The Shortfalls of Digital Assets as Currency and Where To Go From Here

Intro

In this article, I speak to the biggest shortfalls and perceived shortfalls of cryptocurrencies. As there are many assets that fall under the umbrella of “crypto” and since its origins are rooted in ideas of digital cash, in this discussion I will only speak from the perspective of crypto’s value as a currency — or more accurately, as money.

In further articles I ,will tackle this analysis from the perspective of crypto as an application layer (and it’s ssets as a commodity), crypto’s value as a tool for social coordination, and as well since much of the industry and valuations of its assets are now driven from it, crypto’s memetic value (yes, memes). These perspectives should not be conflated with blockchain technology — which has its own, albeit related, values and challenges.

TLDR: In this article, I will discuss the shortfalls of “crypto” as a monetary system.

Framing the problem

It will be hard to understand what’s “wrong” with something if we haven’t first laid out what “right” is supposed to look like. We need to understand what its intended value is and who it’s intended for to give this conjecture proper context.

So what is money? And how is it different from currency?

Money is a broad term that refers to any medium of exchange that is widely accepted in payment for goods and services and in the settlement of debts. Money serves several key functions: it acts as a medium of exchange, a unit of account, a store of value, and sometimes, a standard of deferred payment.

Currency is a specific type of money issued by some form of monetary authority in common use within a specific environment over time, especially for people in a nation-state (or network). It is an embodiment of money within a particular region or country (or network).

The distinction between the two is important for a few reasons:

• Not all money is in the form of currency, so they will have different value propositions. For example, gold bars vs. euros in your Paypal account
• Money can take more forms than currency, which has a narrower definition, and as such its features should be optimized to fulfill a more narrow set of needs. For example, money can take the form of “cash equivalents” like treasury bills, or commodity money like precious metals or cowry shells. But good currencies generally need to have features like divisibility and portability — which some forms of money do not have (you can’t split a treasury bill).

For brevity and because in crypto the lines of differentiation between the two are often unclear, I will speak to crypto’s value prop as both money and currency together, and try my best to clarify the distinction when important.

One more to add for the context of crypto — decentralization. “Decentralization” in this context is a decentralization of monetary authority, where each node in a crypto network is meant to be logically similar or “centralized” — running the same code and agreeing to a set of laws that govern the way monetary policy is administered (e.g. hardcoded max supply of 21m Bitcoins). It’s meant to be resilient to centralized points of failure so that no single entity has the power to censor or arbitrarily debase or bungle monetary policy like most, if not all governments, have done at some point in history.

To summarize, the intended value propositions and features are:

• Store of value — Stability, liquidity, scarcity, independence from counterparty risk
• Medium of exchange — Acceptability, durability, portability, low friction/cost to make the exchange, user experience
• Standard of deferred payment — Widely or legally recognized as a settlement of debts i.e. legal tender
• Unit of account (accounting for value) — Divisible, uniform, counterfeit resistant
• Decentralization — Privacy, self-sovereignty, resilient to centralized points of failure. Serves in support of the (4) stated above, but is important to mention on it’s own

TLDR: “Currency” is a form of “money” and value propositions for cryptocurrencies have elements of both — mainly store of value, medium of exchange, standard of deferred payment, a unit of account, and in the case of cryptocurrencies, decentralization.

Cui bono?

Who benefits from the value provided by a monetary system, especially a crypto one? And how? Capturing and/or slicing and dicing the “who” exhaustively would probably be impossible. So I’ll name just a few major segments — defined by various shared characteristics — that come to mind in order to broaden the context for appraising some of the shortcomings of crypto. They are by no means mutually exclusive or completely representative:

• Merchants and Customers
• Investors
• Libertarian, anti-establishment folk
• Traders
• Institutions
• Governments
• Criminals

For nearly all players the value propositions stated above apply. Where some of the major differences might lie are in degree of control and price stability. For example libertarian, anti-establishment folk might value self-sovereignty and minimal interference, whereas traders might not care at all, and governments highly value capital controls and subjective levers for monetary policy. Businesses and customers might value price stability, investors might want appreciation over time, and traders might value short-term volatility.

