworthy government, in this matter frequently represented by an independent central bank, maintains a predictable value of the money by increasing or decreasing the money supply. Fiat money assumes a value based on what it can be exchanged for, e.g. labour, goods or entitlements to interest, dividends or government taxes.

Bitcoin also has no intrinsic value. In contrast to the existing fiat money, practically speaking, Bitcoin can only be exchanged for fiat money. This is not surprising. In order for a vendor to value their goods in Bitcoin, they would have to pay their employees in Bitcoin, pay their input goods in Bitcoin, pay their dividends in Bitcoin etc. Valuing a good in Bitcoin is very different from saying, "this sandwich costs $3, but you can pay me in Bitcoin at the current $/Bitcoin exchange rate". Therefore Bitcoin has no fundamental value.

So if I can't exchange Bitcoin for anything real and it has no fundamental value, why would anybody want to own Bitcoin? In contrast to fiat money Bitcoin has a somewhat predetermined total quantity. If Bitcoin could be exchanged for something real and many people would want to use it for that purpose, its value would change. Imagine today I get one sandwich for 1 Bitcoin. Imagine furthermore in the future there are a lot of people who want to use Bitcoin. Therefore due to a lack of Bitcoin the price of the sandwich in the future will change. It will cost less in terms of Bitcoin, e.g. 1/2 Bitcoin. Note that this change is not due to an oversupply of sandwiches, but due to a lack of Bitcoin. So the only reason I can imagine why anybody would want to own Bitcoin, is because they believe Bitcoin will at some point be able to be exchanged for something of real value and its use and thereby its value will increase (or in short: "with the Bitcoin I own today I will be able to buy more sandwiches in the future").

This reason why somebody would want to own Bitcoin is exactly the reason why it would make for such bad money. It provides an incentive to not spending (e.g. hiring new employees). Furthermore, by design, the value of Bitcoin will change in a hard to predict fashion while creating uncertainty for those trying to operate in that Bitcoin economy. Bitcoin also does not allow for predictable inflation. Predictable inflation helps to reduce economic inefficiencies, which result from so called nominal rigidity, i.e. the observation that it is more difficult to get nominal prices to decrease than it is to get them to increase (e.g. as a business cannot easily lower an employee's wages, the business has to take an action disproportionate to its actual economic situation and will have to lay off employees or close down altogether).

These questions regarding Bitcoin as money are not really new. At some point there was the gold standard, which bears stark resemblance to Bitcoin. After it was abolished in the 1970s to my knowledge no advanced and no developing economy has gone back to or newly adopted that well known gold standard.  

In summary, I can't come up with any serious reason, why Bitcoin would be better than fiat money. Bitcoin as money would create very serious economic challenges. For accepting that, the distrust in central banks would have to be very strongly justified.