The three main functions of money are: store of value, medium of exchange and a unit of account.
Money should be a good store of value meaning that it does not depreciate over time. Secondly, it must be widely accepted so that it can be used as a medium of exchange and finally, a unit of account so it can be used to compare the prices of different goods.
Bitcoin has proven itself as a store of value throughout its short existence but has yet to achieve medium of exchange and unit of account status. Merchant adoption of bitcoin is still very low and the cryptocurrency is not widely used in commerce. Moreover, there is not a significant number of people pricing their goods or services in bitcoin.
There are several characteristics that are required in order for something to be classified as money, they are:
- Durability: money must be robust and be able to withstand being used frequently to become a medium of exchange and store of value,
- Fungibility: one unit of money is not differentiated from another unit,
- Divisibility: required for a medium of exchange so that money can be divided into smaller units,
- Portability: individuals can move and transport money around easily,
- Scarcity: since money is a commodity, it needs to be scarce to hold value,
- Stability: to prevent excessive hoarding or spending, the value of money must be relatively stable,
- Acceptability: even if something has value because it's scarce and stable, merchants need to be willing to accept it
- Difficult to counterfeit: money must not be easily counterfeited, and
- Easily transactable: to transact the value of money has to be easily identified.
Let’s look at how bitcoin performs against each of these characteristics.
Bitcoin is not a physical asset, so it can be transacted infinitely many times without being eroded or damaged. However, it depends on how you store bitcoin. If bitcoins are stored in a paper wallet, then it is just as durable as paper notes. However, if it is stored in multiple locations with the private key engraved into a sheet of metal, it is slightly better than cash since it cannot be destroyed in a fire.
Bitcoin provides some privacy for its user, but the trail of transactions associated with a particular coin can often taint that coin due to some illicit activities associated with it. It has occurred in the past that some businesses will not accept ‘tainted’ bitcoins, which lowers their value. Also, freshly mined bitcoins (that have no transaction history) reportedly earn a premium when sold in the market. There are precautions bitcoin users can take to improve their privacy, but may be too complicated for new users.
Divisibility is critical for a medium of exchange such that any goods or services can be bought or sold easily in that currency. Bitcoin is divisible into 100 million satoshis, making it suitable for any type of payment large or small. The Lightning Network allows people to send 1 satoshi, which is $0.000083. Therefore, bitcoin fits the divisibility characteristics better than fiat currency.
Bitcoin is highly portable as you can store a private key on a hardware wallet, which is roughly the size of a USB stick, a paper wallet or even by remembering a 24 word seed which can be used to restore a bitcoin wallet with a computer or smartphone. Therefore, bitcoin is much better than cash in this regard, as very large amounts of money can be transported with just a USB stick, paper wallet or just by a mere memory of your 24 word seed.
Money needs to be scarce for it to retain value. If something that was not scarce was used as money, say snail shells, then people would be able to buy whatever they wanted by gathering some shells. Bitcoin, on the other hand, has a fixed supply of 21 million making it very scarce. While traditional money is not unlimited, the number of dollars in circulation vastly outnumber the supply of bitcoin.
Bitcoin is famous for its volatile nature and is perhaps the biggest barrier for the cryptocurrency to become money. Fiat currency, although inflationary, loses value slowly over time and seems to be stable over the short term. However, bitcoin is deflationary and has a tendency to increase in value over the long term, but can experience wild fluctuations in the short run.
Bitcoin started with a value of nothing and had no merchants in the beginning that were willing to accept the cryptocurrency. However, as bitcoin grew more and more companies started to accept it as payment. While merchant adoption has progressed, it is not anywhere near the level of acceptability of fiat currencies.
Difficult to Counterfeit
It is impossible for any counterfeit bitcoins to exist. Instead, the analogous concept is “double spending”, where a malicious user will try to spend the same bitcoins twice and attempt to fool miners. Double spends can only occur if the attacker controls more than 51 percent of the hash rate, which requires significantly more resources than for counterfeiting fiat currencies such as the US Dollar.
Bitcoin is easily transactable but requires some know how to get started. For instance, knowing how to use a bitcoin wallet, having access to the internet or a smartphone, and typing bitcoin addresses correctly are some obstacles. With QR codes and smartphones, transacting with bitcoin is quite easy, but it is not yet as easy as using a card or cash.
In conclusion, bitcoin performs many of the properties of money better than fiat currency, namely durability, divisibility, portability, difficult to counterfeit, and scarcity. Bitcoin’s weaknesses as a form of money lie with acceptability, fungibility, stability and being easily transactable.