Can Bitcoin Become Money?

Bitcoin is money.

Whoa, what did you just hear? Blasphemy!

Let's get serious though. Is Bitcoin money? If not, can Bitcoin become money? When and how could that happen? In this article, we look at:

What is money: the three types of money and how they work.
Bitcoin as money: how Bitcoin scores on money attributes.
The future of digital money: could Bitcoin become money and what would need to happen for that?

Spoiler alert: the short answer is yes, Bitcoin can become money. But the explanation as to why and how is not quick and easy. Strap in for an in-depth look at money and its digital future.

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What Is Money?

At its core, money has three functions:

It's a medium of exchange.
It's a store of value.
It's a measure of value.

Source: https://en.ppt-online.org/317095

Everyday examples of how we use money are valuing and paying for goods and services and storing the proverbial fruits of our labor.

So, why do we need money at all?

A common misconception is that money developed from a barter economy. Imagine an economy without money and with just three participants. Joe produces ice cream, Donald builds towers, and Nancy is a golf instructor. Even if Donald, for some reason, follows an ice cream-only diet and gets all his food from Joe, he won't have any way to pay him. Not to mention Nancy, who may be on a diet! Even a simplified version of this model doesn't work.

Even ancient societies never worked with pure barter economies, since these are too inefficient to function. Thus, we need money.

Sounds good, doesn’t work

The Three Types of Money

There are three types of money:

Commodity
Fiat
Digital

Commodity Money

Commodity money was the type of money humans used for most of their existence. The Austrian school of economics sees commodity money as the best type of money. According to this school of thought, money should be:

Divisible: you can easily divide it into smaller units.
Portable: you can easily transport it.
Durable: it doesn't rot or break easily.
Fungible: units are interchangeable with one another.
Verifiable: you can check it's "the real thing" and not counterfeit.
Scarce: its supply doesn't change quickly.
Utility: it has some sort of intrinsic value.

According to this thinking, money should be what Lyn Alden calls the "most salable good." That is, the good that is most capable of being sold.

Take, for example, cigarettes, which were used as currency in labor and concentration camps. They are the most salable good in that environment, but score poorly on some of the money attributes. Thus, cigarettes are not money in the wider economy. The same goes for commodities with high intrinsic value, such as oil.

It's quite easy to see why this model considers precious metals like gold and silver the best type of money. They score high on all money attributes and have the best stock-to-flow ratio. This is the ratio of circulating supply and new supply being added through mining additional gold and silver. Neither are too rare, which would create too much friction when trading them, nor too easy to create, which would make them easy to dilute.

Despite technological improvements, global gold production has remained remarkably stable. That is why we used gold in particular as money for a long time…until fiat currencies entered the chat.

Fiat Money

In Austrian economics, a currency is not the same as money. Currencies are just liabilities — a claim to money — whereas real money has an intrinsic value.

However, we can see that fiat currencies also score well on money attributes. They are divisible, portable, durable, fungible, verifiable and scarce — at least as long as they are backed by gold. But they are not intrinsically valuable. And modern fiat currencies are not backed by gold anymore.

Comparing physical gold and fiat currency.

What are fiat currencies nowadays backed by?

After abandoning the gold standard in 1971, the world entered the petrodollar system. In short, the dollar is not backed by gold anymore, but all oil trading happens in the dollar. And the world trades a lot of oil. Also, not only oil trading is settled in dollars, but many other goods too.

Thus, the American dollar is backed by the transaction volume of oil trade in dollars. More trading means more demand for USD.

After a while, a flourishing financial industry developed in the U.S., and everyone needs dollars to participate in that too. That's another driver of demand for dollars.

But what if someone, say, a country that doesn't like America, wants to trade oil in another currency?

That's theoretically possible. However, the U.S. government enforces the demand for dollars with the threat of using force against you, against your will. Domestically, that's called taxes. Internationally, that can be anything from trade agreements to invading other countries.

However, the fiat currency system is a historical outlier. It emerged only a little more than 50 years ago (in its current form), so it may or may not work well in the long run.

But we are already at the next frontier after commodity money and fiat money: digital money.