TLDR: Everyone benefits from a well-functioning monetary system although some aspects of it are valuable to different people in different ways.

What are the biggest shortfalls and are they inherently problems with crypto?

Now that we have a framework from which to evaluate whether or not value is being provided, we can jump into where crypto falls short of its promises as money. At the risk of sounding overly obvious, I posit that acceptability (medium of exchange) and stability (store of value) are the biggest high-level gaps in value. The following points are specific manifestations or causes of those shortfalls, and for each general point being made we’ll look at specific assets as a practical way to illustrate the points being made.

Not legally recognized as a settlement of debt, especially for taxes (medium of exchange, standard of deferred payment, acceptability)

The biggest problem for crypto functioning as a currency is that governments — the biggest spenders, borrowers, and lenders in the world — do not recognize it as tender. This in turn means taxes, one of the biggest household expenses, are not able to be paid for in crypto assets.

Governments don’t like crypto for any number of reasons — harder to implement capital controls, tax evasion, lack of identity infrastructure (KYC, taxation), lack of consumer protection, etc. Governments also do not favor stores of value during times of quantitative easing (injecting liquidity), as they are viewed as unproductive assets. In other words, during times of QE, the additional liquidity is meant to flow into goods and services and kickstart the economy instead of dormant stores of value like gold or bitcoin.

Governments also need to be able to transact, borrow, and lend with other countries — so it needs to be legally accepted in as many OTHER jurisdictions as possible, especially in large global trading partners like the U.S. and China. Other reasons include a general lack of understanding and a perceived potential to disrupt the status quo — especially for a reserve currency like the US dollar.

Currently, only one country, El Salvador, accepts Bitcoin as legal tender. The Central African Republic declared Bitcoin as legal tender in 2022 — but reversed its decision a year later.

Without government support, the acceptability of cryptocurrencies will remain highly diminished. It also means it’s impossible to develop a clear regulatory infrastructure. Unclear regulation means compliance is impossible or risky, which means less capital flowing into the sector — hindering developments for other crucial building blocks of a crypto monetary system e.g. legal infrastructure, identity infrastructure, scaling, user experience, and education. All of which reflexively diminish the acceptability of crypto assets as payment.

TLDR: Governments who are the biggest single-entity users of currency do not accept crypto as money.

Lack of merchant adoption (medium of exchange)

The second biggest shortfall is the lack of merchant adoption — especially for large markets like housing, transportation, and food. Although cryptocurrencies have demonstrated large promise and even widespread use in some markets, especially purely digital ones (and yes, illicit ones) — merchants and sellers ultimately need to be able to take the money spent and in turn spend it on business expenses, personal expenses, and taxes.

Currently even payments made in BTC or stablecoins still generally need to be converted into fiat in order to be spent. It’s sort of a chicken and egg problem since in order for merchants to be motivated to accept cryptocurrencies, a sufficient number of other merchants and consumers need to be willing to accept cryptocurrencies so that the former can purchase business assets and pay employees (including themselves) who, in turn need merchants willing to accept crypto so that they can spend it.

The other reasons that I think contribute most to the hesitance to accept crypto as payment are lack of understanding, and high perceived risk with little perceived benefit. Compared to traditional payment rails which generally work well enough, there’s simply not enough selling points at the moment for businesses to justify the added friction from introducing crypto payments.

In its current form that lacks merchant adoption, and thus lacking somewhere to spend crypto on goods and services (housing, transportation, food, business expenses), the market for crypto essentially becomes a zero-sum game for traders and speculators. This is reflected in the crypto-native application landscape that is dominated, one could say completely dominated, by DeFi — trading, lending, and borrowing. Theoretically currencies are meant to grow alongside economic activity. Without anywhere for that activity to take place, the function of crypto as a currency becomes impaired.

TLDR: Merchant adoption is lacking, making it harder for consumers to adopt, which reflexively makes it harder for other merchants to adopt — a classic chicken and the egg problem.

Perception of volatility

As an investment vehicle, crypto assets can often shine. Many have made or lost their fortunes betting on everything from Bitcoin to HarryPotterObamaSonic10Inu (it’s a real token, look it up). However, the allure of these gained or lost fortunes means the perception, and often the reality of these asset valuations is highly volatile and introduces massive counterparty risk as a currency — both for the payor and payee. Imagine getting paid in ETH and a week later when you do want to spend it, the price has dropped by 30% — you’ve just lost a third of your buying power.

