My impression is that cryptocurrencies face some major challenges in achieving some of the basic functions of money. For example, check out Bitcoin – The Promise and Limits of Private Innovation in Monetary and Payment Systems by Beer and Weber. They argue (persuasively in my opinion) that traditional currencies have three functions that cryptocurrencies would have significant challenges in achieving, replicating, or challenging:
unit of account
means of payment
store of value
Based on the Beer and Weber paper, here’s my brief expansion of these problems as they relate to Bitcoin:
Having prices in one currency is more efficient than having them in many. Thus, having just one currency (e.g., a national currency) is more efficient than having multiple. Also, having just one currency facilitates trade. Bitcoin in particular struggles to achieve this because a) it introduces a separate unit of account, b) is has no single and identified issuer, and c) its quantity is fixed.
If prices in the cryptocurrency change dramatically and unpredictably compared to standard currencies, then measuring prices in the cryptocurrency don’t make sense. It’s hard to imagine this asymmetry being overcome entirely unless a single cryptocurrency became so widespread and dominant that it achieved more stability than reserve currencies.
Since there is no institution guaranteeing that the currency will be a reliable store of value, the currency is not a reliable store of value. Bitcoin in particular is a speculative asset.
See also the Impossible Trinity in international political economy to get a sense of yet another problem that cryptocurrencies do not yet have a solution for.
I have not yet seen solutions to these problems and there appear to be good reasons to believe that a system similar to Bitcoin cannot solve them. Future cryptocurrencies may put a serious dent in these problems, but I remain skeptical of their near-term (within a few decades) potential to “fix money”.
Hi Ben, thanks so much for your comment! I do appreciate your good faith engagement. Here I’ll respond to a few of your points, and hope that it can be a good starting point for deeper discussion.
I do think that the paper you cite makes good arguments, particularly for the scalability of bitcoin for payments. But I think you would find that the criticisms are outdated now. If you haven’t yet, I would encourage you to learn about the “lighting network” which is a second layer peer to peer payment channel network built on top of bitcoin. You will find that the network can settle hundreds of millions of transactions per second at instant finality settlement with fees of less than a penny. It is also what the El salvador circular economy is building upon. The exciting aspect of this is that you can achieve high amounts of velocity of money, without credit creation.
Having prices in one currency is more efficient than having them in many.
This is true. Now think about the world adopting a single currency. It would remove so much friction that currently exists due to foreign exchange. This currency would necessarily have to be politically neutral, inclusive, permissionless and censorship resistant ;)
If prices in the cryptocurrency change dramatically and unpredictably compared to standard currencies, then measuring prices in the cryptocurrency don’t make sense. It’s hard to imagine this asymmetry being overcome entirely unless a single cryptocurrency became so widespread and dominant that it achieved more stability than reserve currencies.
Actually completely agree with this point. Bitcoin is still extremely early in its adoption phase, but the fundamental adoption is growing as fast as the internet, in its early days. Any new emerging monetary asset would necessarily have massive volatility on its path to reaching full adoption. I don’t think this disqualifies bitcoin just yet.
Since there is no institution guaranteeing that the currency will be a reliable store of value, the currency is not a reliable store of value. Bitcoin in particular is a speculative asset.
Here I disagree, the value of something is not dictated by whether an institution says it has value. As demonstrated by the gold standard, when we went off the gold peg, many people said that gold only had value because dollars have value and they can be used to redeem gold. This was so wrong that the dollar devalued 10% against gold pretty much directly after the de-pegging. The inverse is also true, no matter how much value the Venezuelan government promises the bolivar to have, they cannot wish value upon the hyperinflating currency. The lesson here is ultimately the value of the currency is based upon trust. And since Bitcoin can verifiably maintain it’s fixed supply, whilst fiat currencies are mathematically guaranteed to debase due to the debt obligations of the government, a lot of people are starting to place their trust in bitcoin more than fiat. Admittedly this is a small but growing number still.
I’ll leave with these thoughts for now. But happy to engage further
To preface these comments, I actually do some professional work on crypto economics and I think that almost no one appreciates just how high the bar is for crypto to truly challenge traditional currencies. So my comments below should be taken in the context that I’d love to see a world where crypto can play a role in opening up particular kinds of economic opportunity that currently aren’t really possible, and I’m actively trying to build such a world—but I think there’s a very long way to go!
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L2 networks and such will certainly improve over prior crypto systems. I do still see a challenge of doing a “trustless” crypto exchange (i.e., massively non-centralized) without it being relatively costly/slow compared to a credible centralized system. But I don’t see this as a major factor either way.