Digital Money

The most popular and most respected form of digital money is Bitcoin. If we look at the attributes of money, Bitcoin scores pretty well:

It's easy to divide Bitcoin into smaller units.
You can easily transport Bitcoin
Bitcoin can't break.
Bitcoin are indistinguishable from one another.
You cannot "fake" Bitcoin.
There are only 21 million Bitcoin.

But what about the elephant in the room: does Bitcoin have intrinsic value?

Yes.

The Bitcoin network is a payment ledger similar to Fedwire. However, unlike Fedwire, Bitcoin is decentralized and censorship-resistant. The commodity the Bitcoin network offers is blockspace registering activity on this payment ledger. This blockspace is so valuable precisely because of Bitcoin's decentralization and censorship-resistance. And because there are only 21 million units of it, people are willing to pay an increasingly higher price for this rare commodity.

A common misconception is that all the value of money comes from its utility. However, only a small fraction of gold is used for industrial purposes. Most is used for jewelry (subjective value) or investments (also subjective). The good with the highest intrinsic value doesn’t become money (otherwise we'd be paying in water), but the most salable good becomes money.

Thus, Bitcoin has objective intrinsic value, simply because people are eager to register entries on its ledger. Most of those happen to be payment transactions, so Bitcoin lends itself to being money. Policymakers and regulators are coming around to this view:

SEC chairman Gary Gensler affirmed Bitcoin is a digital commodity.
Fidelity described it as a monetary good.
Germany treats Bitcoin as private money for tax purposes.

Bitcoin is not the most efficient payment ledger. But it's not trying to be. It is the most decentralized (by number of nodes and their global distribution), with the biggest network effect, making it the most censorship-resistant form of digital money.

In short, Bitcoin is money. But can it also become a currency?

The Future of Digital Money

Now that we agree that Bitcoin is money, we only have to inform the rest of the world about it.

There are two theories of money adoption: top-down and bottom-up.

Top-Down Money Adoption

Top-down adoption is the notion of "use my currency or else." You force someone to use your currency and back up your threat with violence. If you don't pay taxes, the worst-case scenario is that the IRS will hunt you down and, worst-case scenario, put you behind bars.

Side note: that is why "the stablecoin formerly known as UST" failed. For a while, there was demand. But there were no consequences to not using it, and the token design did the rest.

Bottom-Up Money Adoption

Bottom-up adoption is what we observe for Bitcoin in cases like Venezuela and partially in Turkey. Citizens voluntarily convert their fiat currency to Bitcoin because the pain of losing value in the fiat currency is greater than the pain of stomaching Bitcoin volatility. This is bottom-up adoption in the strictest sense as a national currency.

Other examples would be crypto donations or Bitcoin's role in Ukraine. Bitcoin can perform functions of money without necessarily replacing fiat currency entirely.

The two adoption mechanisms are not mutually exclusive. So, when will Bitcoin be recognized and adopted as money?

Can Top-Down Bitcoin Adoption Happen?

Top-down adoption of Bitcoin is already underway. The most salient example of this is El Salvador, which was the first country to accept BTC as legal tender. A second country, the Central African Republic, has followed its lead. Other examples of top-down adoption are the acceptance of BTC as a means of payment in stores (although these may also be bottom-up if customers request them).

However, true top-down adoption can only come at scale by allowing the use of Bitcoin as a means of payment. For example, if the state allowed crypto investors to pay capital gains taxes in BTC, that would be a fairly big example of top-down adoption. You would not have to leave the cryptocurrency ecosystem anymore to pay your taxes, making the process much more efficient. Of course, it is questionable how many people would voluntarily pay in BTC.

If Subway forced its stores to accept BTC, that would be top-down adoption.

One problem with top-down adoption is the lack of enforcement behind it. Quite the opposite, nation-states actually have little incentive to adopt BTC. After all, the Bitcoin network is decentralized. By adopting BTC as legal tender or even doing a lot of transaction volume in Bitcoin, states give up power. That is because they cannot control Bitcoin's monetary policy (the inflation rate and total supply are fixed and unalterable). But monetary policy is an important tool for economic policy-making. Using a foreign currency always means a loss of control and using BTC is no different.

