Bitcoin is money, albeit a decentralised virtual currency and digital commodity functioning on the fringes of existing financial paradigms. Money serves three functions in an economy, though not all money is equal. Bitcoin fulfills the basic conditions of being money, given that it:
It is increasingly accepted as a payment for goods and services, is traded for various currencies and treated as a unit of account and legal currency in Germany, the largest economy in the EU and fifth largest globally, when adjusted for purchasing power parity. Bitcoin also maintains purchasing power over time, serving as a store of value that resists inflationary pressures.
Bitcoin is also gaining traction in Singapore, one of the most competitive, networked and economically liberal states in the Asia Pacific and the greater Asian region. Recently, ACCESS (Association of Cryptocurrency Enterprises and Startups, Singapore), the first cryptocurrency industry body in Asia, has been formed to formulate industry guidelines and provide feedback to regulators, as the industry continues to expand and establish a hub in the city-state.
Bitcoin as money
Bitcoin is a virtual currency with a bi-directional flow, meaning that fiat money can be traded for Bitcoin on exchange sites, using market-based exchange rates. It is best defined as commodity money, which has intrinsic value. Gold is an ideal analogue comparison to Bitcoin’s digital nature, having intrinsic value because of its industrial, technological and cosmetic applications, combined with its limited supply.
Commodity-backed money is a variant of commodity money. Where commodity money uses a commodity itself as direct currency, commodity-backed money can be exchanged on demand for specific commodities. The gold standard exemplified commodity-backed money. Under it, currency holders could trade their currencies for specified amounts of gold.
Fiat money has no intrinsic value but is valued as money due to rule of law enforced by governments. Fiat money works because it satisfies the three functions of money, working because a society acknowledges it as a valid form of currency. Much like how the Bitcoin has a growing critical mass of people that acknowledge its validity.
Bitcoin as an investment
What makes Bitcoin a potential investment vehicle? It shares the disadvantages associated with most digital currency platforms: a lack of clear regulations, lack of consumer protection, volatility, security risks and use in illicit transactions. However, the last three disadvantages are shared with fiat currencies, which are subject to fraud and also used for criminal activities.
However, it does have clear benefits. Björn Segendorf of Sveriges Riksbank commented in his report that, “It can contribute to meeting new payment needs and to making payments cheaper and more secure. Those who choose to use a particular payment service can be expected to do so because it gives them an added value in relation to other payment services. This also applies to virtual currencies, which can, for instance, make some cross-border payments simpler, faster and cheaper. Another advantage is if the payer does not need to share sensitive information, such as card number or bank account number, with the payee.”
Bitcoin’s finite supply, with a hard limit of 21 million Bitcoins, replicates a supply situation similar to gold. There is only so much of it available at any one time, and more cannot be produced beyond a specific threshold at a defined point in time. Its supply also has a predictable and stable growth trajectory, not being subject to the same inflationary pressures or sudden increases in supply fiat currencies face. Rather, it is deflationary in nature, increasing its real value of money.
Essentially, one can buy more goods with the same amount of Bitcoin over time. Unlike savings of fiat money in banks, it maintains its value, though without the same security that fiat money enjoys from laws or other institutions. Bitcoin is fundamentally disconnected from control by any bank or centralised authority, meaning it is driven purely by market mechanics and its user networks. As much as it currently lacks the regulatory frameworks defining fiat money, it is also not subject to the political pressures of misguided monetary policies.
Bitcoin is, in the end, a long-term, high risk investment. And perhaps, it is best suited for sophisticated investors who can afford losses. It remains to be seen whether it will grow with time, be supplanted by something better or consigned to history as a failure. What needs to be understood is the enormous potential of Bitcoin as a concept, not just financially but also technically.