Bitcoin is not money. Therefore it cannot replace the dollar which IS money.

UPDATED on 4/24/21

Bitcoin is not money.  There are three main functions of money: 1) a unit of account (a measurement of value); 2) a medium of exchange; and 3) a store of value.  The most important and unique function of money is to serve as a unit of account and because bitcoin is not a unit of account, bitcoin is not money.

If bitcoin is not money, what is it?  Bitcoin is mainly a store of value like stocks, bonds, rare baseball cards, and lottery tickets.  None of these are money because they do not serve the first two functions of money.  Bitcoin is closer to a form of money than stocks because bitcoin is also occasionally used as a medium of exchange, and this is where bitcoin is unique.  All other mediums of exchange are also used as primary units of account, but bitcoin, uniquely, is occasionally used as a medium of exchange that is never used as a unit of account.  Every bitcoin transaction uses prices not in bitcoin, but in dollars (or another money).  Bitcoin’s failure at the primary function of money is why bitcoin is not money and no economy could operate on bitcoin alone. Capitalism needs money to function and the most fundamental function of money is to serve as a unit of account.

Only the first two functions are really unique to money. Lots and lots of things serve as a store of value and money is one of the worst stores of value, so although this is a function of money, it is a distant third-place function. There is an inherent tension between the store-of-value function and the medium-of-exchange function because you can’t store your money and exchange it too just like you cannot have your cake and eat it too. Anything that is a good a store of value stops being used as a medium of exchange if there are any alternatives for exchange. That is the point of Gresham’s Law which says that whenever there is a choice between different currencies, everyone will hoard the one that is a better store of value and only the worst store of value will circulate as money. If everyone thought that the value of bitcoin was going to steadily and slowly drop whereas the value of the dollar was going to start a long-run appreciation, then people would start hoarding dollars and using bitcoin as money instead, but that isn’t going to happen because we have a competent central bank that will never let dollars appreciate in value.

(Aside:  The last time the dollar appreciated dramatically was the Great Depression and it was the rise in the value of the dollar that was a major that made it so “Great”.  If the central bank had kept the value of the dollar from appreciating, it could have been a Little Recession instead of a Great Depression.  When the dollar started rising in value, people started hoarding dollars rather then spending them which meant that spending plummeted as everyone tried to buy as little as possible which caused incomes to plummet more in a vicious cycle.)

Bitcoin is more like gold than money and neither are money for the same reason. Both gold and bitcoin have very volatile values because they are both mainly used as speculative stores of value. If bitcoin continues to grow in popularity, it won’t replace money, but it could become an increasing substitute for investing in gold and cause the value of gold to drop!  Bitcoin is a fantastic substitute for gold because both are used to hedge system failure.

Goods that are primarily used as a speculative store of value have volatile prices because speculators capriciously speculate about future values rising which drives up prices, or they sell when they think future values will fall which drives prices down out of pure speculation.  In fact, the more that something comes to be seen as primarily a store of value rather than as something that is valued for its intrinsic usefulness, the more volatile its price becomes. For example, housing bubbles are not caused by people who just want use a house as a place to live, but by speculators who see housing as a growing store of value and are hoping to resell at a profit in the future.  Housing bubbles pop when speculators suddenly think that housing prices will fall and they all try to sell before the price falls farther. 

Although bitcoin proponents like to tout bitcoin when it is rising in value as a sign of success, that appreciation causes a major problem for bitcoin as a medium of exchange because nobody wants to exchange anything that it rapidly rising in value.  They want to hoard it and if they need to exchange something, the try to sell something else that is not appreciating as rapidly instead.

In contrast, a modern fiat money almost never goes up in value, so there is almost no incentive to hold it as a store of value.  The main reason people hold ordinary money is to use as a medium of exchange. Central banks actively engineer a little inflation which steadily reduces the long-run value of money. That inflation gives speculators an incentive to buy other things (like stocks, bonds, money-market shares, gold or bitcoin) as stores of value rather than money. It is the “animal spirits” of speculators that cause most of the price volatility in financial markets and by making money a bad bet for speculators, central banks reduce the volatility of the value of money.  A primary responsibility of all central banks is to minimize the volatility of inflation and maintaining a little inflation helps reduce the volatility of inflation.  Because money is held for use as a medium of exchange, there is little speculation about how much it should be worth and speculators focus their volatility-inducing attention on other assets like bitcoin and gold instead.  The lower the volatility of the value of money, the more useful it is both as a unit of account and a medium of exchange.