Even though things like stablecoins or wrapped gold (e.g. PAXG) mitigate this risk by tokenizing relatively stable existing assets (US Dollar, gold) — the perception for most normies and many in government is that crypto is “too volatile”. Whether or not this view is unfounded, it is the perception of many.

There are a couple of reasons that contribute to this volatility. Many crypto assets are not purely currencies but serve as commodities or are basically just memes — this conflation of value propositions (speculation, gas for computation, governance/voting, store of value, etc.) means there is arbitrage in valuation that makes using it purely as money in a traditional sense, subject to the counterparty risk mentioned earlier. This volatility attracts further speculation in a feedback loop of wild prices.

In the case of stablecoins — it is often easier and less risky to just use existing fiat channels for all but a few use cases — Why use the derivative of something (USDT) when you can just use the real thing (USD)? On a similar note for those buying Bitcoin ETFs, why not just buy Bitcoin? 🙂

TLDR: Perceived high price volatility makes adoption as a currency risky.

Privacy and self-sovereignty are not a big enough value proposition (yet) for crypto to be a de facto store of value (decentralization)

Cryptocurrency has its roots in the Cypherpunk movement, tracing back to cryptographer David Chaum on topics such as anonymous digital cash and pseudonymous reputation systems. Its ethos is best embodied in Eric Hughes’ A Cypherpunk’s Manifesto, or Neal Stephenson’s Cryptonomicon, and is often associated with libertarian social ideals, little to no government involvement, a strong need for individual privacy, and decentralized systems as a means to achieve greater personal freedom.

However, I argue that for most players today — crypto’s value is more financial than philosophical. Sure, decentralization and self-sovereignty are still selling points — and used heavily in marketing and startup mission statements. But for most, these selling points are not on their own (yet) reasons to compel people to use it as either a store of value or as currency. People generally value time, convenience, cost, and for some assets price appreciation, over personal control and individual privacy.

This isn’t to say that the value proposition of decentralization and self-sovereignty are insignificant. Centralization has often created broader societal tensions and history has shown us that at a certain point, monopolies start to behave less like valuable ecosystem builders and more like extractive kleptocrats. For example, the U.S. basically has a monopoly of the world reserve currency via the U.S. dollar — and as such it can, and increasingly does — print money to monetize debt and weaponize capital controls. However, what I’m arguing is that this monopoly is not YET extractive and bad enough to make crypto’s philosophical values enough of a unique selling proposition on its own. Things may seem bad but the truth is for now, USD is still among the most stable currencies in the world — making up ~88% of worldwide forex trades, at least half of global trade invoicing, and nearly 60% of global foreign reserves. People tend to be reactive rather than proactive — which means that until things get really really bad, crypto’s original ethos of decentralization is unlikely to hold much sway over normies.

The ethos is even less of a value proposition for businesses — who may also have shareholders and investors who demand certain KPIs, or in the case of small businesses simply need to make ends meet by any means. They will, like the consumer, generally put a greater value on convenience and cost. This trade-off between personal control and time/cost/convenience is exemplified in any number of things: cloud vs. personal servers, ride-sharing vs. owning cars, streaming vs. buying movies, relinquishing personal data to social media platforms, etc.

Self-sovereignty is also hard to measure, whereas time and cost saved are easily quantifiable. I also think the “demand sensitivity with respect to supply” looks like the graph of a scaled ReLu function flipped on its vertical axis, which is to say that people only really care about it when things have gone to absolute sh*t (e.g. Bitcoin in response to the 2008 financial crisis). Time and cost savings, on the other hand, seem to have a more linear and constant slope at an arbitrary glance.

TLDR: Self-sovereignty, privacy, and personal freedoms are not yet acute enough problems to make the decentralized aspect of cryptocurrencies a strong enough selling point for widespread adoption.

