Money Matters Part 1: Bitcoin as Global Currency?

Money Matters Part 1: Bitcoin as Global Currency?

This first of a two-part series about bitcoin examines its viability as a potential global currency. Part 2 looks at the impact of China’s recent bitcoin ban.

In 2009, bitcoin became the first cryptocurrency — or digital medium of exchange — to begin trading. Is it currency or a commodity?  Is it a potential peer or a threat to existing currencies?  Let’s take a closer look.

Bitcoin basics

Here’s a quick summary of the basics:

  • Bitcoins are used to to make payments between people sharing the online Bitcoin network. Users pay for products and services via a personal computer, mobile device or Web service.
  • Transactions transfer ownership of the currency from one user’s account to another.
  • Merchants have incentive to accept bitcoins because transaction fees are lower than the 2% to 3% typically imposed by credit card processors.
  • Bitcoins are generated, or “mined,” online according to algorithms, and their supply is finite. They can be converted into other currencies, such as dollars, based on prices that are set in online trading.
  • Bitcoins are created and traded independently; they are not associated with any world government or any bank.
  • Speculators accumulate bitcoins on the chance their price will rise.
  • Public key cryptography is used for security.

There’s a flip side to bitcoins, however —their use in illicit activity and theft of the currency have been covered extensively in the media and drawn scrutiny from law enforcement agencies. But illicit or otherwise, the use of bitcoins in commerce is currently small compared with their use by speculators, which has fueled price volatility.

Commodity or a currency?

Bitcoin is a type of privately created currency, which has often existed during different eras around the world. As economist and Nobel Prize winner Milton Friedman pointed out, it’s hard to name a commodity that hasn’t been used as money at some point. What differentiates bitcoins from earlier types of private currencies — such as rice, cowrie shells or tobacco — is that they’re a digital, or virtual, currency.

Potential global currency or threat?

Major currencies, such as the US dollar or the euro, meet the three minimum criteria for “money” because they:

  1. Can be used as an effective medium of exchange for a very wide range of transactions.
  2. Can feasibly be used as a unit of account, such as to measure income or wealth.
  3. Act as a stable store of value for savings and investment or for long-term contracts.

Bitcoin doesn’t measure up to these three standards because it’s not a stable store of value. In fact, measured in terms of these three key criteria, while bitcoins have started to be used as a medium of exchange (criterion 1), they are never likely to be used seriously as a unit of account (criterion 2). In addition, as we’ve seen in recent weeks since China banned the currency in early December — which I address in Part 2 of this series — bitcoins are highly unstable in value (criterion 3).

In my view, bitcoins aren’t  a serious threat to any major convertible currencies because these currencies can each be used for all types of payments at home within their country of origin. Moreover, they can also be converted at free market prices without restriction into foreign currency for the purpose of making payments abroad. In my judgement, it never looked likely that bitcoins could become established as anything other than a speculative vehicle for a small minority of adventurous investors.

Important information

An investment in new technologies such as cryptocurrencies may be extremely volatile and not appropriate for all investors.  Additionally, cryptocurrencies and cryptocurrency exchanges are not regulated and offer little to no protections to investors.

John Greenwood

Chief Economist

Invesco Ltd

Based in London, John is Chief Economist of Invesco Ltd. with responsibility for providing economic analysis and forecasts to Invesco portfolio managers and clients.

John started his career in 1970 as a visiting research fellow at the Bank of Japan. He joined our company four years later in 1974 as Chief Economist, based initially in Hong Kong and later in San Francisco. As editor of Asian Monetary Monitor in 1983, he proposed a currency board scheme for stabilising the Hong Kong dollar. John was a director of the Hong Kong Futures Exchange Clearing Corporation for four years until 1991, and in 1992 became a council member of the Stock Exchange of Hong Kong, a position he held for twelve months. In that same year, he was an economic adviser to the Hong Kong Government. He has been a member of the Committee on Currency Board Operations of the Hong Kong Monetary Authority since 1998. He is also a member of the Shadow Monetary Policy Committee in England, and he serves on the board of the Hong Kong Association in London.

John holds an MA from the University of Edinburgh, and an Honorary PhD, also from the University of Edinburgh.

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3 comments

  1. Paul Gordon

    Hi John

    You on only talk about bitcoin the “currency” and make no mention of Bitcoin the distributed protocol/ledger/timestamp/payment network.

    You don’t mention anything about the potential value this network can bring; how ideas such as colored coins (that could allow any value to be associated to each atomic bitcoin unit whilst retaining the benefits of very low cost p2p value transfer); or Mastercoin (the first attempt at a protocol layer built on top of bitcoin giving, possibly producing similar benefits and additional user friendly features); or how it could allow the development of smart property contracts; or deliver autonomous trade-nets; or how it could be used to build a distributed patent network; or how it allows for distributed dispute arbitration.

    Do you plan to offer a more complete analysis based on the above?

    • John Greenwood

      Paul, thanks for your note. I don’t plan to cover bitcoin beyond its role as a potential currency, and any implications for conventional currencies. For more on that topic, please see my blog post from Jan. 7 on China’s bitcoin ban.

  2. Blane Warrene

    Mr. Greenwood – thanks for covering this new landscape as a component impacting money (for lack of a better short descriptor). It is certainly very early in the transformation of transactional use of money from analog to digital – though we have some interesting middlemen examples that have grown rapidly (transactors like Square and of course the pioneer, PayPal).

    What is intriguing about Bitcoin is during the most recent news of its illicit use and criminal proceedings by the FBI (Silk Road) – an interesting step occurred – the FBI took possession of the bitcoin and valued it, potentially giving it legitimacy as a currency.

    No doubt these are the very early days of the next shift in money – in my view purely experimental and you rightly note it as extremely high risk. That said – enough legitimate sources have chosen to accept it – that whatever comes next should be of interest.

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