Bitcoin is not money because nobody uses bitcoin (nor gold) as a unit of account (for measuring value) and that is the most important function of money.  Bitcoin sucks as a unit of account because the value of bitcoin jumps around much more capriciously than almost anything that is actively traded.  Even fresh pork bellies would be a better unit of account than bitcoin because pork bellies have a more stable value! 

The US dollar has been the best money in the world for many decades because it is the best medium of exchange in the world. For example, oil producers in the Middle East use the dollar as their unit of account for selling to everyone because it is the most convenient unit of account for everyone around the world.  It is also frequently used as a medium of exchange between companies that do not use dollars at home.  For example, Airbus has often sold airplanes in places like Argentina using dollars.  Even though Airbus is a European consortium and neither Airbus nor their customer use dollars at home, it can be more convenient to exchange pesos for dollars and then dollars for airplanes and then exchange the dollars for euros, than to exchange pesos for euros directly and buy with euros.

According to Mark Williams, as of 2014, bitcoin had volatility seven times greater than gold, eight times greater than the S&P 500, and 18 times greater than the U.S. dollar.  Even the Bitcoin Foundation sets its employee’s salaries in dollars rather than in bitcoins.  Because bitcoin (and gold) are bad units of account, they are rarely used as a medium of exchange except by criminals. Cryptocurrency has a major advantage for criminal exchanges because it is much harder for police to trace, but for everyone else, the transactions costs due to high price volatility outweighs any other advantage of bitcoin for use as money.

Whatever currency is used as the unit of account has a big advantage for use as the medium of exchange because the medium of exchange has to be converted into the unit of account which adds extra complexity and cost to any transaction.  That added transactions cost means that bitcoin will always be at a disadvantage for transactions compared with dollars which must be involved in any transaction where dollars are used as the unit of account. 

Bitcoin uses block chain technology and that technology could offer a more efficient way of making payments at some point, but prices will always be quoted in money (a unit of account) such as dollars because dollars have a stable value. And as long as dollars are used as the unit of account, they will also be used as primary medium of exchange too because having a single currency that serves both purposes reduces transactions costs. For this reason bitcoin will never replace money as a medium of exchange either.

Blockchain technology may come to have some advantages for reducing some kinds of transactions costs but then blockchain technologies will then be adopted by the dollar-based banking system to reduce transactions costs.   It would be great to modernize our antiquated money transfer system, but even that lousy system is better than bitcoin and as new technologies for exchange come along, they will still use dollars for payments rather than bitcoins.

The big long-run problem with bitcoin specifically is that it will go obsolete as soon as a newer block-chain technology is produced that works better than bitcoin.  Bitcoin cannot change (or only with extreme difficulty) and all technology platforms that cannot change get replaced by newer technologies sooner rather than later. The probability that bitcoin will be replaced by a better blockchain technology in the near future is the biggest long-run threat to bitcoin.  There are already more than 13,015 digital currencies according to CoinMarketCap, and the oldest technology is rarely the best. Newer technologies will inevitably make bitcoin obsolete eventually, and then the value of bitcoin will collapse like the value of telegraph companies. Or bitcoin could collapse in value overnight when its security is successfully attacked by newer technologies because bitcoin cannot evolve to meet new threats. 

Bitcoin is just an information technology that is competing with other rapidly evolving technologies.  Bitcoin itself is almost impossible to update and so as other technologies continue to progress, at some point bitcoin’s technology will seem like a 1970s mainframe computer in comparison to a vastly superior Iphone 13.  Bitcoin will look so inferior to newer alternatives that its value will collapse a bit like the Confederate dollar or other defunct currencies that went obsolete overnight.  Bitcoin is mainly popular because it was the first blockchain currency, but it is such an old, inefficient technology that it is unlikely that it will always be the best blockchain technology.  It has already been surpassed in transactions by Ethereum e-currency and more competition will continue to come.  Bitcoin was invented in 2009 and so it is going to seem increasingly elderly and decrepit compared to new technologies when it is 20 or 30 years old. 

