You use private currency all the time. That deposit in your bank account? Those are Wells Fargo dollars (or Chase dollars or your local bank’s dollars). All deposits in a bank are IOUs from the bank to it’s depositors promising to exchange them for legal tenders (state money) on demand. Similarly, bitcoin is money, but right now it’s fairly low quality money.

The reason most people don’t consider a checking account balance any different from government currency is because they are usually interchangeable on demand- they trade at par value. The relative equivalence of private dollars (Chase bucks/Wells Fargo deposits) and public dollars (legal tenders) is maintained through our complex but remarkably smooth functioning monetary system.

Only in times of turmoil does the the qualitative hierarchy of money reassert itself. When there are financial crises and bank runs, Chase dollars might not always trade at par value with cold, hard cash. That bank deposit might be worthless if the bank is closed and you cannot convert your deposit into legal tender. In this way, liquidity is far more important than solvency.

Recently, in Cyprus, there was a long bank holiday and a haircut on deposits over a certain amount. Technically, deposit euros in banks (over a certain base amount) were converted from bank deposits to lower quality money, equity in the bank they were stored in.

The criteria by which the quality of money is judged in this situation is how widely accepted it is (liquidity), how stable it is as a source of value (volatility), and how scarce it is (in a crisis, scarcer is better).

Using this criteria, currently bitcoin fails to be high quality money- it isn’t a stable reservoir for value (it’s highly volatile) and it isn’t particularly widely tradable for goods (yet). It succeeds in the scarcity aspect, but scarcity alone isn’t the only bar which bitcoin needs to meet to be considered high quality money. There are many equitites and derivatives (not to mention things like art pieces), which are not highly liquid but are scarce. They don’t hold their value in a crisis.

Why does it matter that bitcoin isn’t “high quality” money? It matters for the same reason as why you cannot rack up a tab in a restaurant and pay in equity in your business or a note for 1/100,000 of your home- nobody will accept an illiquid or volatile financial instrument for day to day transactions.

None of this is a knock against bitcoin’s undeniable innovations, especially around implmenting a solution for decentralized transaction authentication, the blockchain. Technical innovations, however, don’t always translate into solutions for real problems in different domains. Putting computers in every classroom (or into the hands of every student) has not yet solved our education problems.

In a future post, I’ll discuss several things which could improve bitcoin’s standing as a currency and it’s quality as money.