Why Cryptocurrencies? I’ve begun to dabble in the cryptocurrencies so I’m collecting my thoughts here and attempting to explain the phenomenon as I understand it… today. In other words, these views are subject to change as more information becomes available to me, possibly by you.
“Bitcoin is not backed by any physical commodity or precious metal” – Investopedia.
So, like Bitcoin, neither are the other cryptocurrencies backed by any physical commodity. Thus, like the US dollar, they are fiat currencies. The US dollar, while a fiat currency, is based on confidence in the US economy, the government, or in America, so to speak. Unfortunately, as America continues to print and/or borrow trillions of dollars, that confidence is quickly eroding. What gives value to cryptocurrencies will be addressed.
First, a few other topics need to be quickly discussed to provide context. For something to function as an acceptable form of money, it must fulfill a couple of key criteria: it must be fungible, it must be portable, and it must have value in the eyes of those attempting to use it.
Fungibility: “Fungibility is the ability of a good or asset to be interchanged with other individual goods or assets of the same type. Fungible assets simplify the exchange and trade processes, as fungibility implies equal value between the assets” – Investopedia.
So, the value that is inherent in money, that is generally accepted by all, can be used to trade for other needs. If you have a bushel of corn that I want and the going price is determined to be $5.00, we can make that trade based on the value we assign, and accept, for a five dollar bill. Now, other things can be used to trade for the corn, as well, but they do not have the fungibility of money. For instance, I can agree to work in your field for an hour in exchange for the corn, but another person might be required to work for less or more time depending on the assessment of any person’s value. Additionally, other skills used to trade for commodities might be appear to have more or less value than the field-worker.
Property and other commodities have value as well but are not portable. For instance, if I have to get up and leave my property due to some imminent danger, I can carry my money with me but I cannot take my property and, depending on the situation, that property could become worthless unless I could convince someone else to trade for it with money than I can take with me. Likewise, other commodities, could become unmanageable due to bulk if one has to hit the road.
Precious metals can function as money because they have value, are portable, and are fungible with regard to their worth. If you have a parcel of land that is deemed to be worth $1,000.00, gold or silver valued at so many dollars per ounce can be used to complete the transaction. If I have to move quickly, precious metals are portable. The more valuable the precious metal, the easier it is to carry. As I write, an ounce of spot gold is worth 68 times the value of spot silver. Thus, to carry the same valued amount of silver as one ounce of gold would require one to haul around 5.5 pounds of silver, both equaling just under $1800.00 USD. Finally, the value of any precious metal is based on two things: it’s actual usefulness and the value people place in it due to its scarcity. For instance, silver has a lot of manufacturing uses and that, along with however valuable it appears to people, establishes its worth. Gold, while not as valuable in manufacturing, has always been viewed as precious by many people in many civilizations and that, along with its scarcity, has caused people for thousands of years to value it and accept it as currency.
Finally, cryptocurrencies. Cryptocurrencies, in my humble opinion, are an attempt to disengage from the traditional financial institutions run by the wealthy. It is an alternative currency, however, like government issued, paper money, that absent any commodity to back it up, and establish its value, is a fiat currency. There is nothing behind the cryptocurrencies but the confidence of the investors. Additionally, there is, as I see it, one major flaw in the cryptocurrency market.
Paper money, like the US dollar, while a fiat currency, has the good will of the American government and people behind it. Yes, it can become more and more worthless via inflation, and the continued issuance of money with nothing to back it up, but as fiat currencies go, it is backed up by a huge economy. Cryptocurrencies, as has become painfully clear, are extremely volatile, rising and falling thousands of dollars in a day, or week, as we’ve seen with Bitcoin.
And then there’s this: I recently read about a question raised to a government official, in light of the massive volatility we’ve observed, as to whether the government was going to regulate cryptocurrencies. The response was that, that would involve regulating the Internet. And therein lies the hook. If there is some type of failure on the electric grid, or any other such anomaly that could occur, adversely affecting the Internet, the cryptocurrency market would collapse and become worthless unless there was some kind of ability to resolve the issue and/or recover the digital currency. And there it is, cryptocurrencies are strictly digital. You lose access to the internet, the ones and zeros, and anything stored digitally becomes unmanageable because it disappears.