Now think about the world adopting a single currency. It would remove so much friction that currently exists due to foreign exchange. This currency would necessarily have to be politically neutral, inclusive, permissionless and censorship resistant ;)
See the impossible trinity for a sense of why this is unlikely to happen. Domestic policy autonomy is reeeeeealy important to countries. And crypto is not going to straight-up beat all the countries. States have too many advantages, so this isn’t even a contest.
Any new emerging monetary asset would necessarily have massive volatility on its path to reaching full adoption. I don’t think this disqualifies bitcoin just yet.
This is only for speculative assets. Note that credible centralized institutions issue value-stable things all the time (currencies, bonds, coupons, reward cards, etc.). This is a major problem for the crypto world, but trustworthy centralized institutions can (and do) regularly do this.
I’d add that no credible stablecoin plan exists. National currencies can easily handle an economic downturn, even a prolonged one. All existing stablecoin plans will simply collapse if a sustained downturn is expected. (I’d love to see a plan that doesn’t fail in this way if one exists!)
I think you may be confused about the potential lessons offered by the de-pegging of gold. The de-pegging was caused by a political (and economic) need for an expansionary monetary system, but the supply of gold could not increase. This meant that the relative value of dollars vs gold was decreasing, so it became insane to keep the peg, since those who hold dollars (like foreign governments) could just get all the gold. (And this was happening before the depegging.) So when the peg is released, of course the dollar devalues! That was the point of the de-pegging. That was the direction of the pressure that caused the de-pegging in the first place. This isn’t evidence that gold is somehow more “valuable” because it isn’t being used as much as a currency. It’s a correction that happened because gold wasn’t fit for purpose as a global currency.
The Venezuelan example is a straw man. Instead, I challenge you to convince me of why I should trust the stable true-real-world-value of any crypto token that currently exists anywhere near as much as I trust the USD, Euro, Yen, GBP, or CAD (to name just a few).
The currency’s value is based on trust but also because institutional commitments and designs can be more or less trustworthy. Independent central banks in the West are pretty trustworthy. Their design, political independence, and history of action are pretty impressive. This is an extremely high bar to beat. I think most pro-crypto people don’t realize just how high this bar is.
Bitcoin’s fixed supply doesn’t address the speculation problem I raised. In fact, it is the cause of it. With limited supply and no way to control inflation/deflation, bitcoin will absolutely cycle up and down in value in a purely speculative way. It isn’t even as anchored in value as gold; you can’t use bitcoins to make jewelry or electronics for example. Bitcoin is not a reliable store of value for precisely this reason. If I put X euro into USD and X euro into bitcoin, which one do you think will be closer in value to what I put in when I check back in on it a few years later (or even seconds later)? This is what being a “reliable store of value” means. Traditional currencies are better at this than bitcoin and stablecoins.
My impression is that cryptocurrencies face some major challenges in achieving some of the basic functions of money. For example, check out Bitcoin – The Promise and Limits of Private Innovation in Monetary and Payment Systems by Beer and Weber. They argue (persuasively in my opinion) that traditional currencies have three functions that cryptocurrencies would have significant challenges in achieving, replicating, or challenging:
unit of account
means of payment
store of value
Based on the Beer and Weber paper, here’s my brief expansion of these problems as they relate to Bitcoin:
Having prices in one currency is more efficient than having them in many. Thus, having just one currency (e.g., a national currency) is more efficient than having multiple. Also, having just one currency facilitates trade. Bitcoin in particular struggles to achieve this because a) it introduces a separate unit of account, b) is has no single and identified issuer, and c) its quantity is fixed.
If prices in the cryptocurrency change dramatically and unpredictably compared to standard currencies, then measuring prices in the cryptocurrency don’t make sense. It’s hard to imagine this asymmetry being overcome entirely unless a single cryptocurrency became so widespread and dominant that it achieved more stability than reserve currencies.
Since there is no institution guaranteeing that the currency will be a reliable store of value, the currency is not a reliable store of value. Bitcoin in particular is a speculative asset.
See also the Impossible Trinity in international political economy to get a sense of yet another problem that cryptocurrencies do not yet have a solution for.
I have not yet seen solutions to these problems and there appear to be good reasons to believe that a system similar to Bitcoin cannot solve them. Future cryptocurrencies may put a serious dent in these problems, but I remain skeptical of their near-term (within a few decades) potential to “fix money”.
Hi Ben, thanks so much for your comment! I do appreciate your good faith engagement. Here I’ll respond to a few of your points, and hope that it can be a good starting point for deeper discussion.
