Bitcoin Is No Money
Bitcoin was invented as digital money, but in the world of innovation, things do not always play out as initially planned. As Bitcoin is facing many issues in its transition from a prototype to a real-world application, we should explore alternative use cases for this ingenious invention.
Bitcoin Is a Bad Currency
While many Bitcoin maximalists fall for the classic selection bias trap and see in Bitcoin the perfect money, the truth is certainly somewhere else. Assessing Bitcoin based on the three main functions of money (1) medium of exchange, (2) unit of account, (3) store of value, it reveals a very lopsided picture.
Medium of Exchange
Being a medium of exchange is probably the most crucial functions of a currency. It’s why currencies exist in the first place. It allows overcoming the barter system in which goods can only be exchanged for goods. Bitcoin serves this purpose. As a native digital asset, it is freely transferrable and entails no counterparty risk. Bitcoin also defies all controls by regulators and is censorship resistant. It’s highly reliable, has reasonably low transaction cost and is rather fast compared to other international payment options. The Lightning Network is an even better medium of exchange, given its significantly lower transaction cost and near-instant transfer speed.
Store of Value
Being a store of value is important to be a widely accepted currency, because holding a currency is a form of investment. Knowing that anything could lose value anytime soon doesn’t make it very attractive. Ideally, it would be rather stable in value so that we don’t need to change price tags every day. As Bitcoin lacks any price-stability mechanisms, the value will always fluctuate. With higher adoption and a higher market cap, the volatility would certainly drop. Still, it would be much more volatile than good national currencies. The volatility of gold is much higher than currencies such as the euro or dollar.
Unit of Account
A unit of account allows us to measure costs and makes asset values comparable. So ideally the value of the asset pricing other assets is stable. Bitcoin will have troubles to become a widely used unit of account in most cases, as its value is highly volatile. Even if its value grew by two more orders of magnitude, which would make it comparable to gold, it would be still volatile compared to the best fiat currencies.
Leveraging Bitcoin’s Strength
Looking at Bitcoin from these different angles demonstrates the various limitations when serving as an everyday currency, leaving it solely as a good medium of exchange. So how can this property be leveraged? The answer is: Payment rail. We could use Bitcoin as a universal medium of exchange, which allows us to transfer value across the globe. In order to circumvent its weaknesses, Bitcoin is only used for the value transfer itself. So every recipient will price a payment in bitcoin, knowing it can be exchanged immediately into local currency at low cost.
The problem of price volatility gets smaller and smaller the shorter bitcoins are held. When bitcoin is used to solely transfer value, it doesn’t matter how volatile or valuable a bitcoin is.
The Bitcoin Payment Option
Let’s assume someone wants to pay online. This someone goes to the website and scans the QR code via the payment app. The user doesn’t need to hold any bitcoin, as the payment app is converting some money into bitcoin and sends them to the merchant. The merchant will likely use a payment provider as well, who directly converts the bitcoins into fiat. Unlike credit cards, it’s an instant settlement. Once the payment provider on the merchant’s side received the bitcoins, the payment provider converts them immediately and credits them to the merchant’s account. The payment provider will likely send the money just once a day, week or month to reduce transaction costs.
This solution gets very interesting with Bitcoin’s Lightning Network, as the fees are significantly lower and the transaction speed as well. In the on-chain Bitcoin case, the fees are in the range of a few cents to a few dollars, likely trending towards the latter, and transactions take an hour to confirm, during which the recipient is exposed to the volatility of the price. Lightning could greatly reduce the transaction fees as dozens of transactions can be done with a single payment channel which requires two on-chain transactions. Also, it removes most volatility exposure problems thanks to its instant transfers. The total fee per such a transaction is roughly 2 x 0.15 % + $0.01, which should result in transaction costs of less than 1 %, even if the two payment providers would like to earn something too. The good thing is also that it converts any currency to any other. Because credit card payments often charge not only network fees, but also expensive exchange rates for foreign currencies.
Bitcoin could in some sense become the money of the internet, but not the money of the people. It might not necessarily be the store of value all speculators hope for, but it would be a solution that works in every place where bitcoins can be efficiently exchanged for local currencies. This vision is not completely disintermediated, but came with zero implications on the user experience and could be easily implemented everywhere without barriers. Such a payment solution would also protect the privacy of its users and is highly scalable. At least to me, this sounds like a giant leap forward.