Huge knowledge gap, perceived risk (acceptability)

I don’t think this is an inherent problem with crypto, but it is nonetheless a hindrance to crypto’s adoption and acceptance as money. From a technical and socio-cultural standpoint, crypto is nuanced and esoteric — filled with technical jargon, big words, and overly long blog posts like this one. People fear what they don’t know and the knowledge gap in crypto is arguably higher than the global wealth gap. Scams and bankruptcies have been sensationalized in popular media just as much as overnight millionaires and dog coins.

It’s still early and crypto still lacks infrastructure that abstracts away complexity (like browsers and simple UIs did for the internet), legal infrastructure for consumer protection, and a vote of confidence from governments and institutions — of which prospects for the latter are still in question. I am, however, still optimistic — more millennials and Gen X coming into corporate and political positions of power, a rapidly increasing trend of waking hours spent online per day, and regulatory arbitrage are some reasons for this optimism.

However, until we’ve either closed this knowledge gap sufficiently or abstracted it away from the general public (how many internet users know how TCP/IP works? How many people using Venmo or Revolut even know what SWIFT is?) crypto’s usage as money will remain esoteric and niche.

TLDR: People fear what they don’t know and the knowledge gap in crypto is disproportionately high.

Where to go from here and what to watch for

So where do we go from here? And what developments should we be keeping an eye out for that might change these shortfall dynamics?

I think the number one thing to look out for is regulation and the administrators that come into power in certain strategic positions in government, especially in the US. The last four years have seen largely anti-crypto, or at least crypto-weary sentiment in key positions of financial influence — Gary Gensler as SEC head, Janet Yellen as Secretary of Treasury, and Elizabeth Warren in the Senate — just to name a few.

We’ve seen agencies fight for ambit over the crypto asset industry (e.g. SEC vs CFTC) rather than thoughtful legislation coming from Congress. We’ve seen a few sparks of bi-partisan attempts from members like Cynthia Lummis (R), Patrick McHenry (R), and Richie Torres (D) — but ultimately we’ll need to see more support from the top, and key positions like the Secretary of Treasury filled with someone crypto-friendly, which in my opinion is more likely if the GOP wins the next election (disclaimer: this is not a motion of support or a reflection of views on anything other than crypto). Much like Al Gore helped spur the development of the internet into what it is today via legislation like the Gore Bill and other forms of early advocacy — we need similar advocacy and legislative support in Congress.

One important agency to look out for that is often lost in the loud noise of SEC filings and federal court orders is the IRS. For example, filings like this one, an amendment to the Infrastructure and Jobs Act, nullifies the original requirement to report over $10k in digital assets as a receipt of “cash” — “until regulations are issued”. To me, this signals that the US still does NOT want to view crypto assets as money or give companies an avenue of interpretation to do so.

Much of the rest of the world often outsources policy to the US — but some jurisdictions to pay attention to are Vietnam, Indonesia, Singapore, UAE, and Saudi Arabia. These are areas of high crypto adoption that all stand to either become regional hubs or benefit from some form of regulatory arbitrage, and as well are rising nations in terms of GDP political influence.

What may help governments accept crypto, and especially stablecoins or Bitcoin, is if they start to see more revenue in the form of taxes. My guess is the more taxes paid from crypto capital gains, and eventually, taxes paid via cryptocurrency — the easier it will be to justify its acceptance as currency. As unpopular of an opinion as it is, what we need here is better tax reporting solutions — especially those that are natively on-chain, as well as better identity and KYC solutions and analytics. This might go against the ethos of crypto, but when was the last time you bought something with Bitcoin or USDT other than more crypto? For most, it serves as a store of value or deferred value until you can convert it into something you can spend in the physical world. The key value prop here in my opinion is the hard-coded logic behind a network or crypto asset’s issuance and its immutable, public ledger — not misplaced ideas of anonymity and self-reliance. If you think you can be completely anonymous or self-reliant in this interconnected world — you’re either living in the woods and trading pelts for homemade ammunition and food or completely delusional, or both.