I do think that the paper you cite makes good arguments, particularly for the scalability of bitcoin for payments. But I think you would find that the criticisms are outdated now. If you haven’t yet, I would encourage you to learn about the “lighting network” which is a second layer peer to peer payment channel network built on top of bitcoin. You will find that the network can settle hundreds of millions of transactions per second at instant finality settlement with fees of less than a penny. It is also what the El salvador circular economy is building upon. The exciting aspect of this is that you can achieve high amounts of velocity of money, without credit creation.
This is true. Now think about the world adopting a single currency. It would remove so much friction that currently exists due to foreign exchange. This currency would necessarily have to be politically neutral, inclusive, permissionless and censorship resistant ;)
Actually completely agree with this point. Bitcoin is still extremely early in its adoption phase, but the fundamental adoption is growing as fast as the internet, in its early days. Any new emerging monetary asset would necessarily have massive volatility on its path to reaching full adoption. I don’t think this disqualifies bitcoin just yet.
Here I disagree, the value of something is not dictated by whether an institution says it has value. As demonstrated by the gold standard, when we went off the gold peg, many people said that gold only had value because dollars have value and they can be used to redeem gold. This was so wrong that the dollar devalued 10% against gold pretty much directly after the de-pegging. The inverse is also true, no matter how much value the Venezuelan government promises the bolivar to have, they cannot wish value upon the hyperinflating currency. The lesson here is ultimately the value of the currency is based upon trust. And since Bitcoin can verifiably maintain it’s fixed supply, whilst fiat currencies are mathematically guaranteed to debase due to the debt obligations of the government, a lot of people are starting to place their trust in bitcoin more than fiat. Admittedly this is a small but growing number still.
I’ll leave with these thoughts for now. But happy to engage further
I appreciate the genuine engagement!
To preface these comments, I actually do some professional work on crypto economics and I think that almost no one appreciates just how high the bar is for crypto to truly challenge traditional currencies. So my comments below should be taken in the context that I’d love to see a world where crypto can play a role in opening up particular kinds of economic opportunity that currently aren’t really possible, and I’m actively trying to build such a world—but I think there’s a very long way to go!
----
L2 networks and such will certainly improve over prior crypto systems. I do still see a challenge of doing a “trustless” crypto exchange (i.e., massively non-centralized) without it being relatively costly/slow compared to a credible centralized system. But I don’t see this as a major factor either way.
See the impossible trinity for a sense of why this is unlikely to happen. Domestic policy autonomy is reeeeeealy important to countries. And crypto is not going to straight-up beat all the countries. States have too many advantages, so this isn’t even a contest.
This is only for speculative assets. Note that credible centralized institutions issue value-stable things all the time (currencies, bonds, coupons, reward cards, etc.). This is a major problem for the crypto world, but trustworthy centralized institutions can (and do) regularly do this.
I’d add that no credible stablecoin plan exists. National currencies can easily handle an economic downturn, even a prolonged one. All existing stablecoin plans will simply collapse if a sustained downturn is expected. (I’d love to see a plan that doesn’t fail in this way if one exists!)
I think you may be confused about the potential lessons offered by the de-pegging of gold. The de-pegging was caused by a political (and economic) need for an expansionary monetary system, but the supply of gold could not increase. This meant that the relative value of dollars vs gold was decreasing, so it became insane to keep the peg, since those who hold dollars (like foreign governments) could just get all the gold. (And this was happening before the depegging.) So when the peg is released, of course the dollar devalues! That was the point of the de-pegging. That was the direction of the pressure that caused the de-pegging in the first place. This isn’t evidence that gold is somehow more “valuable” because it isn’t being used as much as a currency. It’s a correction that happened because gold wasn’t fit for purpose as a global currency.
The Venezuelan example is a straw man. Instead, I challenge you to convince me of why I should trust the stable true-real-world-value of any crypto token that currently exists anywhere near as much as I trust the USD, Euro, Yen, GBP, or CAD (to name just a few).
The currency’s value is based on trust but also because institutional commitments and designs can be more or less trustworthy. Independent central banks in the West are pretty trustworthy. Their design, political independence, and history of action are pretty impressive. This is an extremely high bar to beat. I think most pro-crypto people don’t realize just how high this bar is.
Bitcoin’s fixed supply doesn’t address the speculation problem I raised. In fact, it is the cause of it. With limited supply and no way to control inflation/deflation, bitcoin will absolutely cycle up and down in value in a purely speculative way. It isn’t even as anchored in value as gold; you can’t use bitcoins to make jewelry or electronics for example. Bitcoin is not a reliable store of value for precisely this reason. If I put X euro into USD and X euro into bitcoin, which one do you think will be closer in value to what I put in when I check back in on it a few years later (or even seconds later)? This is what being a “reliable store of value” means. Traditional currencies are better at this than bitcoin and stablecoins.