All stores of value must have some underlying value. Fiat money (like the dollar) is truly useful because it really does minimize transactions costs as a medium of exchange and that produces its underlying value.  If there were something else that was better at facilitating exchange transactions (like bitcoin), we would use it instead of dollars and the dollar would become worthless because it has no other fundamental source of value. Commodity monies like gold and silver can rise and fall in value, but they cannot fall to zero (and did not fall to zero when fiat money replaced them for transactions) because they are inherently useful for other things besides facilitating transactions. They are used for industrial production and for making beautiful things like the shiny gold plating that Donald Trump likes to surround himself with. Fiat money would have no value if it isn’t the best medium of exchange somewhere.

Even a poorly-managed fiat money cannot fall completely to zero value if a government requires that everyone pay taxes using it.  Almost a quarter of US income is paid in taxes each year and that would prevent the value of dollars from falling to zero even if the Fed were incompetent. But the Fed manages the dollar well which makes it the best kind of money for every other transaction in America and for a huge share of international transactions too.

Bitcoin gets much of its fundamental value because cryptocurrency is the best form of money for a peculiar fraction of the World’s transactions.  It is the cheapest and best form of payment for evading taxes, criminal transactions, and funding terrorism.  In 2017, researchers estimated that 46% of bitcoin transactions were for facilitating criminal activities.  Although there are also some ideologues who are willing to use it for legal transactions despite its higher cost, most legal users treat bitcoin as a speculative asset and do not use it for making a lot of transactions.  A notable difference between those who use it for legal purposes versus illegal purposes is that illegal users tend to hold less bitcoin as an asset (a stock) relative to the amount that they use for transactions (flows).

So a big part of the bitcoin economy depends upon how much governments are willing to tolerate the black-markets it sustains.  Because bitcoin’s main advantage as a medium of exchange is for use by terrorists and criminals, governments have an incentive to shut down the companies that exchange bitcoin for real money and that would make bitcoin worthless for criminals who rely upon real money for most of their legal transactions.

Most people are excited about bitcoin based on the theory that it could eventually become a new global money, but it is never going to beat government money as a medium of exchange (for legal transactions), nor as a unit of account as long as governments are functional, but what about if  governments collapse? The best argument for a fundamental function for bitcoin is as a hedge against civilizational collapse. This function is also big part of what gives gold fundamental value.

…one reason gold is valuable is that some people see it as a hedge against the collapse of governments. In medieval and early modern Europe, as well as in many other premodern states, gold was used as money for cross-border payments because governments weren’t stable enough to be able to maintain stable fiat currencies. Even if we never return to that sort of anarchic world, people might want some kind of insurance against the possibility.

Gold’s current total market cap is estimated at a bit over $10.6 trillion. Bitcoin’s market cap, as of this writing, is about a tenth of that. So if Bitcoin were to become as big of a hedge against global disaster as gold is, it would probably be worth a lot more than it is now.

Another fundamental reason for Bitcoin to have long-term value is its usefulness in [illegal activities] or use as a currency in places where the government has broken down, [such as] where hyperinflation makes local fiat currency effectively useless…

In general, all of these uses can be grouped under a single umbrella concept: System failure. The system of governments, banks, financial regulations, etc. etc. that currently runs the world is not infinitely robust. In the places and times and future conditions in which that system fails, peer-to-peer financial solutions like Bitcoin are inherently very valuable. That gives Bitcoin fundamental value.

So bitcoin could be useful if the ordinary banking system collapses, but again, this is a motive for using bitcoin as a store of value because it could become useful as a form of money at some point if our ordinary monetary system collapses.

Ordinarily a fiat money like the US dollar is cheaper to use than bitcoin as a medium of exchange because 1) its value is more stable because it is actively managed by the central bank which makes it a better unit of account; 2) it is required for paying taxes so Americans have to use lots of dollars every year; 3) the fact that everyone uses dollars creates a kind of economy of scale called a network effect which makes dollars more convenient to use simply because all other Americans are already using them; 4) bitcoin is structurally prone to deflation which would contribute to recessions if it were adopted for an entire economy.  That fact alone will prevent any sovereign economy from adopting it.