If crypto assets become legally accepted tender, only then are we likely to start seeing merchant adoption — I think starting with purely digital assets/digital marketplaces like Saas or GPU processing, or maybe with the rise of online worlds (ok fine, “metaverse”) — although my guess is the Disneys and Metas might want to keep any in-game currency walled within their respective ecosystems at first. As we trend towards living more and more of our lives online, I think it’s logical that the first markets to adopt crypto as payment will be natively digital and then to the physical world (like QR codes in grocery stores in China). And if cryptocurrencies start to get widespread acceptance, the knowledge gap will naturally close and the nitty-gritty will naturally be abstracted away and normalized — much like when Boomers finally learned to use Facebook.

Legal acceptance or even a friendlier stance towards crypto will hopefully be accompanied by thoughtful regulation — especially for futures markets and institutional involvement like ETFs or Mutual funds which will help smooth price volatility over time. It’s already happening and you can see it in Bitcoin’s volatility index over time. This will help address perceptions of counterparty risk due to volatility.

From a short-term macro standpoint in the US, two things I think will happen in the next election, regardless of who wins.

#1: A debt-to-GDP ratio of ~130% combined with high rates means the US will need to print money to service its growing debt. Eventually, rates will need to come down and liquidity injected — this stimulus often serves the PR needs of the administration in power and even when rates come down, we’ll still need the ability to be stimulative for a myriad of reasons (PR, potentially some form of war with China over Taiwan which will shock supply chains in almost every sector, worsening inequality gaps, price inflation, etc.). Either way we’ll continue to print the money and monetize the debt until eventually, the gig is up — it happened to the Qing Dynasty, to the Dutch with the guilder, to the British with the pound sterling — pretty much all world powers since the invention of money. “History never repeats itself, but it does often rhyme”. The US Dollar serves as the de facto world reserve currency, and as the US continues to debase it, the unique benefit that something like Bitcoin or another decentralized/deflationary asset promises to deliver- becomes more and more tantalizing.

As well as the U.S. engages in debt monetization and slowly erodes the trust of other nations, it will need net buyers of that debt (treasuries). Stablecoin issuers, especially those domiciled in the U.S. like Circle, do exactly that — and I hope that it makes a stronger case for more favorable or at the very least thoughtful, stablecoin regulation.

#2: Whoever wins the next election at this point will likely not be putting out the fires of political polarization, if anything adding fuel to the fire. At the time of this writing, it doesn’t seem like any moderates are in a position to win. An increasingly divided state will likely mean more unrest, but also a stronger perceived need for alternative or neutral payment/monetary systems. I also think both administrations are likely to continue an antagonistic stance towards China — especially the GOP. There is a small chance of weaponizing the dollar (similar to what the US has done with Russia), further eroding confidence and trust in USD and making the case for an alternative reserve currency around the world stronger.

Cryptocurrencies fulfill different features of money well — it’s global (portable), divisible, uniform, and counterfeit-resistant. Some are sufficiently decentralized against bad actors and centralized points of failure. Others are cost-effective and low-latency when compared to traditional financial rails. It is on its own often a better form of currency, and an adaption of money to the needs of the times — much like gold was a better store of value than cowry shells or pelts, gold coins were a better standardization of value than gold nuggets and dust, banknotes with a claim on gold were more portable than gold, and sending money through Paypal or Venmo is easier than writing a check and mailing it to the recipient.

However, certain large-scale shifts in government or institutional attitudes and behavior are needed for crypto assets to realize its true potential as a currency or monetary system — at least in the near future. There is a potential for a bottom-up change in dynamic, where people transact with it on the fringes until it eats up enough market share of total transactions from the bottom and it becomes widespread enough to challenge and overtake the status quo (This Innovator’s Dilemma argument). If we are to see widespread adoption of crypto as money or currency in a reasonably near future however, we will need buy-off from large institutions like governments — who are the biggest single entity of borrowing, lending, and spending. Drawing a parallel to the classic example of the innovator’s dilemma and market disruption — the disruption of steel production by mini-mills spanned a period of several decades starting from the 1960s to well into the 1990s. How long do you think an organic bottom-up disruption of the massively more complex and interdependent worldwide monetary system will take? Think about that. We’re still early and time will tell if we’ll be able to speed things along.

TLDR: We need government buy-in or at least a friendlier stance towards crypto payments, especially in the US, for crypto to be widely adopted as a monetary system or currency. Macro factors are currently in place that can increase the value of crypto monetary systems like Bitcoins.