Moreover, Bitcoin is seen as a store of value, at least in the crypto space. Crypto investors would rather part with their dollars (unlimited supply) or at least other coins instead of with their bitcoin. A gold bug can view gold as ultimate hard money and support a gold standard. But that doesn't mean they would spend their gold on coffee. The same is the case for Bitcoin.

Bet you wouldn’t want to be that Bitcoin pizza guy

Can Bottom-Up Bitcoin Adoption Happen?

Bottom-up adoption is much more likely. However, that's not easy either. To have true hyperbitcoinization (or something close to it), fiat currencies would have to become so worthless that people would rather choose Bitcoin volatility over fiat's loss of value. That is true for countries with hyperinflation, but those are rare.

A more realistic scenario would be increasing adoption of Bitcoin scaling solutions like the Lightning Network, coupled with Bitcoin as collateral for a fiat currency. In gold standard times, people did not actually pay with gold but with fiat backed by gold. So, could a Bitcoin standard be possible?

In theory, yes. But you again run into the incentive problem for governments. Besides that, fiat volatility and Bitcoin volatility are not the same. Fiat loses value, but it is more like a melting glacier — disappearing slowly but steadily. Bitcoin is more comparable to a lake — it can evaporate in real-time, or it can grow bigger if it rains enough (i.e., new users join the network).

Fiat disappears like the glacier left (slow but inevitably). Bitcoin could grow or evaporate like the puddle on the right.

Most likely, it will be a slow process that needs a supply-side push (like increasing use of scaling solutions and BTC-backed digital currencies) and a demand-side push (a massive devaluation of fiat and real economic pain).

When Could Bitcoin Become Recognized Money?

A Bitcoin standard would be the biggest monetary revolution since the invention of fiat currencies and probably bigger than the petrodollar system. Such a paradigm shift needs to be preceded by a long development process.

For example, fiat currencies were adopted because industrialization allowed states to project more power and project it farther. When you can sail to the other end of the globe, you need more money to build a navy capable of doing that. That is easier done with fiat currencies and monetary policy to control the debt needed to do so. The petrodollar system was just an extension of this.

A Bitcoin standard would require forces that undermine the trust in the current fiat system. And some of them are already at work:

Increasing digitalization: we spend more time online than offline. Our money being digital is simply the next logical evolution.
Loss of trust in institutions: trust in our societies making good political decisions is decreasing. Trust in U.S. political institutions and government is abysmal.
Accelerating loss of value of fiat currencies: the joke in the crypto industry is that the dollar is a centralized token with insider allocation, unlimited supply and total centralization. It certainly doesn't hold up well versus gold.
Network effects of new technology: if two people use the internet, it's useless. But if two billion do, it's a revolution. The same goes for cryptocurrencies: the more people have access to efficient payment channels, the higher the chances those will be used.

Apart from global trends, big and sudden changes can be an additional impulse. For instance, Zimbabwe experienced hyperinflation and abandoned its local currency in favor of the dollar for a while. It later went back to the Zimbabwean dollar, which duly started hyperinflating again. Venezuela has been battered by hyperinflation, making its citizens turn to Bitcoin. The government reacted by launching the Petro, a commodity-backed CBDC, which received a tepid reaction from the local population (at least it’s exempt from the 20% crypto tax).

Source: Coindesk

In the future, a country experiencing hyperinflation may be at least more prone to recognizing BTC as a currency in one way or another. Other examples would be small or micro-nations that project no power internationally and have little to lose in that regard. If the benefits of adopting Bitcoin outweigh the costs of giving up monetary policy, this may become an option. However, such nations would ideally already have a highly tech-literate population.

Finally, stateless nations could look into Bitcoin as a way of achieving sovereignty. Examples are Kurds and Catalans, which both aspire to have their own nation. Still, these would also face the same trade-offs as existing states.

Conclusion

Bitcoin has notoriously outperformed expectations and proven its naysayers wrong. However, with greater influence, the network will also face more resistance from the existing system. One thing is almost certain: Bitcoin is not going to go away any time soon.

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