5) Bitcoin is expensive to store and gets more expensive and environmentally destructive as the bitcoin economy expands.

6) Bitcoin transactions are extremely expensive and slow relative to dollar transactions in the conventional banking system.  This is one of the biggest failures of bitcoin as a money.  As Marketwatch points out, “Credit cards can settle 5,000 transactions per second. One bitcoin transaction takes 10 minutes.”  Visa and Mastercard charge about 3% transaction fee which is a ridiculously large, inefficient monopolistic fee. Hopefully a blockchain technology will someday be able compete with the banks to force down their fees at some point, but so far the credit card duopoly is safe because bitcoin transactions are much more expensive than Mastercard:

to use bitcoin to buy a $4 latte at Starbucks, you might have to either wait several hours for the purchase to go through or pay $5 to speed it up. “One of the biggest challenges for bitcoin has been that the fees are too high for it to be used as a simple transaction account, and it takes too long,” O’Hara said. “The number of bitcoin transactions that can be added in any given time is orders of magnitude smaller than, say, Visa cards.”

Even the “free” work that is done to process bitcoin transactions have high real costs.  Those costs are actually paid by bitcoin “miners” who do the calculations that process transactions for which the system “prints” them new bitcoins.  In the process they consume an incredible amount of electricity.  It is tremendously expensive and wasteful.


Bitcoin mining alone uses more electricity than 159 different countries and in order to make it worthwhile for miners to continue processing transactions, bitcoin will have to deflate in value because there is a finite amount of bitcoin that can be “mined” and as we approach that hard limit, the costs of mining (processing transactions) continues to rise, plus there are limits to how many blockchain transactions can be processed per minute.  Perhaps that is why we reached peak Bitcoin transactions way back in 2017:

Meanwhile, the rising expense of processing transactions won’t be worthwhile unless the value of bitcoin continually rises.  That may sound good, but a rising value of a currency is called deflation and deflation is extremely harmful for an economy when it is caused by a money supply that does not expand as fast as the number of transactions that people want to make.  Because the costs of processing Bitcoin transactions must rise over time, it will continue to get even worse as a medium of exchange.  Inflation is much healthier for macroeconomic stability than the same amount of deflation because deflation turns money into a store of value which causes hoarding rather than the transactions that make the economy go round.

Bitcoin’s technology has some advantages, but the dollar is better for almost all legal transactions. Plus, if the technological advances of blockchain were truly important, some part of the dollar banking system would easily copy them.  The only real advantage of bitcoin seems to be facilitating criminal transactions and it isn’t even ideal for that use because although it does provide a degree of confidentiality, it is anything but anonymous because every transaction made from every account is public information for everyone.  Other technologies provide both confidentiality and anonymity, including good old-fashioned cash.

So far bitcoin speculators have been hoping that bitcoin’s technological advantages will eventually prove to be so much better than the dollar as a medium of exchange that everyone will someday want bitcoins for conducting all their daily business (except paying taxes presumably). But it is more likely is that the dollar system will eventually adopt some of bitcoin’s technologies and wipe out what little advantages bitcoin currently has for exchanges.  Plus, because bitcoin’s main advantage for exchange has been its ability to fund illegal activities, it will probably eventually be used to fund a major terrorist act and that will motivate large governments to clamp down on the exchanges that connect the bitcoin network to the global financial network.  That would be the sudden end of bitcoin except as a historical curiosity like the great tulip bubble of 1637.

I hope that doesn’t happen because bitcoin is that it provides a backstop alternative for the fiat monies of the world.  A fiat money is always in peril of being managed badly and that has dire consequences for the people who depend upon it such as in the Zimbabwe hyperinflation.  But if a fiat money ever becomes a worse option than bitcoin, then people could switch and bitcoin might be used as a backstop in that case.  Bitcoin may be inefficient, but it would be better to have a really inefficient form of money than no money.

