I’ve recently started to dabble in the cryptocurrency market. As an FX strategist I thought it was time to address the concept of Bitcoin and its ilk as a currency. The topic continues to gain the attention of both central bankers as well as the heads of top-tier financial institutions.
Bitcoin as currency
In our current understanding of a currency we need to have a few things present.
• First, it has to be generally accepted as a medium of exchange.
Traditional currencies as we know them (The Dollar, Euro, Peso, etc…) are broadly accepted around the world as a method of payment. You know their value because the items you are purchasing remain relatively stable.
• Second, a currency needs to have a lender of last resort, someone that will step up to the plate and provide access to money in a crisis.
The Dollar has the Federal Reserve Bank, the Euro has the European Central Bank, and so on.
The real question, though, is does that matter?
I would say yes, it matters. If the price of a loaf of bread was priced in bitcoin, it could rise or drop in value 10% or more a day. There would be no means to understand what you would pay for anything at any time.
However, that does not mean that cryptocurrencies are a fad or a fraud, as some major heads of financial institutions have stated. Quite the contrary, it is a new version of an emerging market currency.
When the world moved from the gold standard to paper money, people were skeptical, but over time paper money became widely accepted. Here we are years later and we have fewer and fewer transaction using paper money.
Some economies around the world, like Sweden for instance, are virtually paperless. How many of us carry no cash on us at all?
Where can cryptocurrency go?
So can we move cryptocurrencies from the category of speculative trading instruments to something more commonly used for transactions? Absolutely.
The first step is support from a broad spectrum of regulatory bodies. I didn’t say add layers of regulation, I said support, and we are already heading in that direction.
Central banks like the Bank of Canada and the Swedish Riksbank are already studying the concept of e-currencies or digital currencies. In fact the International Monetary Fund (IMF) has done an extensive study on the use of digital currencies. While this is not exactly the same as the world of cryptocurrencies like Bitcoin, it is a start to the realization that we are evolving. There are already banks in Sweden that don’t distribute money and that haven’t accepted checks in over 20 years. These are all steps in the right direction.
Finally, to make Bitcoin or any of the other cryptocurrencies more accepted, they need to meet six widely accepted characteristics of money. These criteria are: to be divisible, portable, scarce, durable, acceptable, and stable.
Cryptocurrencies meet all but the last two criteria. To gain traction as a currency, cryptocurrencies must be more widely accepted. That will not occur until we can reduce price volatility and make them more stable. The price of Bitcoin went from $1,800 to almost $5,000 in two months, and then dropped to $3,000 in a matter of days.
Think about going to the gas station one week and paying $50 to fill your tank, and two months later paying close to $140. That alone would cripple any economy.
Crypto’s day is coming
As a currency strategist I know that increased liquidity and access to a currency will reduce volatility. When I mentioned that cryptocurrencies were an emerging market currency, I meant it. It is similar to the Mexican Peso of 25 years ago. The Peso was highly illiquid and volatile. But as their economy emerged and more was transacted in Pesos it became less volatile and more accepted.
Be patient, the day will come when we all carry no cash, when stores accept no cash—and when a digital currency will be as commonplace as the Dollar or even replace the Dollar.
That day is not as far away as you think.