In the last post, I put forward the idea that Bitcoin could and should be treated as an asset and suggested readers think of it just like gold. This week I hope I can offer some credence to the idea that Bitcoin is better than gold. Well at least in some respects. As you read though, please think of “digital currency: in general, rather than Bitcoin in particular.
The functions of money
Standard economic theory lists three functions for money. First: “Store of Value”. In plain English, whether something holds its value; a 10 pound note today is worth 10 pound tomorrow. Of course there is inflation to worry about or devaluation if you live in Greece and they drop the Euro. Gold holds its value well, but prices do go up and down. On the one hand, in troubled and uncertain times there are two things that almost certainly increase in value: the Swiss Franc and gold. On the other when there are doubts about gold itself, it loses value. Now, having established in the prior Blog that, like gold, Bitocoin or a digital currency should be considered an asset and a currency, there is the question of price fluctuation. Although Bitcoin has shown more price volatility than gold, it is nonetheless a store of value. Perhaps 1:0 for Gold.
Unit of Account. This has three characteristics:
Countable: this has to be a draw. You can count gold, in whatever units you choose and you can count Bitcoin or digital currency.
Fungible: Bitcoin has the edge here. All balances can be aggregated. That is not quite true of gold. If you have a vbar of gold, it is 12.4 Kg. Now it may look a bit like a Toblerone but you can’t easily divide it and you cannot add a gold bar and a gold Kruggerand together.
Divisible: Bitcoin has an edge in terms of the third characteristic; one unit can be split into 100 million parts. That makes it perfect for so called nano-payments; paying a very small amount of money to do something once, for example streaming the latest Taylor Swift song or reading an article.
Advantage Bitcoin by 2 ½: ½.
Medium of Exchange. Simply put this means can you pay for things with it? For gold, the answer is kind of. If you have just the right lump or form of gold you could pay for something. But, if you have one gold bar, that could be worth $500k. Using it to pay for anything other than the deposit on a house in Chelsea or a new Ferrari poses some problems. First, will the seller want to take it and even if they would, do you want the change in local currency? That is the same problem as trying to pay in pounds for something at Frankfurt Airport and then getting some Euro change just as you are about to fly off and leave the Eurozone; awkward.
To the standard three functions of money, I would also look at a characteristic of holding gold vs. holding a digital currency. Does it cost something to hold it? For a digital currency, the answer is a clear no. For gold, that is not the case. If you have some gold bars, rather than a few loose coins in your pocket, you need to store them somewhere and quite possibly insure them. Gold bars are typically held in what is know as “unallocated” form. In other words, you have a share of a gold inventory that is stored somewhere safe, for example deep in the vaults at a Swiss bank. That normally comes with a fee. There is even an implicit fee if you store the gold in a safe deposit box with some other valuables.
Lessons to be Learned
So Bitcoin, or rather a digital currency, is better than gold in three ways.
If after reading the last post, you had reached some level of comfort in thinking of Bitocoin as an asset with some broad similarities to gold, then after this week’s post, I hope you are thinking that that as an asset, a digital currency has many advantages as an asset in comparison to gold.
I will hazard a guess and think the next word that comes to mind is: but. But, I keep my gold in my safe or at my bank and banks are more trustworthy than some distributed ledger something or other where my Bitcoin or digital currency is stored.
So your understanding might have increased, but your comfort level with a digital currency may not have risen to the same level, if at all. The next post will be making a contribution to that cause.
Understanding Bitcoin
My own epiphany in matters Bitcoin and distributed ledger technology is the result of three independent sources: I am indebted to Emmanuel Mogenet at Google for his inspiring gift of a Bitcoin, to Richard Brown at IBM for so readily sharing views and educating the latecomer and finally to Reid Hoffman for his seminal article in the May 2015 edition of Wired UK: “Reid Hoffman: Why the block chain matters.”
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