But I’d rather have gold, because if the US government collapses, then our communications and electric grid will also probably collapse and that would make bitcoin useless.  So bitcoin provides some insurance for the world’s monetary system, but it isn’t a very secure insurance.  For example, in Zimbabwe’s economic collapse most people have been using the fiat currencies of other nations, most commonly, the US dollar, rather than bitcoin. There is simply no major economy where bitcoin has replaced fiat currencies as the main medium of exchange except in some parts of the criminal underworld and they still rely upon real money to serve as the unit of account.

Bitcoin is a fascinating new kind of store-of-value, a lot like baseball cards and other collectables and it is also occasionally used as a medium of exchange, but it isn’t money.

Posted in Macro
3 comments on “Bitcoin is not money. Therefore it cannot replace the dollar which IS money.
  1. Sylvain says:

    A few notes here:

    Bitcoin is not anonymous, it is “pseudonymous”, we don’t know who hides behind each “pseudonym”, but a little research can help figure it out, and once you find the person behind 1 pseudonym, since all transactions made in bitcoin are stored publicly on the block chain, you can trace all the transactions of that person and from there make an investigation to figure out other identities. Therefore, it is a terrible idea for criminals to use bitcoin. For example if the FBI catches a drug dealer and that drug dealer uses bitcoin, they can obtain his pseudonym and then trace all the transactions he ever made, potentially figuring out who his clients and providers are. Cash is a much better money for criminals. And a few other cryptocurrencies provide better anonmity, but not bitcoin.
    “you can’t store your money and exchange it too” : why not? Why couldn’t a money be both a medium of exchange and a store of value? I would even argue that this is what many many people do around the world. And they end up being more or less screwed because fiat money is indeed a poor store of value.
    Why would it be preferable to have assets with a primary use (housing, gold, stocks, etc) be used as a store of value, rather than a purely speculative asset such as bitcoin? I don’t think so many people would mind if the price of a house was based on the supply and demand for housing, instead of the supply of housing and the demand for housing + store of value. Same with any other asset that has a primary use. These assets end up being used as a store of value, simply because people do not have a better practical alternative (their money is being inflated away).

    What bitcoin offered, when it started in 2009, was a medium of exchange. What it is now in 2017 is actually a poor medium of exchange, because contrary to what is claimed in that article, the transaction costs of bitcoin are quite expensive today, and transactions can take too much time to be confirmed if you don’t pay a more or less expensive transaction fee. That means bitcoin (BTC) today can not be used to buy a cup of coffee, as the price would end up being more than twice what you would pay using fiat currency (some other cryptocurrencies are better for that use).

    What bitcoin is today is a store of value, and a very appreciating one at the moment.
    We know its supply is fixed: more bitcoins can not be produced at whim (like with fiat currencies), and a higher value does not imply more production (like with metals, housing, etc).
    What we don’t know, is its demand. What is the demand for a pure store of value that is easily storable, easily transferable, secure, and that can not be inflated away nor centrally controlled? There is quite a strong case to be made that such a demand could be rather high… and if you look at the evolution of the price of 1 BTC from 2009 to 2017, it seems the belief in using bitcoin as a store of value is growing, and at quite a fast pace. You’re right that the price floor is 0 as there isn’t really any other use to bitcoin than as a store of value, but that is still quite a huge use case, and the ceiling for that use case is rather high.

    • You’re right that pseudonymous is a better term. Good point, thanks.
      “you can’t store your money and exchange it too” for the same reason that you can’t have your cake and eat it too. Either you exchange it away or you keep it. You can’t do both at the same time.
      If you prefer to use purely speculative assets as a store of value, then more power to you, but it is risky because of bubbles, and whereas the fundamental value of something like stocks or gold can steadily go up over centuries, there is no fundamental value of a purely speculative asset, so there isn’t any rational floor upon which the value can rest.
      Thanks for the good point about the transactions costs of bitcoin. I only recently learned that they have gotten so enormous and made a more recent post referring to that. That is just another reason why the bitcoin bubble is doomed. I’d give it less than a year. I still don’t get what the case is for the “huge use” value of bitcoin obviously, but that is just the opposite of my point of view, so I guess I wouldn’t. But thanks for the excellent rejoinder with good corrections and points.

  2. […] of account is the most essential function of money followed by usefulness as a medium of exchange. Bitcoin is not money because it is never used as a unit of account and it is rarely used as a medium of exchange except […]

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