To ask the question as to whether cryptocurrencies can ever be fiat currencies (a national currency that is not backed by any commodity such as gold or silver) is to ask if cryptocurrencies can ever become money. In this article we attempt to find out.
Money typically has three core functions, medium of exchange, a store of value and a unit of account. Certainly, all cryptocurrencies serve as a medium of exchange, which is critical to their existence. However, cryptocurrencies must fulfil the other two core functions of money, a store of value and a unit of account to be considered money. Cryptocurrencies have historically been too unstable to be used as a unit of account. This is because they have tended to have a rigid supply coupled with extremely volatile demand.
Of the main cryptocurrencies, Bitcoin has the greatest potential to have a store of value. This is because it has low supply growth and no single authority can alter its supply. However, historically Bitcoin has performed poorly as a store of value. Bitcoin’s wild price fluctuations have undermined any ability to perform any of the three core functions. For example during 2013 Bitcoin’s volatility was three to four times higher than a traditional equity. Even worse, its exchange rate with the US dollar was ten times more volatile than compared to the Yen, Euro and other major currencies.
Furthermore, Bitcoin’s dollar price shows no correlation when the dollar is compared against other currencies. Nor does the Bitcoin dollar price correlate to the price of gold. With a value that is so volatile, and one that cannot be linked to any existing value, this makes Bitcoin extremely difficult to hedge against risk.
Other cryptocurrencies fare even worse because they have centralised control and use tokens (the difference between a token and a coin is that a coin is meant to be used directly for transactions whereas a token represents an asset that is payable with a coin) which make them unlikely to ever fulfil the requirements of money.
Even if Bitcoin could fulfil the three main functions of money, there are still challenges to it being accepted as a standard currency. The current banking system is not set up to accept cryptocurrencies as it is to accept standard currency. Cryptocurrencies are stored in digital wallets which have proved less than secure, having fallen prey to hackers and thieves. Having said this, the rise of the Crypto Custodian could go some way to address this. Custodians such as BNY Mellon and State Street have started entering the crypto market and providing custody for digital assets (see https://shorelineawc.com/custodians_for_cryptocurrencies/ for more on Crypto Custodians).
The lack of deposit insurance that exists for standard banking customers would also mean that customers’ cryptocurrency deposits are not protected if the bank fails financially. In addition, no lender is currently using cryptocurrency for loans, consumer credit or mortgages. Furthermore, no credit or debit cards are currently in any form of cryptocurrency, limiting the scope for widespread adoption as a form of money.
Even if all these issues could be overcome, Bitcoin has one final hurdle in that it has a fixed supply. Only 21 million Bitcoins can ever exist and this is a problem whereby the money supply has to keep pace with the growth of the economy. If Bitcoin were to become a country’s currency, as supply began to run out, workers would be faced with having to accept pay cuts each year. Furthermore, you could expect to see the prices of goods and services falling. This will undoubtedly prove to be very unpopular with the public and will lead to a demand for change.
Although it is technically possible for existing cryptocurrencies to become money, at present there are just too many hurdles to overcome. Any potential cryptocurrency would need to function, not only as a medium of exchange, but also a store of value. Whilst Crypto Custodians do exist, the wider banking system must be set up to accept cryptocurrency and to be able to offer loans and credit in this currency. This change is potentially still a long way away.